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Screening for upgrade candidates in non-QM RMBS
admin | March 8, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Post-crisis private RMBS have seen a significant series of upgrades in recent years. Fast prepayments, relatively pristine credit performance and certain structural features have contributed in varying degrees to upgrades across non-QM securitizations. Collateral performance should remain strong, but prepayments today across the MBS market run at or near a 20-year low. Non-QM deals with higher WACs, more seasoning and more mark-to-market equity look better positioned for further upgrades than more recent deals.
Collateral performance across non-QM securitizations has been better than anticipated, generally buoyed by robust home price appreciation, WAC compression, which has created refinancing opportunities, and overall credit curing as borrowers get further removed from prior credit events. As both the structures and borrowers de-lever, rating agencies have upgraded bonds in the mezzanine and junior portions of the capital structure, in some cases materially. Looking across the transactions of the four most prominent non-QM issuers Angel Oak, Caliber, Deephaven and Verus, more than half of the original ‘A’ and ‘BBB’ bonds have been upgraded. (Exhibit 1)
Exhibit 1: Ratings migration across non-QM issuance
Source: Amherst Insight Labs, Amherst Pierpont
Based on significant upgrades so far, a handful of criteria look likely to drive drive future upgrades. The 2016 vintage COLT deals serve as good examples. All three 2016 vintage COLT transactions have seen their original ‘BBB’ bonds upgraded to ‘AAA.’ These deals all have a handful of common characteristics: low deal factors, elevated prepayment speeds, higher WACs, significant cumulative HPA and low mark-to-market CLTVs. (Exhibit 2)
Exhibit 2: Collateral attributes of 2016 COLT transactions
Source: Bloomberg LP, Amherst Pierpont
A scan of outstanding non-QM transactions for mezzanine bonds with similar attributes but without a significant upgrade shows promising results. There are a handful of 2017 vintage bonds that were originally rated ‘B’ or ‘BB’ that may be poised for further upgrades based on the above criteria. All five transactions have de-levered significantly as each has a 50% deal factor or less. All have gross WACs greater than 6.25% and average 6-month voluntary speeds in excess of 30 VPR. Three transactions have at least seven points of average cumulative HPA and mark-to-market CLTVs in the mid 60’s. Sixty plus day delinquency rates vary from just under 1% to 6.55% across the five transactions. Four of the five transactions have at least a 10-point increase in credit enhancement since issuance. (Exhibit 3)
Exhibit 3: Potential upgrade candidates in 2017 non-QM mezzanine bonds
Source: Bloomberg LP, Amherst Pierpont
Obviously these are not the only bonds in the structures that have upgrade potential, and, in some cases, rating agencies have already upgraded more senior bonds significantly. For example, AOMT 2017-1 A3 has been upgraded from an original ‘A’ rating to ‘AAA’ by Fitch. Fitch has also upgraded the original ‘A’ bond in the COLT 2017 -1 transaction to ‘AAA.’ There has been more limited ratings migration on DRMT 2017-1A, VERUS 2017-1A and COLT 2017-2. Despite having the highest deal factor and mark-to-market CLTV, the COLT 2017-2 M1 may be best poised for a material upgrade. It has one of the highest WACs, is prepaying the fastest of all upgrade candidates, has one of the lowest delinquency rates and has credit enhancement more than 20 times greater than the percentage of loans 60+ days delinquent in the pool.
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