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Provident Funding moves into private MBS

| December 6, 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.

The original disclaimer for this article has been updated as of December 12, 2019, to reflect that Amherst Pierpont Securities was an underwriter for the Provident Funding transaction described here.

Provident Funding recently priced the first post-crisis private MBS collateralized primarily by owner-occupied loans eligible for agency TBA pools. The deal is likely significant not only for the collateral but for the likely motivation of the issuer, too.

Provident’s PFMT 2019-1 ‘represents a milestone in post-crisis, private label securitization as it is the first transaction to contain 100% agency eligible mortgage loans, none of which are investor purpose,’ according to KBRA’s pre-sale report. While the deal is the first of its kind, the securitization of agency eligible loans in post-crisis PLS is by no means novel. Agency eligible loans have made a meaningful contribution to post-crisis issuance. Currently, regular conforming and high balance conforming loans make up nearly 40% the outstanding volume of post-crisis private label issuance. Regular conforming loans make up just over 10% of outstanding balances, while high balance loans, which are capped at 150% of the national conforming loan limit, make up approximately another 28% of the outstanding universe. (Exhibit 1)

Exhibit 1: Agency eligible loans make up nearly 40% of post-crisis PLS collateral

Source: Amherst Insight Labs, Amherst Pierpont Securities

Deal comparison and relative value

PFMT 2019-1 differs fairly substantially from the majority of current prime jumbo issuance. The primary difference between the Provident deal and the majority of prime PLS issuance is the deal has a materially lower average loan size than most prime jumbo issuance. The average loan size of the deal is just over $357,000, marginally higher than the average loan size of pools being delivered into UMBS 3.0% TBA, which averaged roughly $340,000 in the November TBA cycle. The deal has a small population of loans that are above the conforming limit. Only 8.15% of the collateral in the Provident deal are high balance conforming loans, below the 10% limit on conforming high balance loans that originators can comingle with regular conforming balances and deliver into TBA.

Comparing the Provident transaction to a recent prime jumbo deal, JPMMT 2019-8, shows the deal also has significantly less dispersion in loan size, less large loan risk and greater diversification. The deal also employs a 25 bp servicing fee and an intra-month prepayment period definition, which even in the event of elevated prepayments should better protect investors from prepayment interest shortfalls which have affected bonds across the capital structure in a spate of recently issued prime jumbo deals.. (Exhibit 2)

 

Exhibit 2: A side by side comparison: PFMT 2019-1 vs JPMMT 2019-8

Source: KBRA, Amherst Pierpont Securities

The relative value of PFMT shows up in comparing PFMT and JPMMT super-senior pass-throughs to their respective TBA benchmarks. The PFMT pass-through offers a 20 bp pick up in yield and 11 bp more OAS than the TBA. Both bonds have very comparable effective duration, DV01, option cost and convexity. By comparison, despite being priced to a wider spread versus the benchmark, the JPMMT pass-through is a 14 bp give in yield and an 8 bp give in OAS versus UMBS 3.5%. The PLS pass-through is also shorter duration hand has a higher option cost than TBA. (Exhibit 3)

Exhibit 3: A relative value comparison

Source: YieldBook, Amherst Pierpont Securities

Likely motivation of the issuer

Agency loans in recent years have found their way into private MBS often for the better pricing on certain specified stories. But since the Provident deal is backed by mostly generic agency-eligible loans, it may be less about best execution and more about the issuer taking a view on their own underwriting and credit quality by retaining certain credit sensitive parts of the deal. To date, the issuer has exhibited very strong credit performance with even pre-crisis vintages exhibiting just 1% in aggregate credit losses, substantially lower than the broader cohort (Exhibit 4). It seems plausible that originators with similar views on their credit and underwriting could follow suit, with the caveat that they would need to be adequately capitalized to hold retained interests.

Exhibit 4: Provident total cumulative credit losses by vintage

Source: Provident Funding

Prior to this transaction, agency-eligible loans have been flowing into private label deals because of a best execution advantage. Looking at September’s total GSE production, nearly all the investor loans pooled by the agencies show a better estimated execution in PLS, while roughly 40% of cash out refinancings and 25% of jumbo loans would have had better PLS execution (Exhibit 5). In reality, jumbo pass-throughs trade much tighter than our pricing assumption, which would skew more conforming high balance production into PLS.

Exhibit 5: Estimating GSE eligible execution in PLS

Note: This analysis applies rating agency criteria to determine estimated ‘AAA’ subordination, prices the subordinate stack and prices the ‘AAA’ pass-through one point back of its specified pool benchmark. In the case of conforming jumbo collateral, which trades roughly 28/32s behind TBA, the analysis prices the ‘AAA’ pass-through at $1-28/32s behind TBA. Source: Amherst Insight Labs, APS, Fannie Mae, Freddie Mac

Please note that Amherst Pierpont Securities was an underwriter for the transaction described in this article.

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