Fitch Rates Fannie Mae's Connecticut Ave Securities, Series 2016-C05
--$385,709,000 class 2M-1 notes 'BBB-sf'; Outlook Stable;
--$257,139,000 class 2M-2A exchangeable notes 'BB+sf'; Outlook Stable;
--$459,178,000 class 2M-2B exchangeable notes 'B'; Outlook Stable;
--$716,317,000 class 2M-2 notes 'Bsf'; Outlook Stable;
--$257,139,000 class 2M-2F exchangeable notes 'BB+sf'; Outlook Stable;
--$257,139,000 class 2M-2I exchangeable notional notes 'BB+sf'; Outlook Stable.
The following classes are not rated by Fitch:
--$37,120,941,838 class 2A-H reference tranche;
--$20,301,302 class 2M-1H reference tranche;
--$13,534,534 class 2M-AH reference tranche;
--$24,167,597 class 2M-BH reference tranche;
--$80,000,000 class 2B notes;
--$306,676,477 class 2B-H reference tranche.
The 'BBB-sf' rating for the 2M-1 note reflects the 2.95% subordination provided by the 1.95% 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 consist of mortgage loans with loan-to-values (LTVs) greater than 80% and less than or equal to 97%.
Connecticut Avenue Securities, series 2016-C05 (CAS 2016-C05) is Fannie Mae's 14th 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 $38.67 billion pool of mortgage loans currently held in previously issued MBS guaranteed by Fannie Mae where principal repayment of the notes is 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 2M-1 and 2M-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.
KEY RATING DRIVERS
High-Quality Mortgage Pool (Positive): The reference mortgage loan pool consists of high-quality mortgage loans that were acquired by Fannie Mae from July through December 2015. In this transaction, Fannie Mae has only included one group of loans with LTVs from 80%-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 sixth 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 the pool 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 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 maturity in its analysis and applied a reduction to its lifetime default expectations.
Seller Insolvency Risk Addressed (Positive): A loan will be removed from the reference pool if a lender has declared bankruptcy or has been put into receivership and, per the quality-control (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 second 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 QC processes. The sample selection was limited to a population of 7,262 loans that were previously reviewed as part of Fannie Mae's post-purchase QC review and met the reference pool's eligibility criteria. Of those loans, 1,998 were selected for a full review (credit, property valuation and compliance) by third-party due diligence providers. Of the 1,998 loans, 552 were part of this transaction's reference pool. 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 the 2M-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 2M-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 2M-2 and 2B classes will not receive any scheduled or unscheduled allocations until their 2M-1 classes are paid in full. The 2B classes will not receive any scheduled or unscheduled principal allocations until the 2M-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 2A-H senior reference tranches, which have an initial loss protection of 4.00%, as well as at least 50% of the first loss 2B-H reference tranches, sized at 100 bps. Fannie Mae is also retaining an approximately 5% vertical slice/interest in the 2M-1 and 2M-2 tranches.
Receivership Risk Considered (Neutral): Under the Federal Housing Finance Regulatory Reform Act, the Federal Housing Finance Agency (FHFA) must place Fannie Mae into receivership if it determines that Fannie Mae's assets are less than its obligations for more than 60 days following the deadline of its SEC filing, as well as for other reasons. As receiver, FHFA could repudiate any contract entered into by Fannie Mae if it is determined that the termination of such contract would promote an orderly administration of Fannie Mae's affairs. Fitch believes that the U. S. government will continue to support Fannie Mae; this is reflected in our current rating of Fannie Mae. However, if, at some point, Fitch views the support as being reduced and receivership likely, the ratings of Fannie Mae could be downgraded and the 2M-1 notes' ratings affected.
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 MVDs of 10%, 20%, and 30%, in addition to the model-projected 22% at the 'BBB-sf' level and 14% at the 'Bsf' level. 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 11%, 11% and 35% would potentially reduce the 'BBB-sf' rated class down one rating category, to non-investment grade, and to 'CCCsf', respectively.
USE OF THIRD-PARTY DUE DILIGENCE PURSUANT TO SEC RULE 17G-10
Fitch was provided with due diligence information from Clayton and Adfitech, Inc. The due diligence focused on credit and compliance reviews, desktop valuation reviews and data integrity. Clayton and 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.
Form ABS Due Diligence-15E was not provided to, or reviewed by, Fitch in relation to this rating action.
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 was not prepared for this transaction. Offering documents for U. S. credit risk transfer transactions do not typically include RW&Es that are available to investors and that relate to the asset pool underlying the security. Therefore, Fitch credit reports for U. S. credit risk transfer transactions will not typically include descriptions of RW&Es. For further information, please see Fitch's Special Report titled 'Representations, Warranties and Enforcement Mechanisms in Global Structured Finance Transactions,' dated May 2016.