Six years after the financial crisis, the recovery in issuance of non-agency residential mortgage backed securities remains anemic and disappointing.
There have been approximately 50 prime transactions issued since the market re-started in 2010. Most of that volume placed over the past 24 months. The market’s recovery continues to face serious headwinds including the ongoing dominance by Fannie Mae and Freddie Mac, strong portfolio demand for high quality mortgage assets, and challenging securitization incentives. The result is a sector that continues to decline as new issue supply fails to keep pace with amortization of legacy transactions.
However, not all is negative on the issuance front. A growing source of supply in 2014 has come from GSE risk transfer programs. Both Fannie Mae and Freddie Mac have issued multiple transactions in 2014 and all indications suggest they will continue to be active for the remainder of the year.
According to the Federal Housing Finance Agency’s 2014 Scorecard for Fannie Mae and Freddie Mac, each enterprise is expected to execute credit risk transfers on residential mortgages of at least $90 billion of unpaid principal balances. This represents a three-fold increase from last year’s scorecard. In addition, the GSE’s are encouraged to explore other transactions types, which can include a senior/sub structure or other alternatives. As such, Fitch Ratings expects both Fannie Mae and Freddie Mac to be an active source of supply of mortgage credit securities in 2014.
The structure and collateral profiles of GSE risk transfer transactions are also likely to expand going forward. For example, the recent Freddie Mac transactions offered investors three classes of securities, including two rated mezzanine securities. As part of its last transaction, Fannie Mae included a high loan to value (HLTV) reference pool. Fitch expects new transactions to include these features and possible introduce further innovation.
Given the low interest rate environment and investor yield demand, the market is also seeing very strong demand for non-traditional mortgage transactions, including non-performing loans, re-performing loans, and single family rental securitizations. A noteworthy example is the emergence of the SFR market, a brand new sector with very limited history. A number of concerns are currently preventing Fitch from assigning AAA’ ratings to these transactions, though Fitch continues to actively track the evolution of the market.
While volume has been disappointing, a bright spot for the market has been stellar performance of post-transactions. New issue RMBS are backed by high quality collateral and are recording incredibly clean performance. Of the 20,000 loans securitized since 2010, only one loan is currently more than 60 days delinquent.
In fact, prime jumbo vintages securitized over the last four years are exhibiting even stronger attributes than those securitized prior to 2005, long considered an industry benchmark for traditional prime lending. For instance, post-crisis RMBS contain higher FICO scores (771), lower combined loan-to-value ratios (68% versus 70%) and more loans that are fully documented (100% versus 64%) than deals that came to market prior to 2005.
Heading into the second half of this year, Fitch expects collateral to remain high-quality. If anything, there may be some modest credit drift as more purchase loans surface. Only a handful of non-QM loans have been securitized to date, though Fitch expects to see more non-QM loans in the second half. Initial expectations are for non-QM loans included in securitizations to be very high quality. However, the non-QM credit box will expand over time.
The handful of GSE risk sharing deals securitized thus far are also performing well. Even compared with strong-performing vintages (like benchmark 2005) the reference pools have significantly higher FICO scores (764 versus 716). Of the mortgage loans included in the transactions issued to date, only 23 basis points are currently delinquent. Low prepayment rates to date also reflect the increase in mortgage rates since origination for most of the mortgage loans in the reference pools.
Given the structural challenges still facing the market, Fitch maintains its forecast of a slow recovery on the issuance front. The slow start to the year will make it difficult to meet last year’s issuance volume. That said, the collateral remains high quality. Additionally, some new issuers will test the private label market, while non-QM loans will begin making their way into securitizations. Given their success to date, GSE risk transfer transactions will continue to be an active source of supply in the second half of the year.
Lastly, given current rates and investor yield demands, non-traditional mortgage securitizations will remain active.
Rui Pereira is head of U.S. RMBS research at Fitch Ratings