NEW YORK–(BUSINESS WIRE)–
Link to Fitch Ratings’ Report: Structured Agency Credit Risk Debt Notes, Series 2014-DN2 (US RMBS)
Fitch Ratings expects to assign the following ratings and Rating Outlooks to Freddie Mac’s fourth risk transfer transaction: Structured Agency Credit Risk debt notes series 2014-DN2 (STACR 2014-DN2):
–$230,000,000 class M-1 notes ‘Asf’; Outlook Stable;
–$230,000,000 class M-1F exchangeable notes ‘Asf’; Outlook Stable;
–$230,000,000 class M-1I notional exchangeable notes ‘Asf’; Outlook Stable;
–$345,000,000 class M-2 notes ‘BBB-sf’; Outlook Stable;
–$345,000,000 class M-2F exchangeable notes ‘BBB-sf’; Outlook Stable;
–$345,000,000 class M-2I notional exchangeable notes ‘BBB-sf’; Outlook Stable;
–$575,000,000 class M-12 exchangeable notes ‘BBB-sf’; Outlook Stable.
The $26,880,367,090 class A-H reference tranche, $51,469,812 class M-1H reference tranche, $77,204,718 class M-2H reference tranche, $391,000,000 class M-3 notes, $391,000,000 exchangeable class M-3F note, $391,000,000 exchangeable class M-3I note, $87,498,681 class M-3H reference tranche, $966,000,000,000 exchangeable class MA note and $84,440,945 class B-H reference tranche will not be rated by Fitch.
The ‘Asf’ rating for the M-1 notes reflects the 3.50% subordination provided by the 1.50% class M-2 notes, the 1.70% class M-3 notes and the non-offered 0.30% B-H reference tranche. The ‘BBB-sf’ rating for the M-2 notes reflects the 2.00% subordination provided by the 1.70% class M-3 notes and the non-offered 0.30% B-H reference tranche. The notes are general unsecured obligations of Freddie Mac (rated ‘AAA’/Outlook Stable by Fitch) subject to the credit and principal payment risk of a pool of certain residential mortgage loans held in various Freddie Mac-guaranteed MBS.
STACR 2014-DN2 is Freddie Mac’s fourth risk transfer transaction issued as part of the Federal Housing Finance Agency’s Conservatorship Scorecard for 2013 for each of the government sponsored enterprises (GSEs) to demonstrate the viability of multiple types of risk transfer transactions involving single family mortgages with at least $30 billion of unpaid principal balance in 2013.
The objective of the transaction is to transfer credit risk from Freddie Mac to private investors with respect to a $28.1 billion pool of mortgage loans currently held in previously issued MBS guaranteed by Freddie Mac where principal repayment of the notes are subject to the performance of a reference pool of mortgage loans. As loans become 180 day delinquent or other credit events occur, the outstanding principal balance of the debt notes will be reduced by a pre-defined, tiered loss severity percentage related to those credit events.
While the transaction structure simulates the behavior and credit risk of traditional RMBS mezzanine and subordinate securities, Freddie Mac will be responsible for making monthly payments of interest and principal to investors. Because of the counterparty dependence on Freddie Mac, Fitch’s expected rating on the M-1, M-1F, M-1I, M-2, M-2F, M-2I and M-12 notes will be based on the lower of: the quality of the mortgage loan reference pool and credit enhancement available through subordination; and Freddie Mac’s Issuer Default Rating. The M-1 and M-2 notes will be issued as uncapped LIBOR-based floaters and will carry a 10-year legal final maturity.
KEY RATING DRIVERS
Prime Quality Mortgage Reference Pool: The reference mortgage loan pool consists of 116,677 prime quality mortgages totaling $28.15 billion acquired by Freddie Mac in 3Q 2013. Weighted average combined-loan-to-value, debt-to-income and credit scores are 76.4%, 33.2% and 760, respectively. All loans were underwritten with full documentation. The reference pool also benefits from significant geographic diversity with the largest metropolitan statistical area (MSA) accounting for 7.5%.
