Fitch Rates Fannie Mae's Connecticut Ave Securities Series 2013-C01
NEW YORK -- October 24, 2013
Fitch Ratings assigns the following rating and Rating Outlook to Fannie Mae's
inaugural risk transfer transaction, Connecticut Avenue Securities series
--$337,500,000 class M-1 notes 'BBB-sf'; Outlook Stable.
The $337,500,000 class M-2 notes will not be rated by Fitch.
The 'BBB-sf' rating for the M-1 notes reflects the 1.65% subordination
provided by the 1.35% class M-2 notes and the non-offered 0.30% B-H Reference
Tranche. The notes are general senior unsecured obligations of Fannie Mae
(rated 'AAA' Rating Watch Negative by Fitch) subject to the credit and
principal payment risk of a pool of certain residential mortgage loans held in
various Fannie Mae-guaranteed MBS.
Connecticut Avenue Securities 2013-C01 (CAS 2013-C01) is Fannie Mae's
inaugural risk transfer transaction issued as part of the Federal Housing
Finance Agency's Conservatorship Scorecard for 2013 for each of the government
sponsored enterprises (GSEs) to demonstrate the viability of multiple types of
risk transfer transactions involving single family mortgages with at least $30
billion of unpaid principal balance in 2013.
The objective of the transaction is to transfer credit risk from Fannie Mae to
private investors with respect to a $26.8 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 become 180 days delinquent or other credit
events occur, the outstanding principal balance of the debt notes will be
reduced by a pre-defined, tiered loss severity percentage related to those
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 M-1 notes will be based on the lower of: the quality of
the mortgage loan reference pool and credit enhancement available through
subordination and on Fannie Mae's Issuer Default Rating. The M-1 notes will be
issued as uncapped LIBOR-based floaters and will carry a 10-year legal final
KEY RATING DRIVERS
Prime Quality Mortgage Reference Pool: The reference mortgage loan pool for
the transaction consists of high-quality prime mortgages acquired by Fannie
Mae during the third-quarter 2012. The reference pool comprises 112,871 loans
totaling $26.8 billion. Weighted average combined-loan-to-value,
debt-to-income, and credit scores are 75.9%, 31.8%, and 765, respectively. All
loans were underwritten with full documentation. The reference pool also
benefits from significant geographic diversity.
Improved Aggregator Platform: Fannie Mae's risk management/quality control
processes have evolved over time, and some were recently implemented in
conjunction with the rep and warranty framework introduced for loan purchases
this year. However, the majority of the processes were developed following the
crisis and implemented prior to 2013. Based on a comprehensive review of the
platform, Fitch believes that Fannie Mae has a robust lender quality assurance
and loan quality control review platform in place. Fitch applied a modest
reduction to its default expectations to account for the lower risk associated
with the recent acquisitions.
Fixed Loss Severity: One of the unique structural features of the transaction
is a fixed-loss severity schedule that is tied to cumulative net credit
events. If actual loan loss severity is above the set schedule, Fannie Mae
absorbs the higher losses. Fitch views the fixed loss severity positively as
it reduces uncertainty that may be driven by future changes in Fannie Mae loss
mitigation or loan modification policies. The fixed severity also offers
investors greater protection against natural disaster events where properties
are severely damaged and there is limited or no recourse to insurance.
Advantageous Payment Priority: The payment priority of the M-1 class will
result in a shorter life and more stable credit enhancement 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 M-1 class can
receive a full pro rata share of unscheduled principal immediately as long as
a minimum credit enhancement level is maintained. Additionally, unlike PL
mezzanine classes, which lose subordination over time due to scheduled
principal payments to more junior classes, the M-2 and B-H classes will not
receive any scheduled or unscheduled allocations until the M-1 is paid in
full. The B-H class will not receive any scheduled or unscheduled principal
allocations until the M-2 is paid in full.
10-Year Hard Bullet Maturity: The M-1 and M-2 notes benefit from a 10-year
legal final maturity. As a result, any collateral losses on the reference pool
that occur beyond year 10 are borne by Fannie Mae and do not impact the
transaction. Fitch accounted for the 10-year hard bullet window in its default
analysis and applied a 10% reduction to its lifetime default expectations.
Rep and Warranty Gaps: While the loan defect risk for 2013-C01 is notably
lower than for agency and non-agency mortgage pools securitized prior to 2009,
Fitch believes the risk is greater for this transaction than for recently
issued U.S. PL RMBS. Notably, neither Fannie Mae nor an independent third
party will conduct loan file reviews for credit events, and Fannie Mae will
not conduct any reviews of loans from a seller once it has filed for
bankruptcy. Fitch incorporated this risk into its analysis by treating all
historical repurchases as if they were defaulted loans that were not
repurchased. Consequently, the rating analysis includes an assumption that the
loans will experience defect rates consistent with historical rates and that
those defects will not be repurchased.
