A newly revived residential mortgage-backed securities (RMBS) market has not only begun to flourish over the past couple of years but also to evolve with new features that according to Kroll Bond Rating Agency (KBRA) “merit additional consideration from a credit standpoint.”
Both the prime and non-prime RMBS markets have experienced a reinvigoration over the past two years with private label securities issuances scaling to $50 billion in 2017. That’s up from just $18.8 billion in 2016 and $29.3 billion in 2017, according to KBRA in a report released recently.
This is a significant change from just three years ago in 2015 when, KBRA says, “prime issuance was nearly non-existent, and in 2016, prime sponsors were exiting the market, not accessing it.”
The most active newcomers to the RMBS market are Flagstar Bank, which issued eight RMBS transactions in 2017; Invictus Capital Partners, which issued six; and American International Group, Inc. (AIG), which issued four. KBRA expects these institutions to continue their role in the RMBS market. The non-QM market experienced increased activity with risk retention from Redwood Trust, Galton Funding, Neuberger Berman, Starwood Property Trust, and Annaly Capital Management, Inc.
KBRA attributes some of the growth in RMBS issuances to tightening spreads, investor acceptance of alternative loan products, and “to the surprise of many participants,” growth in agency-eligible collateral.
The reinvigorated RMBS market has changed from pre-crisis days though. Three key differences in today’s transactions are the inclusion of stop advance provisions, variable servicing fees, and alternative documentation.
Stop advance provisions prevent servicers from advancing interest on delinquent loans after a set time, often 120 days. This feature generally leads to a “significant increase in ultimate principal recovery as well as a commensurate decrease in current interest paid to certificate holders,” according to KBRA.
Pre-crisis RMBS transactions typically featured set servicing fees, and often the fees were in excess of the servicing costs. “The desire for more efficiency and the potential for higher investor yield led to the development of variable servicing fee structures,” according to KBRA, which noted both “advantages and drawbacks to this fee structure.”
Alternative documentation also has its pros and cons. They allow for self-employed and non-traditional wage earners to enter the market, but KBRA offers a note of caution. Not all alternative documentation programs are alike, and each should be examined and considered thoughtfully.
When it comes to income duration or asset qualification, “less robust methods likely involve higher ATR claim risk,” KBRA stated.