Western Asset’s high-quality private label presents forbearance risk

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On the heels of its first CLO transaction this year, Western Asset Management is back in the market with a $355.72 million private-label RMBS offering in which a tenth of the borrowers have been granted forbearance in light of the ongoing coronavirus pandemic.

Arroyo Mortgage Trust 2020-1 is Western Asset’s fifth private-label RMBS deal, and it is split into seven portions, topped by a $298.45 million AAA-rated piece, with the remainder split into tranches notching down to single-B and a $4.09 million unrated piece.

S&P Global Ratings noted in a June 23 pre-sale report the collateral pool is stronger than most it has rated.

“Relative to other nonprime borrowers, those underlying this transaction had higher FICO scores and made larger down payments on their homes,” S&P says. “Many loans were originated by depository banking institutions to borrowers for which there was an ongoing banking relationship.”

Nothing is perfect, however. As of June 17, S&P notes, borrowers were granted forbearance by the servicer for generally up to three months as a result of the COVID-19 pandemic on 61 mortgages, or 10.1% of the pool. The rating agency says it anticipates temporary forbearance of loans in the securitization pool to continue “at some level,” and it has applied a 1.15 times pool-loss-level adjustment factor for the different rating levels to account for the portion already on active forbearance.

S&P derived the 1.15 times factor by considering aspects such as the seasoning of the loans and forbearance plans, payment pattern prior to entering forbearance, and its general expectations of additional forbearance. The rating agency says it views the credit quality of mortgages on forbearance plans to be weaker than a current loan but potentially stronger than a 20-day delinquent loan exhibiting payment issues in a normal macroeconomic environment.

The higher the percentage of loans under forbearance, the greater the risk to investors from a credit standpoint. S&P says it will monitor credit behavior related to temporary forbearance and may adjust its loss coverage levels and ratings accordingly.

For example, if it increased its adjustment factor to 1.4 times, similar to the factor it uses for 60-day delinquent loans, then the rating could drop by a couple of notches.

Pricing on the deal was unavailable but likely will be significantly higher than the 115 basis points on the AAA portion of its previous RMBS deal completed last summer. Western Asset recently completed a CLO in which pricing on all the tranches jumped by more than 50% and sometimes more than 100% from its earlier CLO.

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