RMBS Raters Spar Over Geographic Concentration

Rating agencies are talking tough about residential mortgage backed securities (RMBS) again.
This time the fuss isn’t about selling defective loans back to the originators. Instead, raters disagree about the risk of deals with a large number of mortgages on homes in the same state, or even the same city.

At issue is a $440-million residential mortgage backed security (RMBS) by Nomura Corporate Funding. Closed in mid July, the deal is Nomura’s first RMBS since the financial crisis. Its collateral consists entirely of 30-year, fixed-rate loans originated by First Republic Bank, a jumbo lender that is a recurring originator for Redwood Trust’s RMBS and boasts a strong performance history.

Both Kroll Bond Rating Agency and Standard & Poor’s rated the senior tranches of Nomura’s deal triple-A. In an unsolicited comment, Fitch Ratings questioned that coveted grade for a transaction with stark geographic concentration: California is home to 75% of the properties secured by the deal’s underlying mortgages.

What is more, Fitch believes that too many of those home are in overvalued neighborhoods. The agency said that, if it were asked to rate the deal, it would apply a 75% increase to the default frequency assumption for this pool.

This would require a 9%-10% credit enhancement for the senior class to achieve ‘AAA.’ But the deal is actually structured with 7.6% enhancement.

The agency has no problem with the credit quality of the loans, which have a weighted average FICO score of 770 and an average combined-loan-to-value ratio of 65.6%. “While the attributes of the underlying pool are strong, Fitch believes that meaningful risk is introduced with concentrations of loan production,” managing directors Roelof W. Slump and Rui Pereira said in a presale report.

Kroll and S&P feel that the creditworthiness of the borrowers helps offset the risk that falling housing prices in California could weigh on the deal’s performance.

Kroll acknowledges geographic concentration as an important risk factor. In its presale report, the rating agency said that it took this into account in rating the deal, applying a 67% increase to the default frequency assumption for the pool. But analysts feel that the credit quality of the collateral is so high that credit enhancement of 7.6% is sufficient to justify the ‘AAA’ rating.

“A significant portion of the borrowers exhibit high levels of verified assets, and most loans demonstrate prudent debt-to-income ratios, especially given relatively high borrower incomes,” Kroll said in the report.

Kroll also took into account First Republic’s experience as a jumbo mortgage lender and servicer.
“If you look at the performance history of First Republic collateral, it’s one of top performing” originators, Michele Patterson, the primary Kroll analyst on the deal, said in a telephone interview.

“Some of these borrowers have $1 million in reserves. If there are any issues, borrowers can continue to pay the mortgages,” she said.

Glenn Costello, a senior managing director at Kroll, noted that First Republic’s mortgage origination has always been concentrated in California, even during the financial crisis. “We can see how it performed when hit with very severe home price declines,” he said in the same telephone interview.

Another mitigating factor, according to S&P, is that due diligence was performed on 100% of the loans in the pool by a third-party due diligence provider. “The results are consistent with high-quality underwriting,” it said in its presale report.

Unlike some RMBS issued this year, assurances as to the quality of the loans backing this deal are not being disputed. A $616 million RMBS issued by J.P. Morgan in March drew criticism from Moody’s, which said it was too easy for originators, including First Republic, to avoid buying back defective loans. Fitch and Kroll both assigned top ratings to the deal, saying that its additional credit enhancement offset any concerns about the quality of so-called representations and warranties.

Kroll noted in its report that Nomura’s deal has no “sunset provision” releasing First Republic from a requirement to repurchase defective loans after a certain date. Some recent deals with such a provision attracted criticism from rating agencies. Neither Moody’s Investors Service nor DBRS commented on the Nomura deal.

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