Since the housing crisis, the credit ratings agencies are much more careful when it comes to handing out AAA ratings, providing high ratings to only the most pristine mortgage bonds.
Before the crisis, ratings shopping led to a race to the bottom in credit ratings, where the various ratings agencies would provide high ratings to mortgage bonds that ultimately did not deserve those ratings in any form or fashion.
The ratings agencies received their punishment for the ratings shenanigans, as Standard & Poor's Ratings Services , DBRS and others received fines for their mortgage bond rating practices.
So since the crisis, credit ratings agencies changed and became more selective with their AAA ratings.
Bond issuers also slowed significantly when it came to securitizing loans outside the very specific post-crisis securitization window, as prime, jumbo securitizations became the post-crisis norm.
But the world of post-crisis mortgage bond trading is about to change, as a new mortgage bond is set to hit the market that features loans that would be considered non-prime, and also carries AAA ratings – a post-crisis first.
Both Fitch Ratings and DBRS handed the deal AAA ratings on the largest tranche of the deal, but the deal is not a return to the pre-crisis Wild Wild West of ratings, at least not yet.
The offering, COLT 2016-3 Mortgage Loan Trust, is backed by 474 loans that carry a total balance of approximately $225.75 million.
So first and foremost, the deal is significantly smaller than pre-crisis subprime or Alt-A securitizations.
According to details provided in Fitch’s presale report, the average legacy prime securitization was for $460.6 billion, while the average legacy Alt-A securitization and the average legacy subprime securitization were both for more than $1 trillion.
So this deal is microscopic, by comparison, but the loans are still outside of the Qualified Mortgage window, which means that the loans do carry some more risk than other QM-backed deals.
But the deal is not as risky as it might appear for investors, at least according to the presale reports of Fitch and DBRS.
An article on Bloomberg from Matt Scully notes that both DBRS and Fitch handed AAA ratings to the COLT mortgage bond, but did not provide full details on the technical specifications of the deal, which shows that the deal is supported by various credit mechanisms that support the AAA ratings.
Both Fitch and DBRS handed AAA ratings to the Class A-1 tranche of the deal, which carries a balance of $129.92 million.
The Class A-1 tranche also carries a credit enhancement of 42.45%, nearly triple the typical credit enhancement on typical post-crisis mortgage bonds that also received AAA ratings.
The remaining portions of the deal received AA and lower ratings. Those other tranches also carried various levels of credit enhancement, including 30.6% on the $26.75 million Class A-2 tranche, which received a AA rating.
Additionally, Fitch projects a loss of 24.75% and DBRS projects a loss of 23% for the AAA-rated tranche, meaning investors are not going into this deal blind.
But deal does carry risk, as noted in a separate report from Moody’s Investors Service.
Moody’s, interestingly enough, put out a report calling out some of types of loans in COLT 2016-3 Mortgage Loan Trust as risky, but did not issue a presale report of its own on the deal.
HousingWire contacted Moody’s to check if it was asked to rate the deal, but as of publication, Moody’s had not responded to that request.
The Moody’s report calls out some of the underlying loans in a previous deal in the COLT series, COLT 2016-2, which included 65 loans where only a 30-day bank statement was used to verify the borrower’s income.
According to Fitch’s repot, in COLT 2016-3, 112 of the non-QM loans included in the pool were underwritten to a bank statement program, where a one-month or 12-month bank statement was used to verify income.
As Fitch notes about those loans, “while employment and assets are fully verified, the limited income verification resulted in application of a probability of default penalty of approximately 1.4 times for the bank statement loans.”
Overall, the loans carry a weighted average credit score of 712, which is lower than the weighted average credit score of 741 for legacy prime loans, but significantly above the weighted average credit score for legacy subprime loans, which was 626.
The borrowers in COLT 2016-3 also carry significant liquid reserves, which protects the bond holder against a borrower's temporary disruption of income.
According to Fitch’s report, on average, borrowers in the pool were able to document more than $151,000 in liquid reserves. When the reserves are measured as a number of monthly payments, roughly 92% of the pool has over 12 months of monthly payments in reserves.
In fact, 56% of the underlying borrowers carry more than two years worth of cash on hand.
