Fitch Expects to Rate Fannie Mae's Connecticut Ave Securities, Series 2016-C03; Presale Issued
OREANDA-NEWS. Fitch Ratings expects to assign the following ratings and Rating Outlooks to Fannie Mae's risk transfer transaction, Connecticut Avenue Securities, series 2016-C03:
--$157,758,000 class 1M-1 notes 'BBB-sf'; Outlook Stable;
--$56,342,000 class 1M-2A exchangeable notes 'BB+sf'; Outlook Stable;
--$123,953,000 class 1M-2B exchangeable notes 'B+'; Outlook Stable;
--$180,295,000 class 1M-2 notes 'B+sf'; Outlook Stable;
--$56,342,000 class 1M-2F exchangeable notes 'BB+sf'; Outlook Stable;
--$56,342,000 class 1M-2I exchangeable notional notes 'BB+sf'; Outlook Stable;
--$241,218,000 class 2M-1 notes 'BBB-sf'; Outlook Stable;
--$156,792,000 class 2M-2A exchangeable notes 'BB+sf'; Outlook Stable;
--$325,645,000 class 2M-2B exchangeable notes 'B'; Outlook Stable;
--$482,437,000 class 2M-2 notes 'Bsf'; Outlook Stable;
--$156,792,000 class 2M-2F exchangeable notes 'BB+sf'; Outlook Stable;
--$156,792,000 class 2M-2I exchangeable notional notes 'BB+sf'; Outlook Stable.
The following classes will not be rated by Fitch:
--$11,387,071,699 class 1A-H reference tranche;
--$8,303,462 class 1M-1H reference tranche;
--$2,965,665 class 1M-AH reference tranche;
--$6,523,863 class 1M-BH reference tranche;
--$45,000,000 class 1B notes;
--$73,615,331 class 1B-H reference tranche;
--$24,375,769,743 class 2A-H reference tranche;
--$12,696,268 class 2M-1H reference tranche;
--$8,252,274 class 2M-AH reference tranche;
--$17,139,262 class 2M-BH reference tranche;
--$45,000,000 class 2B notes;
--$208,914,269 class 2B-H reference tranche.
The 'BBB-sf' rating for the 1M-1 note reflects the 2.60% subordination provided by the 1.60% class 1M-2 note and the 1.00% 1B note, and their corresponding reference tranches. The 'BBB-sf' rating for the 2M-1 note reflects the 3.00% subordination provided by the 2.00% class 2M-2 note and the 1.00% 2B note, and their corresponding reference tranches. The notes are general senior unsecured obligations of Fannie Mae (rated 'AAA', Outlook Stable) subject to the credit and principal payment risk of a pool of certain residential mortgage loans held in various Fannie Mae-guaranteed MBS.
The reference pool of mortgages will be divided into two loan groups. Group 1 will consist of mortgage loans with loan-to-values (LTVs) greater than 60% and less than or equal to 80% while group 2 will consist of mortgage loans with LTVs greater than 80% and less than or equal to 97%. While each loan group has its own issued notes, each group's structure will be identical. There will be no cross-collateralization.
Connecticut Avenue Securities, series 2016-C03 (CAS 2016-C03) is Fannie Mae's 12th risk transfer transaction issued as part of the Federal Housing Finance Agency's Conservatorship Strategic Plan for 2013 - 2017 for each of the government sponsored enterprises (GSEs) to demonstrate the viability of multiple types of risk transfer transactions involving single family mortgages.
The objective of the transaction is to transfer credit risk from Fannie Mae to private investors with respect to a $37.25 billion pool of mortgage loans currently held in previously issued MBS guaranteed by Fannie Mae where principal repayment of the notes are subject to the performance of a reference pool of mortgage loans. As loans liquidate, are modified or other credit events occur, the outstanding principal balance of the debt notes will be reduced by the loan's actual 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, Fannie Mae will be responsible for making monthly payments of interest and principal to investors. Because of the counterparty dependence on Fannie Mae, Fitch's expected rating on the M-1 and M-2 notes will be based on the lower of: the quality of the mortgage loan reference pool and credit enhancement (CE) available through subordination; and Fannie Mae's Issuer Default Rating. The notes will be issued as uncapped LIBOR-based floaters and will carry a 12.5-year legal final maturity.
