WE’RE HEARING there’s no easy way to get a high rating on an REO-to-rental securitization. But a strong sponsor helps.
The problem is that the bankruptcy risks mount when you try to securitize equity, according to a recent Moody’s report. And there hasn’t been a feasible alternative.
When I asked Moody’s vice president-senior credit officer/manager Kruti Muni if there have been other structures proposed given the equity structure’s risks, she told me Moody’s has “mostly seen” the equity proposal because there is “an additional cost in the structure for mortgages.”
That cost is so high that it raises the question as to whether securitizing REO-to-rental through a mortgage structure “makes economic sense,” she said. Specifically, “it’s costly for the sponsors,” Moody’s vice president and senior credit officer Yehudah Forster added.
In an equity REO-to-rental deal, there are sponsor-related costs, too. At least if the sponsor has a relatively low rating. Forster said in this circumstance it’s “highly unlikely” the deal will get a rating above Baa, and you’re probably going to need some third-party oversight of the sponsor to get that.
This is because the sponsor plays a key role when it comes to the risk that “investors, under certain bankruptcy scenarios, could lose their senior rights to the properties,” Forster explained.
“If the sponsor sells off the properties/conducts unauthorized sales of the properties, investors could lose out,” he said. “If there are other liens on the properties, they could trump investors’ claims to the properties.”
Forster stressed that the risk is not one that crops up in every bankruptcy scenario. In fact it’s an “extremely unlikely” one in which not only would the sponsor have to go bankrupt, but a court would have to come to the conclusion that the sponsor and the issuer “had disregarded their interdependence” to the point where it “would be fair to consolidate them as one single company.”
This is a power that courts have “rarely used, but given the increased incentives [compared to a mortgage structure], creditors may be more likely to expend considerable resources to get at the assets,” Forster told me.
“In this structure, there’s no mortgage on the properties. So if the sponsor were to go bankrupt—and creditors of the sponsors were to successfully argue to consolidate the assets of the issuer with the sponsor—then the assets would be shared by all of the creditors of the sponsor group and not just the securitization investors. That could lead to a large loss [for the securitization investors],” he said.
That being said, while Baa is probably the highest rating you could get with a weak sponsor, a stronger sponsor and other strong credit characteristics could make a difference. In the latter case, the risk is surmountable and a higher rating may be achieved.
The upshot: Unless you’re happy with a Baa or lower, an REO-to-rental securitization needs a strong sponsor. At least until someone figures out an economically viable way to structure them as mortgage securitizations.
Bonnie Sinnock is managing editor of National Mortgage News and editor of Origination News. She has been covering the mortgage industry since 1995.