DBRS’ report provides more details on the loans that make up the deal.
The loans in deal COLT 2016-3 were originated by Caliber Homes Loans (71%), Sterling Bank and Trust (22%), and Lendsure Mortgage (7%).
As DBRS notes, many of the loans were originated by Caliber, as part of a non-agency loan program Caliber began offering in 2014.
According to DBRS’ report, 31.2% of the loans originated by Caliber fall under its “jumbo alternative” program, which made to borrowers with “unblemished credit who do not meet strict prime jumbo or agency/government guidelines.” DBRS notes that these loans may have interest-only features, higher debt-to-income and loan-to-value ratios, or lower credit scores as compared with those in traditional prime jumbo securitizations.
Additionally, 29.8% of the loans in Caliber’s origination pool are from its “Homeowner’s Access” program, which are made to “borrowers who do not qualify for agency or prime jumbo mortgages for various reasons, such as loan size in excess of government limits, alternative or insufficient credit, prior derogatory credit events that occurred more than two years prior to origination.”
It’s also interesting to note the product type and interest rate of the underlying loans.
As DBRS notes, the collateral pool consists of 25.7% fixed-rate, 5.8% three-year hybrid adjustable-rate mortgages, 53.7% five-year hybrid ARM, and 14.8% seven-year hybrid ARM first-liens with original terms to maturity of 30 years.
Approximately 1.4% of the loans have interest-only features with 120-month IO terms.
The average coupon rate for the underlying loans is 6.44%, much higher than the market rate, which just recently topped 4%.
As Moody’s notes, this is not the first non-prime deal to be issued in the COLT series.
So what’s different this time?
In addition to the strength of the borrowers, as highlighted above, this deal also carries lower loan-to-values, and higher retail channel origination than the previous COLT deals.
Additionally, the deal is structured differently than previous deals.
“The most notable structural change is a pro rata principal distribution among the top three investment grade classes (rated ‘AAAsf’, ‘AAsf’, and ‘Asf’), rather than the top two (previously rated ‘Asf’ and ‘BBBsf’),” Fitch notes in its report.
“Consequently, the ‘BBBsf’ is not initially expected to receive principal payments until the more senior classes have paid off,” Fitch adds. “Also, the performance triggers are modestly tighter resulting in earlier conversions to sequential payment priorities under Fitch’s rating stress scenarios. Fitch views the tighter performance triggers as beneficial in retaining credit enhancement.”
DBRS also notes that the non-agency loans originated by Caliber have performed well since the inception of the program two years ago.
“Caliber began originating loans under the five programs in Q4 2014,” DBRS notes in its report. “Of the approximately 1,621 mortgages originated to date, 32 were ever 30 days delinquent, which generally self-cured shortly after. Four loans have been 60 days delinquent and two loans have been 90 days delinquent.”
According to Fitch’s report, the operations of each originator also serves a strength of the deal.
“Fitch reviewed Caliber’s, Sterling’s, and Lendsure’s origination and acquisition platforms and found them to have sound underwriting and operational control environments, reflecting industry improvements following the financial crisis that are expected to reduce risk related to misrepresentation and data quality,” Fitch noted. “All loans in the mortgage pool were reviewed by a third-party due diligence firm and the results indicated strong underwriting and property valuation controls.”
Despite those characteristics, the borrowers in this deal are not without their warts.
According to Fitch’s report, approximately 39% of the pool by unpaid principal balance (and 47% by loan count) had one or more prior credit event including foreclosure, bankruptcy, short sale, or deed in lieu of foreclosure.
“Performance data for borrowers that had a mortgage credit event two years prior to obtaining a new mortgage indicated that borrowers with a prior mortgage event were approximately 20% more likely to default on their new mortgage than the entire population of new mortgage borrowers after controlling for credit score,” Fitch said in its report.
Therefore, Fitch and DBRS both applied a higher probability of default to those loans.
As Fitch and DBRS both note, the loans in this deal are not without risk, but the deal itself is structured in a way that warrants (at least in their view) AAA ratings.
Time will tell if this deal is one-of-a-kind, or just the first of its kind.