It’s no coincidence that the first private label residential mortgage bonds to be sold this year were backed by loans that were once delinquent.

Cerberus Capital Management gets the bragging rights for more than being fastest out of the gate; the $395.75 million Towd Point Mortgage Trust 2015-1 was also the first securitization of reperforming loans to obtain two investment grade ratings, even if it came at the cost of credit enhancement of nearly 50%.

The deal is another sign of growing demand from investors for assets that are anything but pristine as yields on safer investments remain stubbornly low.

While the bulk of this year’s private label RMBS are likely to be backed by prime jumbo loans, like the second and third deals of the year, from Two Harbors and Redwood Trust, that’s not necessarily what investors are clamoring for.

The pool of borrowers who fell behind on payments following the financial crisis is unquestionably vast, and the housing market recovery is well enough established that many who received modifications have been current for long periods of time, an important consideration for rating agencies.

“There’s a fair amount of collateral out there, and reperforming transactions have been getting done on an unrated basis for a couple of years,” said Rui Pereira, a managing director at Fitch Ratings. “My expectation is that we’ll likely see more of these [rated] transactions in 2015.”

“A rating potentially helps in terms of lowering financing costs and tapping into a broader investor base,” Pereira said.

Fitch assigned an ‘AAA’ to the senior, $209 million tranche of Towd 

Point. It also rated a $644 million deal completed by Credit Suisse in December, though the senior tranches of that deal only earned a ‘BB,’ two notches below investment grade. The subordination was set at 48.95%.

No Set Template for Deals

There are some stark differences between the collateral and the structure backing Towd Point and RPMLT 2014-1 Trust, which illustrates that that there is no set template for such transactions.

Certain special purpose entities owned by affiliates of Cerberus Capital Management obtained the loans in the pool backing Towd Point through seven purchases in the secondary market in 2014, according to the presale report. Approximately 88% of these loans have received one or more modifications since they were originated, and 83.7% of the pool has made consecutive on-time payments under the original or modified note terms for the past 24 months or more.

Roughly 68.8% of the loans are fully amortizing, while 31.2% are still in their interest-only periods.
By comparison, approximately 5.6% of the loans backing Credit Suisse’s deal, RPMLT 2014-1 Trust, are still behind on payments, and roughly one-fifth, or 21% have experienced a delinquency in the past 24 months.
Seasoning matters. “Our default expectations can vary significantly based on a loan’s pay history and seasoning,” Pereira said.

Current payment status is not the only factor that rating agencies take into consideration, however. Borrowers who have fallen behind on payments once are considered to be at a higher risk of defaulting than those who have never been delinquent. Therefore, Fitch gives greater consideration to a servicer’s ability to foreclose and liquidate the property.

Fitch characterized the representation and warranties framework for Towd Point as being ‘Tier 2’ because of the inclusion of knowledge qualifiers and the exclusion of certain loans from some reps as a result of third-party due diligence findings. The rating agency’s scale ranges from Tier 1 to Tier 5.

Fitch’s presale report on RPMLT 2014-1 Trust, meanwhile, describes the deal’s rep and warranties framework as “very weak.” Of the roughly 34 reps Fitch typically expects to see in an investment grade transaction, only 13 are included, and there is no automatic review of delinquent loans.

Weak rep and warranties are not the only thing that kept Fitch from assigning an investment grade credit rating to the Credit Suisse deal, however. In its ratings report on RPMLT 2014-1 Trust, Fitch said that it has not rated, or even reviewed, the deal’s servicer, Rushmore Loan Management Services, and that there is no master servicer on the transaction. Otherwise, the rating agency said, it might have assigned a low investment grade rating to the deal.

Servicing of the loans backing Towd Point will be performed by Select Portfolio Servicing, rated ‘RSS1’ by Fitch. Select Portfolio Services is a subsidiary of Credit Suisse. The deal does not have a master servicer.
In addition to the senior tranche, Fitch assigned ratings ranging from ‘AA’ to ‘B’ to five subordinated tranches.

Moody’s Investors Service also assigned an ‘Aaa’ to the senior tranche of Towd Point; it did not rate the rest of the deal. In its presale report, the rating agency said that the loans underlying the transaction “exhibit collateral characteristics similar to weak Alt-A loans originated before 2010.”

Moody’s takes comfort in the fact that there is an asset manager for the deal, FirstKey Mortgage LLC, that will oversee the servicer. “An asset manager can provide oversight that typical private label mortgage backed securities do not have,” the presale report states.

The only other private-label residential mortgage securitization to seek a credit rating was sponsored by Bayview Asset Management, which is partly owned by the Blackstone Group. The deal was quietly shelved early last year following a public spat between Fitch and Standard & Poor’s over the value of the houses underlying the deal.

Indeed, Kevin Dwyer, an RMBS analyst at Morningstar, says that “the biggest hurdle is getting through data that the originator has, because mortgages have been sold and servicing has been transferred a few times.
“You have to get some updated info such as FICO, an updated valuation on property that is not a full appraisal, you have to be comfortable with BPO [broker price opinion] or some other methodology.