Market Value Decline Sensitivity: Fitch considered additional market value decline (MVD) sensitivities in addition to those generated by its sustainable home price model. These scenarios aligned Fitch’s ‘Asf’ sustainable MVD assumptions with peak-to-trough market value declines experienced during the housing crisis through 2009. The sensitivity analysis, which was factored into Fitch’s loss expectations, resulted in applying a sMVD of 12% from 14%.
Solid Lender Review and Acquisition Processes: Based on its review of Freddie Mac’s aggregator platform, Fitch believes that Freddie Mac has a well-established and disciplined credit-granting process in place and views its lender approval and oversight processes for minimizing counterparty risk and ensuring sound loan quality acquisitions as positive. Loan quality control (QC) review processes are thorough and indicate a tight control environment as is most evidenced by the very few findings noted by the third-party due diligence results. Tight controls lower operational risk and improve overall loan quality. The lower risk was accounted for by Fitch by applying a lower default estimate for the reference pool.
Few Findings in Third-Party Diligence: While only 1,000 loans in the reference pool were selected for review by a third-party diligence provider, the results indicated limited findings or were deemed as nonmaterial by Fitch. The overall results are reflective of Freddie Mac’s tight control over the documentation and loan delivery process.
Eminent Domain Risk Mitigated: The STACR series 2014-DN2 transaction includes a provision that protects investors against eminent domain risk. Loans will be removed from the reference pool if they are seized pursuant to any special eminent domain proceeding brought by any federal, state or local government.
Fixed Loss Severity: The transaction’s fixed loss severity schedule tied to cumulative net credit events is a positive feature as it reduces uncertainty that may be driven by future changes in Freddie Mac’s loss mitigation or loan modification policies and offers investors greater protection against natural disaster events where properties are severely damaged and there is limited or no recourse to insurance. If the actual loan loss severity is above the set schedule, Freddie Mac absorbs the higher losses.
Advantageous Payment Priority: The payment priority of the M-1 class will result in a shorter life and more stable credit enhancement than mezzanine classes in PL RMBS, providing a relative credit advantage. Unlike PL mezzanine RMBS, which often do not receive a full pro rata share of the pool’s unscheduled principal payment until year 10, the M-1 class can receive a full pro rata share of unscheduled principal immediately as long as a minimum credit enhancement level is maintained and the net cumulative credit event is within a certain threshold. Additionally, unlike PL mezzanine classes, which lose subordination over time due to scheduled principal payments to more junior classes, the M-2, M-3 and B-H classes will not receive any scheduled or unscheduled allocations until the M-1 is paid in full. The B-H class will not receive any scheduled or unscheduled principal allocations until the M-3 is paid in full.
10-Year Hard Maturity: The M-1, M-2 and M-3 notes benefit from a 10-year legal final maturity. As a result, any collateral losses on the reference pool that occur beyond year 10 are borne by Freddie Mac and do not affect the transaction. Fitch accounted for the 10-year hard maturity window in its default analysis and applied a 10% reduction to its lifetime default expectations.
Rep and Warranty Sunsets: All of the loans were acquired by Freddie Mac in 3Q 2013, which qualify for the new representation and warranty framework adopted by Freddie Mac through its regulator, Federal Housing Finance Agency (FHFA), for conventional loans sold or delivered after Jan. 1, 2013. Under the new framework, lenders will be provided repurchase relief from underwriting breaches for loans that have made 36 consecutive on-time payments or those with no more than two 30-day delinquencies and no 60-day or greater delinquencies that were current on the 60th month. In conjunction with this change, Freddie Mac enhanced its performing loan quality control process and instituted incentives for lenders to maintain high quality loan standards.