In February 2016, Fitch released an exposure draft criteria report, which incorporates several proposed enhancements to its 'U.S. RMBS Loan Loss Model Criteria,' dated August 2015. The changes are detailed in the report titled 'Exposure Draft: U.S. RMBS Loan Loss Model Criteria' available on Fitch's website at www.fitchratings.com. Although the credit risk profile of this reference pool is consistent with the previous transaction, the exposure draft model estimated modestly lower expected losses as a result of the model updates for group 1 and modestly higher expected losses for Group 2. The bonds for this transaction were analyzed with both criteria approaches, with a greater weight on the exposure draft model results. The difference in ratings for this transaction using the two separate models is less than one rating notch.
There was one variation from criteria related to an outside-the-model amortization credit that was applied. Fitch feels the credit is more consistent with historical observations as well as with Fitch's loss timing curve. The amortization credit is consistent with Fitch's mid-loaded loss-timing curve with benchmark prepayments. The difference in ratings for this transaction is less than one rating notch. While this credit was applied outside of the model for this transaction, Fitch expects to incorporate the amortization credit in its 'US RMBS Loan Loss Model Criteria' for future transactions, subject to the review and approval by a criteria review committee.
KEY RATING DRIVERS
High-Quality Mortgage Pool (Positive): The reference mortgage loan pools consist of high-quality mortgage loans that were acquired by Fannie Mae from March through June 2015. The Group 1 reference pool will consist of loans with LTVs greater than 60% and less than or equal to 80%, and Group 2 will consist of loans with LTVs greater than 80% and less than or equal to 97%. Overall, the reference pool's collateral characteristics are similar to recent CAS transactions and reflect the strong credit profile of post-crisis mortgage originations.
Actual Loss Severities (Neutral): This will be Fannie Mae's fourth actual loss risk transfer transaction in which losses borne by the noteholders will not be based on a fixed loss severity (LS) schedule. The notes in this transaction will experience losses realized at the time of liquidation or modification, which will include both lost principal and delinquent or reduced interest.
Mortgage Insurance Guaranteed by Fannie Mae (Positive): The majority of the loans in Group 2 are covered either by borrower paid mortgage insurance (BPMI) or lender paid MI (LPMI). Fannie Mae will be guaranteeing the MI coverage amount, which will typically be the MI coverage percentage multiplied by the sum of the unpaid principal balance as of the date of the default, up to 36 months of delinquent interest, taxes and maintenance expenses. While the Fannie Mae guarantee allows for credit to be given to MI, Fitch applied a haircut to the amount of BPMI available due to the automatic termination provision as required by the Homeowners Protection Act when the loan balance is first scheduled to reach 78%.
12.5-Year Hard Maturity (Positive): The 1M-1, 1M-2, 1B, 2M-1, 2M-2 and 2B notes benefit from a 12.5-year legal final maturity. Thus, any credit or modification events on the reference pool that occur beyond year 12.5 are borne by Fannie Mae and do not affect the transaction. In addition, credit or modification events that occur prior to maturity with losses realized from liquidations or modifications that occur after the final maturity date will not be passed through to the noteholders. This feature more closely aligns the risk of loss to that of the 10-year, fixed LS CAS deals where losses were passed through at the time a credit event occurred - i.e. loans became 180 days delinquent with no consideration for liquidation timelines. Fitch accounted for the 12.5-year hard maturity in its default analysis and applied a reduction to its lifetime default expectations.
