Fitch Expects to Rate J. P. Morgan Mortgage Trust 2016-2; Presale Issued
--$96,570,700 class A-1 exchangeable certificates 'AAAsf'; Outlook Stable;
--$20,101,000 class A-M exchangeable certificates 'AAAsf'; Outlook Stable;
--$78,947,400 class 1-A-1A certificates 'AAAsf'; Outlook Stable;
--$45,403,600 class 1-A-1B certificates 'AAAsf'; Outlook Stable;
--$9,451,000 class 1-A-2 certificates 'AAAsf'; Outlook Stable;
--$140,136,000 class 2-A-1 exchangeable certificates 'AAAsf'; Outlook Stable;
--$10,650,000 class 2-A-2 exchangeable certificates 'AAAsf'; Outlook Stable;
--$6,045,000 class B-1 certificates 'AAsf'; Outlook Stable;
--$4,232,000 class B-2 certificates 'Asf'; Outlook Stable;
--$2,569,000 class B-3 certificates 'BBBsf'; Outlook Stable;
--$1,512,000 class B-4 certificates 'BBsf'; Outlook Stable.
Fitch will not be rating the following certificates:
--$3,325,053 class B-5 certificates;
--$15,113,753 class RR exchangeable certificates.
KEY RATING DRIVERS
High-Quality Mortgage Pool (Positive): The collateral pool consists of very high-quality prime loans to borrowers with strong credit profiles, low leverage and large liquid reserves. 100% of the loans in the pool were originated by FRB, which Fitch considers to be an above-average originator of prime jumbo product. The pool has a weighted average (WA) FICO score of 766 and an original combined loan-to-value (CLTV) ratio of 60%.
High Geographic Concentration (Concern): The pool's primary concentration risk is in California, where approximately 50% of the collateral is located, followed by New York at 30%. Approximately 80% of the pool is located in the top five regions in the subject pool (New York, San Francisco, Los Angeles, San Jose and Boston). Given the pool's significant regional concentrations, an additional penalty of approximately 23% was applied to the pool's lifetime default expectation.
Payment Shock Exposure (Concern): The pool consists entirely of ARM loans, while approximately 32% also have interest-only (IO) features. Loan products that result in periodic changes in a borrower's payment, such as ARMs and IOs, expose borrowers to payment reset risk. Future increases in interest rates and payment re-amortization after the expiration of IO periods can raise monthly payments considerably. To account for this risk, Fitch applied a probability of default (PD) penalty of approximately 1.8x to the pool.
Straightforward Deal Structure (Positive): The mortgage cash flow and loss allocation are based on a senior-subordinate, shifting-interest structure, whereby the subordinate classes receive only scheduled principal and are locked out from receiving unscheduled principal or prepayments for five years. The lockout feature helps maintain subordination for a longer period should losses occur later in the life of the deal. The applicable credit support percentage feature redirects subordinate principal to classes of higher seniority if specified credit enhancement (CE) levels are not maintained.
To mitigate tail risk, which arises as the pool seasons and fewer loans are outstanding, a subordination floor of 2.50% of the original balance will be maintained for the certificates. Additionally, there is no early stepdown test that might allow principal prepayments to subordinate bondholders earlier than the five-year lockout schedule.
Leakage from Reviewer Expenses (Concern): The trust is obligated to reimburse the breach reviewer, Pentalpha Surveillance LLC (Pentalpha), each month for any reasonable out-of-pocket expenses incurred if the company is requested to participate in any arbitration, legal or regulatory actions, proceedings or hearings. These expenses include Pentalpha's legal fees and other expenses incurred outside its annual fee schedule and are not subject to a cap or certificateholder approval.
Furthermore, certificateholders are obligated to pay Pentalpha a termination fee of $140,000 from year two to five, $80,000 from year five to eight and $25,000 after year eight, to terminate the contract. While Fitch accounted for the potential additional costs by upwardly adjusting its loss estimation for the pool, Fitch views this construct as adding potentially more ratings volatility than those that do not have this type of provision.
Extraordinary Expense Adjustment (Concern): Extraordinary expenses, which include loan file review costs, arbitration expenses for enforcement of the reps and additional fees of Pentalpha, will be taken out of available funds and not accounted for in the contractual interest owed to the bondholders. This construct can result in principal and interest shortfalls to the bonds, starting from the bottom of the capital structure. To account for the risk of these noncredit events reducing subordination, Fitch adjusted its loss expectations upward by 40 bps at the 'AAAsf' level.
Tier 3 Representation and Warranty Framework (Concern): Fitch believes that the value of the rep and warranty framework is diluted by the presence of qualifying and conditional language in conjunction with sunset provisions, which reduces lender breach liability. While Fitch believes the high credit-quality pool and clean diligence results mitigate these risks, the weaker framework was considered in the analysis.
Fitch's analysis incorporates a sensitivity analysis to demonstrate how the ratings would react to steeper market value declines (MVDs) than assumed at the MSA level. 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 may be considered in the surveillance of the transaction. Two sets of sensitivity analyses were conducted at the state and national levels to assess the effect of higher MVDs for the subject pool.
This defined stress sensitivity analysis demonstrates how the ratings would react to steeper MVDs at the national level. The analysis assumes MVDs of 10%, 20%, and 30%, in addition to the model projected 6%. The analysis indicates that there is some potential rating migration with higher MVDs, compared with the model projection.
Fitch also conducted sensitivities to determine the stresses to MVDs that would reduce a rating by one full category, to non-investment grade, and to 'CCCsf'.
Fitch's stress and rating sensitivity analysis are discussed in its presale report released today 'J. P. Morgan Mortgage Loan Trust 2016-2', available at 'www. fitchratings. com' or by clicking on the link.
USE OF THIRD-PARTY DUE DILIGENCE PURSUANT TO SEC RULE 17G-10
Fitch was provided with Form ABS Due Diligence-15E (Form 15E) as prepared by AMC Diligence, LLC (AMC), and Opus Capital Markets Consultants (Opus). The third-party due diligence described in Form 15E focused on a compliance review, credit review and valuation review. The due diligence companies performed a review on 100% of the loans. Fitch considered this information in its analysis and it did not have an effect on Fitch's analysis or conclusions. Fitch believes the overall results of the review generally reflected strong underwriting controls.
REPRESENTATIONS, WARRANTIES AND ENFORCEMENT MECHANISMS
A description of the transaction's representations, warranties and enforcement mechanisms (RW&Es) that are disclosed in the offering document and which relate to the underlying asset pool is available by accessing the appendix referenced under 'Related Research' below. The appendix also contains a comparison of these RW&Es to those Fitch considers typical for the asset class as detailed in the Special Report titled 'Representations, Warranties and Enforcement Mechanisms in Global Structured Finance Transactions,' (May 2016).