Solid Alignment of Interests: While the transaction is designed to transfer
credit risk to private investors, Fitch believes the transaction benefits from
solid alignment of interests. Fannie Mae will be retaining credit risk in the
transaction by holding the senior reference tranche A-H, which has 3% of loss
protection, as well as the first loss B-H reference tranche, sized at 30bps.
Fannie is also retaining a 6.6% vertical slice/interest in the M-1 and M-2
Limited Size and Scope of Third-Party Diligence: Only 608 loans in the
reference pool were selected for review by a third-party diligence provider.
This sample selection was also limited to a population of 1,917 loans that had
been previously reviewed by Fannie Mae. Furthermore, third-party due diligence
findings noted 907 compliance findings, which were waived by Fannie Mae due to
its limited post-close loan quality review for compliance. These concerns are
mitigated by Fitch's review of Fannie Mae's risk management and quality
control process/infrastructure, which has been significantly improved over the
past several years.
Special Hazard Leakage: Fitch believes the structure is vulnerable to special
hazard risk as there is no consideration for payment disruptions related to
natural disaster events in the 'credit event' definition. As such, credit
protection in the transaction may be eroded by natural disasters that may
cause extended delinquencies (that may in part be allowed by disaster relief
programs) but where borrowers ultimately cure. Fitch considered this risk in
its analysis and conducted sensitivity analysis and found, based on prior
observed performance in post-natural disaster events including Hurricane
Katrina and the Northridge earthquake, the risk exposure is relatively low.
Receivership Risk Considered: 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 longer 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 it would promote an
orderly administration of Fannie Mae's affairs. Fitch believes that the U.S.
government will continue to support Fannie Mae, as reflected in its 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 M-1 notes' rating affected.
Fitch's analysis incorporates a sensitivity analysis to demonstrate how the
ratings would react to steeper market value declines (MVDs) than assumed at
the state or MSA level. 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. Two sets of sensitivity analyses were
conducted at the state and national level to assess the effect of higher MVDs
for the subject pool.
Historical Economic Data Incorporated in sMVD Projections: In its analysis,
Fitch considered placing a greater emphasis on recent economic performance in
determining MVDs for the pool. While Fitch's current loan loss model looks to
three years of historical data and one year of projections, this does not
incorporate recent notable economic improvement. To reflect the more recent
economic environment, a sensitivity analysis was performed using two years
historical economic data and two years of projections.
California sMVDs: Roughly 27% of the pool is located in California, in areas
with both high and low MVD projections. The MVD projections are key
contributors to Fitch's default assessment of this pool. Fitch conducted
sensitivity analysis assuming sMVDs were 5%, 10%, and 15% higher than that for
California. The sensitivity analysis indicated an impact on ratings for the
Additional Decline in sMVD at the National Level: This set of sensitivity
analysis demonstrates how the rating would react to steeper MVDs at the
national level. The analysis assumes MVDs of 5%, 10% and 15% in addition to
the model-projected 29.8% for this pool. The analysis indicates a rating
impact with a further 5% MVD from the current model projection with further
rating migration for the additional 10% and 15% MVD assumptions.
Key Rating Drivers and Rating Sensitivities are further detailed in Fitch's
accompanying presale report, available at 'www.fitchratings.com' or by
clicking on the above link.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research
--'Connecticut Avenue Securities Series 2013-C01 (October 2013);
--'Connecticut Avenue Securities Series 2013-C01 Representations and
Warranties Presale Appendix' (October 2013);
--'U.S. RMBS Mortgage Loan Loss Model Criteria' (August 2013);
--'U.S. RMBS Originator Review and Third-Party Due Diligence Criteria' (April
--'U.S. RMBS Cash Flow Analysis Criteria' (April 2013);
--'U.S. RMBS Representations and Warranties Criteria' (June 2013);
--'U.S. RMBS Rating Criteria' (July 2013);
--'Global Structured Finance Rating Criteria'(May 2013);
--'Global Rating Criteria for Single- and Multi-Name Credit-Linked Notes'
Applicable Criteria and Related Research:
Connecticut Avenue Securities Series 2013-C01 (US RMBS)
Connecticut Avenue Securities Series 2013-C01 -- Appendix
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Sendhil Selvaraj, +44 (0) 207 682 7218
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