The following classes will not be rated by Fitch:
The 'BBB-sf' rating for the 1M-1 notes reflects the 1.75% subordination provided by the 1.45% class 1M-2 notes and the non-offered 0.30% 1B-H reference tranche. The 'BBB+sf' rating for the 2M-1 notes reflects the 2.40% subordination provided by the 1.75% class 2M-2 notes and the non-offered 0.65% 2B-H reference tranche. The notes are general senior unsecured obligations of Fannie Mae (rated 'AAA'; Outlook Stable 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.
The reference pool of mortgages will be divided into two loan groups. Group 1 will consist of mortgage loans with loan-to-values (LTVs) of less than or equal to 80% while group 2 will consist of mortgage loans with LTVs greater than 80% and less than or equal to 97%. Each loan group has its own loss severity schedule and issued notes. There will be no cross-collateralization. Aside from distinct loss severity schedules, each group's structure will be identical.
The objective of the transaction is to transfer credit risk from Fannie Mae to private investors with respect to a
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 1M-1 and 2M-1 notes will be based on the lower of: the quality of the mortgage loan reference pool and credit enhancement available through subordination; and Fannie Mae's Issuer Default Rating. The 1M-1 and 2M-1 notes will be issued as uncapped LIBOR-based floaters and will carry a 10-year legal final maturity.
KEY RATING DRIVERS
Enhanced Quality Control Process: Starting with the 2013 acquisitions, Fannie Mae implemented further enhancements to its performing loan quality control (QC) framework, which Fitch found to be robust and should reduce the risk of credit events arising from faulty loan origination practices and sunset provisions. Fitch believes that Fannie Mae is an above average aggregator for 2013 acquisitions. As a result, Fitch applied a reduction to its default expectations to account for the lower risk associated with the recent acquisitions.
Market Value Decline Sensitivity: Fitch considered further market value decline (MVD) sensitivities, in addition to those generated by its sustainable home price (SHP) model. These scenarios aligned Fitch's 'Asf' sustainable MVD assumptions with peak-to-trough MVDs experienced during the housing crisis through 2009. The sensitivity analysis, which was factored into Fitch's loss expectations, resulted in applying a sustainable MVD (sMVD) of 14% from 16% for Group 1 and an sMVD of 10% from 11% for Group 2.
Few Due Diligence Findings: The due diligence review resulted in minimal findings. The findings are reflective of the improvements made to Fannie Mae's risk management and QC processes, which have evolved over time, with the majority of the processes developed following the crisis and implemented prior to 2013. The findings also reflect the scope of the due diligence review to better indicate Fannie Mae's QC process.
Fixed Loss Severity: One of the unique structural features of the transaction is a fixed loss severity (LS) schedule tied to cumulative net credit events. If actual loan LS is above the set schedule, Fannie Mae absorbs the higher losses. Fitch views the fixed LS positively, as it reduces the uncertainty that may arise due to future changes in Fannie Mae's loss mitigation or loan modification policies. The fixed severity also offers investors greater protection against natural disaster events where properties are severely damaged, as well as in cases of limited or no recourse to insurance.
Advantageous Payment Priority: The payment priority of M-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 M-1 notes can receive a full pro-rata share of unscheduled principal immediately, as long as a minimum CE 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 in each group will not receive any scheduled or unscheduled allocations until the M-1 class is paid in full. The B-H classes will not receive any scheduled or unscheduled principal allocations until the M-2 class is paid in full.
10-Year Hard Maturity: The 1M-1, 1M-2, 2M-1 and 2M-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 affect the transaction. Fitch accounted for the 10-year hard maturity in its default analysis and applied a 10% reduction to its lifetime default expectations.
Rep and Warranty Gaps: While the loan defect risk for 2014-C02 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.
Rep and Warranty Sunsets: All the loans were acquired by Fannie Mae in 1Q13, which qualifies them for the new rep and warranty framework adopted by Fannie Mae through its regulator, the
Solid Alignment of Interests: While the transaction is designed to transfer credit risk to private investors, Fitch believes the transaction benefits from a solid alignment of interests. Fannie Mae will be retaining credit risk in the transaction by holding the A-H senior reference tranches, which have a loss protection of 3% in Group 1 and 3.75% in Group 2, as well as the first loss B-H reference tranche, sized at 30 bps and 65 bps, respectively. Fannie Mae is also retaining a 5.2% vertical slice/interest in the M-1 and M-2 tranches for Group 1 and 7.75% for Group 2.
Limited Size/Scope of Third-Party Diligence: Only 608 loans of those eligible to be included in the reference pool were selected for a full review (credit, property valuation and compliance) by a third-party diligence provider. Of the 608 loans, 459 were part of this transaction's reference pool (347 in Group 1 and 112 in Group 2). An additional 608 loans were selected for a property-valuation-only review. Of this population, 472 were part of this transaction's reference pool (356 in Group 1 and 116 in Group 2). The sample selection was limited to a population of 5,572 loans that were previously reviewed by Fannie Mae and met the reference pool's eligibility criteria. Furthermore, the third-party due diligence scope was limited to reflect Fannie Mae's post-close loan review for compliance. Fitch's review of Fannie Mae's risk management and QC process/infrastructure, which has been significantly improved over the past several years, indicates a robust control environment that should minimize loan quality risk.
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 (which may, in part, be allowed by disaster relief programs) but of which borrowers ultimately cure. Fitch considered this risk in its analysis, conducted sensitivity analysis and found, based on prior observed performance in post-natural disaster events (including Hurricane Katrina and the Northridge Earthquake), that the risk exposure is relatively low.
Receivership Risk Considered: Under the Federal Housing Finance Regulatory Reform Act, 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
Fitch's analysis incorporates sensitivity analyses to demonstrate how the ratings would react to steeper market value declines (MVDs) than assumed at both the 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 market value declines at the national level. The analysis assumes market value declines of 10%, 20%, and 30%, in addition to the model projected 31% and 27% for group 1 and group 2, respectively. 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 MVD of 9% would potentially reduce the rated class 1M-1 and 2M-1 down one rating category.
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 link.
Additional information is available at 'www.fitchratings.com'.
--'U.S. RMBS Mortgage Loan Loss Model Criteria' (
--'U.S. RMBS Originator Review and Third-Party Due Diligence Criteria' (
--'U.S. RMBS Cash Flow Analysis Criteria' (
--'U.S. RMBS Representations and Warranties Criteria' (
--'U.S. RMBS Rating Criteria' (
--'Global Structured Finance Rating Criteria' (
--'Global Rating Criteria for Single- and Multi-Name Credit-Linked Notes' (
--'Connecticut Avenue Securities Series 2014-C02 Representations and Warranties Presale Appendix' (
Source: Fitch Ratings
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