Seller Insolvency Risk Present: While the loan defect risk for 2014-DN2 is notably lower than for agency and non-agency mortgage pools securitized prior to 2009, Fitch believes the risk is greater for this transaction than for recently issued U.S. PL RMBS. Notably, Freddie Mac does not conduct reviews of loans from a seller once it has filed for bankruptcy. Fitch incorporated this risk into its analysis by treating all historical repurchases as if they were defaulted loans that were not repurchased. Consequently, the rating analysis includes an assumption that the loans will experience defect rates consistent with historical rates and that those defects will not be repurchased.
Solid Alignment of Interests: While the transaction is designed to transfer credit risk to private investors, Fitch believes the transaction benefits from solid alignment of interests. Freddie Mac will be retaining credit risk in the transaction by holding the senior reference tranche A-H, which has 4.5% of loss protection, as well as the first-loss B-H reference tranche, sized at 30bps. Freddie Mac is also retaining an 18% vertical slice/interest in the M-1, M-2 and M-3 tranches.
Special Hazard Leakage: Fitch believes the structure is vulnerable to special hazard risk as there is no consideration for payment disruptions related to natural disaster events in the credit event definition. As such, credit protection in the transaction may be eroded by natural disasters that may cause extended delinquencies (that may in part be allowed by disaster relief programs) but where borrowers ultimately cure. Fitch considered this risk in its analysis, conducted sensitivity analysis and found, based on prior observed performance in post-natural disaster events including Hurricane Katrina and the Northridge earthquake, the risk exposure is relatively low.
Receivership Risk Considered: Under the Federal Housing Finance Regulatory Reform Act, the FHFA must place Freddie Mac into receivership if it determines that Freddie Mac’s assets are less than its obligations for longer than 60 days following the deadline of its SEC filing, as well as for other reasons. As receiver, FHFA could repudiate any contract entered into by Freddie Mac if it is determined that it would promote an orderly administration of Freddie Mac’s affairs. Fitch believes that the U.S. government will continue to support Freddie Mac, as reflected in its current rating of Freddie Mac. However, if at some point Fitch views the support as being reduced and receivership likely, the rating of Freddie Mac could be downgraded and the ratings on the M-1 and M-2 notes, along with their corresponding MAC notes, could be affected.
Fitch’s analysis incorporates sensitivity analyses to demonstrate how the ratings would react to steeper market value declines (MVDs) than assumed at both the metropolitan statistical area (MSA) and national levels. The implied rating sensitivities are only an indication of some of the potential outcomes and do not consider other risk factors that the transaction may become exposed to or be considered in the surveillance of the transaction.
This defined stress sensitivity analysis demonstrates how the ratings would react to steeper market value declines at the national level. The analysis assumes market value declines of 10%, 20%, and 30%, in addition to the model projected 34.1% at the ‘Asf’ level and 28.2% at the ‘BBB-sf’ level. The analysis indicates that there is some potential rating migration with higher MVDs, compared with the model projection.
Fitch also conducted defined rating sensitivities which determine the stresses to MVDs that would reduce a rating by one full category, to non-investment grade, and to ‘CCCsf’. For example, additional MVDs of 7%, 16% and 34% would potentially reduce the ‘Asf’ rated class down one rating category, to non-investment grade, and to ‘CCCsf’, respectively.
Key Rating Drivers and Rating Sensitivities are further detailed in Fitch’s accompanying presale report, available at www.fitchratings.com or by clicking on the above link.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research
–‘U.S. RMBS Mortgage Loan Loss Model Criteria’ (August 2013);
–‘U.S. RMBS Originator Review and Third-Party Due Diligence Criteria’ (April 2013);
–‘U.S. RMBS Cash Flow Analysis Criteria’ (April 2013);
–‘U.S. RMBS Representations and Warranties Criteria’ (June 2013);
–‘U.S. RMBS Rating Criteria’ (July 2013);
–‘Global Structured Finance Rating Criteria’ (May 2013)
–‘Global Rating Criteria for Single- and Multi-Name Credit-Linked Notes’ (February 2013);
–Structured Agency Credit Risk Debt Notes, Series 2014-DN2 Representations and Warranties Presale Appendix’ (March 2013).
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