The following classes will not be rated by Fitch:
The 'A-sf' rating for the M-1 notes reflects the 4.10% subordination provided by the 1.55% class M-2 notes, the 1.80% class M-3 notes and the non-offered 0.75% B-H reference tranche. The 'BBB-sf' rating for the M-2 notes reflects the 2.55% subordination provided by the 1.80% class M-3 notes and the non-offered 0.75% B-H reference tranche. The notes are general unsecured obligations of Freddie Mac (rated 'AAA'/Rating Outlook Stable by Fitch) subject to the credit and principal payment risk of a pool of certain residential mortgage loans held in various Freddie Mac-guaranteed MBS.
STACR 2014-HQ1 is Freddie Mac's sixth risk transfer transaction issued as part of the
The objective of the transaction is to transfer credit risk from Freddie Mac to private investors with respect to a
While the transaction structure simulates the behavior and credit risk of traditional RMBS mezzanine and subordinate securities, Freddie Mac will be responsible for making monthly payments of interest and principal to investors. Because of the counterparty dependence on Freddie Mac, Fitch's expected rating on the M-1, M-1F, M-1I, M-2, M-2F, M-2I and M-12 notes will be based on the lower of: the quality of the mortgage loan reference pool and credit enhancement available through subordination; and Freddie Mac's issuer default rating. The M-1 and M-2 notes will be issued as uncapped LIBOR-based floaters and will carry a 10-year legal final maturity.
KEY RATING DRIVERS
Special Hazard Risk Mitigated: Freddie Mac recently introduced to its STACR DN3 transaction an 18-month grace period for delinquent borrowers who experience a natural disaster and are placed in a forbearance plan by the servicer, which is also applicable to this transaction. Fitch views this enhancement positively, as it reduces the risk of eroding credit protection for temporary borrower delinquencies arising from natural disasters that typically cure, but possibly after 180 days of delinquency.
Seller Insolvency Risk Addressed: Freddie Mac will conduct QC reviews on all loans that experience a credit event, irrespective of the seller's insolvency, as long as the rep and warranty period has not sunset. Effective
Market Value Decline Sensitivity: Fitch considered 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 (sMVD) 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 sMVD of 9% from 10%.
Solid Lender Review and Acquisition Processes: Fitch found that Freddie Mac has a well-established and disciplined process in place to purchase loans and views its lender-approval and oversight processes for minimizing counterparty risk and ensuring sound loan quality acquisitions as positive. Loan QC review processes are thorough and indicate a tight control environment that limits origination risk. Fitch has determined Freddie Mac to be an above-average aggregator for its 2013 and later product. Fitch accounted for the lower risk by applying a lower default estimate for the reference pool.
Few Findings in Third-Party Diligence: While only 850 loans were selected for review by a third-party diligence provider, the results indicated limited findings or were deemed as nonmaterial by Fitch. The overall results reflect Freddie Mac's tight control over the documentation and loan-delivery process.
Eminent Domain Risk Mitigated: The STACR series 2014-HQ1 transaction includes a provision that protects investors against eminent domain risk. Loans will be removed from the reference pool if they are seized pursuant to any special eminent domain proceeding brought by any federal, state or local government.
Fixed Loss Severity: The transaction's fixed LS schedule tied to cumulative net credit events is a positive feature, as it reduces uncertainty that may be driven by future changes in Freddie Mac's loss mitigation or loan modification policies and offers investors greater protection against natural disaster events where properties are severely damaged with limited or no recourse to insurance. If the actual loan LS is above the set schedule, Freddie Mac absorbs the higher losses.
Advantageous Payment Priority: The payment priority of the M-1 class 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 class can receive a full pro-rata share of unscheduled principal immediately, as long as a minimum CE level is maintained and the net cumulative credit event is within a certain threshold. Additionally, unlike PL mezzanine classes, which lose subordination over time due to scheduled principal payments to more junior classes, the M-2, M-3 and B-H classes will not receive any scheduled or unscheduled principal allocations until the M-1 class is paid in full. The B-H class will not receive any scheduled or unscheduled principal allocations until the M-3 class is paid in full.
10-Year Hard Maturity: M-1, M-2 and M-3 notes benefit from a 10-year legal final maturity. As a result, any credit events on the reference pool that occur beyond year 10 are borne by Freddie Mac and do not affect the transaction. Fitch accounted for the 10-year hard maturity window in its default analysis and applied a 10% reduction to its lifetime default expectations.
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. Freddie Mac will retain credit risk in the transaction by holding the senior reference tranche A-H, which has 6.50% of loss protection, as well as the first-loss B-H reference tranche, sized at 75 basis points (bps). Initially, Freddie Mac will retain an approximately 20% vertical slice/interest in the M-1, M-2 and M-3 tranches but may re-insure at the most 15% in the future.
Receivership Risk Considered: Under the Federal Housing Finance Regulatory Reform Act, FHFA must place Freddie Mac into receivership if it determines that Freddie Mac's assets are less than its obligations for longer than 60 days following its
Fitch's analysis incorporates sensitivity analyses to demonstrate how the ratings would react to steeper MVDs than assumed at both the metropolitan statistical area (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 MVDs at the national level. The analysis assumes market value declines of 10%, 20%, and 30%, in addition to the model projected 31% at the 'A-sf' level and 26% at the 'BBB-sf' level. 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 MVDs of 9%, 15% and 36% would potentially reduce the 'A-sf' rated class down one rating category, to non-investment grade, and to 'CCCsf', respectively.
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'.
--'Global Rating Criteria for Single- and Multi-Name Credit-Linked Notes' (
--'Global Structured Finance Rating Criteria' (
--'Counterparty Criteria for Structured Finance and Covered Bonds' (
--'U.S. RMBS Master Rating Criteria' (
--'U.S. RMBS Loan Loss Model Criteria' (
--'U.S. RMBS Cash Flow Analysis Criteria' (
--'Rating Criteria for U.S. Residential and Small Balance Commercial Mortgage Servicers' (
--'U.S. RMBS Surveillance and Re-Remic Criteria' (
--'Structured Agency Credit Risk Debt Notes, Series 2014-DN3 Representations and Warranties Presale Appendix' (
Global Structured Finance Rating Criteria
Structured Agency Credit Risk Debt Notes, Series 2014-DN3 (US RMBS)
Structured Agency Credit Risk Debt Notes, Series 2014-DN3 - Appendix
U.S. RMBS Surveillance and Re-REMIC Criteria
U.S. Residential and Small Balance Commercial Mortgage Servicer Rating Criteria -- Effective
U.S. RMBS Cash Flow Analysis Criteria
U.S. RMBS Loan Loss Model Criteria
U.S. RMBS Master Rating Criteria
Counterparty Criteria for Structured Finance and Covered Bonds
Source: Fitch Ratings
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