Onslow Bay is making its debut in the securitization market with $231 million of bonds backed by mortgage loans the real estate investment trust acquired from several lenders, according to Standard & Poor's.

Onslow Bay is owned by Hatteras Financial and was founded in 2013. It purchases only prime jumbo loans that meet the safe harbor criteria for qualified mortgages under the ability-to-repay rule. When the loans are acquired, servicing is transferred to Specialized Loan Servicing.

The majority of the loans backing its debut deal, Onslow Bay Mortgage Loan Trust 2015-1, were purchased from five lenders: Stonegate Mortgage Corp., Prime Lending, Flagstar Bank, Pacific Union Financial and Caliber Home Loans.

The mortgage loans are divided into two pools. Notes in pool one are backed by mortgages with an initial five-year, fixed-interest rate. After the initial five-year period, the loans adjust on annual basis according to an index plus a margin. The second pool is comprised of loans with an initial seven-year, fixed-rate period that then adjusts annually.

ARMs carry a greater default risk relative to fixed-rate pools because they are subject to interest rate changes.

However, the loans are of good credit quality, which offsets the interest rate risk, according to S&P. Leverage in the pool is low as evidenced by the weighted average LTV of 69.5% and the weighted average FICO score of borrowers in the pool is 762.

Of the 307 mortgage loans, 19 (6.9% of the pool by balance) were made to borrowers with current FICO scores below 700. The loss estimate of the mortgage pool has been increased to account for the increased default risk of these loans.

The average loan size in the pool is $753,000. As loan counts decrease during a transaction's life, a default in one or more loans — particularly with larger balances — can significantly affect impact the pool's credit stability, depending on the available credit support. This is called tail risk.

"In a shifting-interest structure, such as the one in this transaction, because principal payments increase to subordinate tranches over time, losses occurring later in a transaction's life (back-loaded losses) can exacerbate this effect," said S&P. "Without structural mitigating factors, less credit enhancement is available to the more senior classes."

The transaction is therefore structured with a subordination floor that protects senior classes from tail risk as the pool pays down.

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