Obtaining updated appraisals on reperforming mortgages is not the norm. It’s both expensive and impractical, since borrowers have no obligation to provide the necessary access to a property just because a loan has changed hands.

Rating deals under these circumstances is “not necessarily a plug and play,” Dwyer said. “It’s more work, but you can get it done.”

Vast Quantity of Potential Collateral

Fitch Ratings believes that reperforming market could be as large as $250 billion to $350 billion. That’s based on an estimate of between 1.5 million and 2.5 million of loans with an average balance of $150,000 siting in the delinquent portfolios of both banks and nonbank or on modification plans.

Bank of America is calling for some $15 billion of nonperforming and reperforming securitizations this year, regardless of whether they obtain a credit rating. Analysts see the risk on the upside; the bank underestimated 2014 volume, which reached $26 billion.

While those may not seem like a big numbers, there were only $7.0 billion or so of rated private-label deals printed last year, according to data published by Morgan Stanley in December.

Reperforming loans aren’t the only kinds of collateral on many investors’ wish lists. There’s strong interest in loans that don’t meet the standards for Qualified Mortgages (QM) under the new Ability-to-Repay Rule.

No firm has securitized a pool consisting exclusively of non-Qualified Mortgages (non-QM) because originations have been slow. Lenders aren’t sure if they can make a product that is high-yielding enough so that it attracts investors, but cheap enough so that borrowers will take it. Most of these costs are due to legal risks that could stem from mistakes in underwriting.

Even Subprime is Securitizable

Redwood was the first to dip its toe in the water; it has completed two transactions that included a tiny percentage of non-QM loans. The real estate investment trust’s inaugural 2015 deal had just four, or 0.8% of the pool, fall outside of QM guidelines and are therefore at greater risk of litigation-related losses. But they are just barely outside the guidelines. One has a debt-to-income ratio in excess of 43% and the other three have “minor” exceptions to documentation requirements, according to rating agency presale reports.
“I don’t think a smattering of non-QM is what people want,” said Brian Grow, a managing director at Morningstar. “They really want to move down the credit scale.”

Appetite for yield is such that some large asset managers are committing to purchase non-QM loans in advance. One of the most notable examples is RPM Mortgage, which said in November that it has a contract to sell $2.5 billion of such loans.

“There’s a lot of capital ready to put to work for these loans, it’s just getting people to originate it,” Grow said.

While Morningstar has yet to see any securitizations backed by large quantities of such loans, “We’re seeing hypothetical loan tapes,” Grow said.

“I wouldn’t rule out what we used to call subprime,” he said. “It’s securitizable, there is a market there to be underwritten, though a lot more conservatively, and with a lot more data from borrowers.”

To be sure, non-QM covers a lot of ground, including subprime. But some that fall short of QM standards could be relatively safe, according to Ron D’Vari chief executive officer and cofounder of NewOak, a financial advisory firm sepcializing in mortgage risk analytics.

In commentary published by the firm on its website late last year, D’Vari argues that high-net-worth borrowers who have significant equity in their homes are a safer bets than borrowers with lower net worth and little home equity. Yet current regulatory standards emphasize the traditional sources of income from regular employment more.

“It’s an irony that the government is promoting loans with 97% LTV,” D’Vari said in a telephone interview. “I’d rather have a loan with a DTI of 50 and an LTV of 70 than one with a DTI of 43 and an LTV of 97. I’ll take that loan all day. Non-QM could be a better bet because you control your variables.”

He adds, “there’s nothing magical about securitizing non-QM. The reason you don’t see much of it is a bit of an intermediation issue. The loans need to be warehoused. The source of capital is slowly coming in, but it may not be the banks.”

Strong Case for Non-QM

New Oak’s itself may be one of those sources of capital. It’s asset management unit has quietly launched a private fund to buy a non-QM loans. The fund, named Super Jumbo Mortgage Acceptance Corp., will specialize in buying newly originated, nonqualified residential mortgages with slightly weaker credit than a traditional prime jumbo loan, according to a person with direct knowledge of the matter.

SJMAC, which the person described as a hedge fund, launched with a “significant amount of capital” to purchase non-QM loans, but it is also seeking a leverage provider, possibly a bank or insurance company, according to the person.

Ray Jahaly, a managing partner at the New York firm, is a chief contact person for SJMAC, the person also said. Jahaly did not respond to multiple messages requesting comment. According to Finra records, Jahaly first registered with NewOak in 2012, and has previously worked on capital markets teams at BrookView Capital, Credit Suisse and Lehman Brothers.

“It is our policy not to make any comments about the private funds managed by NewOak Asset Management,” D’Vari told ASR sister publication American Banker when reached by email.
A different NewOak subsidiary, which provides advisory and credit services, is encouraging lenders to originate more nonqualified residential mortgages.

Current clients consist of smaller banks and independent mortgage bankers that are serving borrowers with strong credit, but nontraditional income sources, to make loans ranging from $1 million to $3 million, some of which have debt-to-income ratios touching 49%, according to the person.

NewOak’s credit services unit is also selling a “Mortgage Defense Package,” with services intended to “help mortgage originators and investors address increased regulatory and enforceability risks,” according to a press release.

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