Seller Insolvency Risk Addressed (Positive): An enhancement was made with regards to insolvency risk. A loan will be removed from the reference pool if a lender has declared bankruptcy or has been put into receivership and, per the QC process, an eligibility defect is identified that could otherwise have resulted in a repurchase. In earlier CAS deals, if a lender declared bankruptcy or was placed into receivership prior to a repurchase request made by Fannie Mae for a breach of a rep and warranty, the loan would not be removed from its related reference pool or treated as a credit event reversal if it became 180 days past due. This enhancement reduces the loss exposure arising from MI claim rescissions due to underwriting breaches by insolvent sellers.
Limited Size/Scope of Third-Party Diligence (Neutral): This is the first transaction in which Fitch received third party due diligence on a loan production basis, as opposed to a transaction specific review. Fitch believes that regular, periodic third-party reviews (TPRs) conducted on a loan production basis are sufficient for validating Fannie Mae's quality control processes. The sample selection was limited to a population of 6,333 loans that were previously reviewed as part Fannie Mae's post-purchase quality control (QC) review and met the reference pool's eligibility criteria. 1,998 loans of those loans were selected for a full review (credit, property valuation and compliance) by a third-party due diligence provider. Of the 1,998 loans, 608 were part of this transaction's reference pool (230 in Group 1 and 378 in Group 2). Fitch views the results of the due diligence review as consistent with its opinion of Fannie Mae as an above average aggregator; as a result no adjustments were made to Fitch's loss expectations based on due diligence.
Advantageous Payment Priority (Positive): The payment priority of M-1 notes will result in a shorter life and more stable CE than mezzanine classes in private-label (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 notes can receive a full pro-rata share of unscheduled principal immediately, as long as a minimum CE level is maintained and the delinquency test is satisfied. Additionally, unlike PL mezzanine classes, which lose subordination over time due to scheduled principal payments to more junior classes, the M-2 and B classes in each group will not receive any scheduled or unscheduled allocations until their M-1 classes are paid in full. The B classes will not receive any scheduled or unscheduled principal allocations until the M-2 classes are paid in full.
Solid Alignment of Interests (Positive): While the transaction is designed to transfer credit risk to private investors, Fitch believes that it benefits from a solid alignment of interests. Fannie Mae will be retaining credit risk in the transaction by holding the A-H senior reference tranches, which have an initial loss protection of 4.00% in Group 1 and 4.00% in Group 2, as well as the first loss B-H reference tranches, sized at 100 basis points (bps) for each group. Fannie Mae is also retaining an approximately 5% vertical slice/interest in the M-1 and M-2 tranches for Group 1 and 2, respectively.
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 MVDs at the national level. The analysis assumes MDVs of 10%, 20%, and 30%, in addition to the model-projected 23% at the 'BBB-sf' level and 16.7% at the 'B+sf' level for Group 1 and 22.1% at the 'BBB-sf' level and 14.2% at the 'Bsf' level for Group 2. 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 12%, 12% and 32% would potentially reduce the Group 1 'BBB-sf' rated class down one rating category, to non-investment grade, and to 'CCCsf', respectively. And additional MVDs of 11%, 11% and 33% would potentially reduce the Group 2 'BBB-sf' rated class down one rating category, to non-investment grade, and to 'CCCsf', respectively.
DUE DILIGENCE USAGE
Fitch was provided with due diligence information from Adfitech, Inc. The due diligence focused on credit and compliance reviews, desktop valuation reviews and data integrity. Adfitech examined selected loan files with respect to the presence or absence of relevant documents. Fitch received certifications indicating that the loan-level due diligence was conducted in accordance with Fitch's published standards. The certifications also stated that the company performed its work in accordance with the independence standards, per Fitch's criteria, and that the due diligence analysts performing the review met Fitch's criteria of minimum years of experience. Fitch considered this information in its analysis and the findings did not have an impact on the analysis.
The offering documents for CAS 2016-C03 do not disclose any representations, warranties, or enforcement mechanisms (RW&Es) that are available to investors and which relate to the underlying asset pools. Please see Fitch's Special Report for further information regarding Fitch's approach to the disclosure of a transaction's RW&Es as required under SEC Rule 17g-7.