Some of the most talked-about securitizations did not make it to market during the month of February.
Ratings agencies have received a number of proposals for private-label residential mortgage backed securities and they apparently do not like what they see. Analysts at both Fitch Ratings and Moody’s Investors Service issued special reports late in the month saying the credit quality of certain deals that have passed through their hands leaves something to be desired.
The culprit? The representations and warranties as to the condition of loans, the subject of so much litigation between sponsors and investors in legacy deals. The ratings agencies say the reps and warranties underlying the structures of proposed RMBS are weaker than the ones animating the deals issued by Redwood Trust off its Sequoia Mortgage Trust Shelf.
Fitch fired the first shot Feb. 20. The agency warned that the reps & warranties embedded in recent deal proposals may expose investors to sharper risks from poor underwriting as well as “defective” mortgages.
Where possible, additional credit enhancement would be needed to offset these added risks, the agency said.
Fitch didn’t name any names, but there has been much talk about at least two major banks, JPMorgan and Bank of America, as well as additional real estate investment trusts approaching the market.
Fitch said a rep and warranty framework established by the American Securitization Forum, and present in all the Redwoods deals to date, “reflects a high standard that provides the most assurances about loan origination and underwriting quality.” These reps contain few knowledge qualifiers, the repurchase obligations are for the life of the loan, and there is little ambiguity.
But new proposals contain provisions that Fitch deems flawed. One, for instance, lets lenders off the hook for buying back defective loans after the first 36 months.
Moody’s joined its peer on Feb. 25, and offered a specific ceiling for deals with two or more weaknesses in their rep and warranty frameworks: A1 (sf).
The agency said deals would face that ratings cap if they had narrow pre-securitization due diligence, limited obligations from the lender to buy back defective loans, and misaligned interests between the sponsor and investors.
One particular problem Moody’s cited was broad materiality standards. This would reduce the likelihood that a borrower would buyback a flawed loan. As an example, under such an approach, a loan that was incorrectly assigned an loan-to-value of 60% because of a faulty appraisal process could remain in the pool, provided its LTV didn’t rise above the 80% stipulated by the structure. This would not be consistent with a triple-A under Moody’s criteria.
The agency added that, if transactions failed to meet only one of the criteria for a top notch rep and warranty framework, it could potentially achieve up to a Aa1 (sf) rating.
As of press time, Standard & Poor’s had not chimed in. Perhaps that’s not surprising, because, in late November, S&P gave triple-A to the senior tranches of a $329.9 million private-label RMBS deal sponsored by Credit Suisse that set limits, also known as “sunset provisions,” on the amount of time investors in the deal have to make claims that loans used as collateral do not meet stated underwriting criteria Additionally, the deal, CSMC Trust 2012-CIM3, contains language intended to clarify what constitutes a breach of representations and warranties of the underwriting criteria.
S&P said in a special report issued Dec. 3 that the CIM3 transaction is the first of what it expects will be many nonagency examples of the effort to provide greater clarity around the issues.
“The RMBS market has attempted to balance the interests of investors and issuers while providing clear guidelines to all participants involved in the securitization process,” the agency said.
S&P noted that the Federal Housing Finance Agency recognizes both the need to offer the market certainty about the transfer of risk to the private market as well as the negative effect the GSEs’ own repurchase demands can have in that process.
Investor sentiment remained firm across all sectors of the securitization market in February. For investors looking to pick up some extra yield on pricing spreads, off-the sectors like auto dealer floorplan ABS and private label credit cards offered some opportunity.
Dealer floorplan deals picked up the pace with over $3 billion of issuance during the month that priced to good investor demand. These deals are structured as revolving trusts; they finance inventory for the dealers of large manufacturing companies.
The busy month means this asset class is on track to exceed $10 billion of primary issuance volume this year, according to S&Ps. Floorplan deals account for 21% of the approximate $19 billion of total ABS primary issuance volume this year, compared with 14% a year earlier, said analysts at Bank of American Merrill Lynch in a Feb. 22, report.
Citigroup’s projections are even more bullish: analysts expect $15 billion of dealer floorplan ABS issuance this year, a 7% increase from last year, according to a Feb. 21 report.
Dealer floorplan issuance spiked to roughly $14 billion from 17 deals in 2012. In 2011 and 2010 the total for the sector was $7.1 billion and $7.7 billion from 10 transactions, respectively. Outstanding dealer floorplan ABS is a roughly $30 billion market.
Issuance volumes for this asset class have been boosted by strong auto sales and the refinancing of maturing transactions. More than 1.2 million new vehicles were estimated to have been sold over last month, a 4.3% increase over last year, according to Edmunds.com. For 2013, the equity research group covering auto companies for BofAML expects new vehicle sales to reach 15.7 million units. Over 75% of auto dealers’ inventory stays on their lots for less than three months, with only 9–12% taking more than six months to turnover, according to latest master trust prospectuses, said Citigroup.
BofAML said the low cost of ABS funding relative to on balance-sheet funding is another factor driving issuance last month.