Foreclosure-rental bonds come to market without ratings

Fri Aug 24, 2012 10:55pm IST

Aug 24 (IFR) - The first so-called real estate owned (REO)-to-rental securitizations in the United States may go ahead without credit ratings, as agencies ponder how to assign grades to the new and potentially risky products.

In the planned deals, real estate and private equity investors would buy up blocks of foreclosed properties and rent them out to borrowers who have been displaced due to their unpaid mortgages. The rental payment streams - and possibly the proceeds from an eventual sale of the properties - would provide payments to bond investors.

"There are unrated deals in the works," said Suzanne Mistretta, a senior director at Fitch.

"Right now investor demand is focused on short-term [two years or less] unrated offerings, but by next year, we could be presented with a new rated transaction. Beyond a two-year average life, investors may want a rating."

Over the past three months, Fitch, S&P, DBRS and Morningstar have each published initial assessments of the potential risks of the new asset class. But no agency has yet published official criteria for the product.

Fitch said that such transactions are unlikely to merit a rating above Single A -- and even that would require sufficient historical rental-payment data or a solid record from the property's operator/manager.

Moody's issued its first report on the subject on Thursday, but said that since it had not seen a formal proposal yet, it was too early to tell exactly what rating it would assign a transaction. However, it noted that even extra credit enhancement would not mitigate a lack of historical rental-payment data, and therefore some transactions might not merit top grades.

"We would like to see the specific underwriting criteria that the operator is using to choose these tenants," Kruti Muni, a Moody's analyst, told IFR.

"Obviously the operators would rely on income information, the existence of security deposits, history of utility payments, etc. The diversity of the geography of the pools of homes is significant as well."

Moody's also said that before assigning a rating, it would need to know detailed information about the operator, and would conduct a review of the operator's performance, its experience and its ability to perform its role in the transaction, which includes determining tenant default rates and re-leasing periods.

S&P, which published its initial thoughts on the idea in May, also would not specify a specific rating ceiling, while Kroll said that it was monitoring the development of the product.

RISKS INVOLVED

The agencies have spoken to numerous market participants interested in the idea, but say no potential issuer has yet presented them with a concrete proposal. However, smaller unrated deals are already being assembled.

Securitization specialists say that Jefferies and Wells Fargo, among other banks, are interested in an early rollout of the product.

Interest in these transactions is rising because the housing market depression has left financial institutions with a large inventory of single-family foreclosed properties. At the same time, demand for family rental homes is rising because mortgage underwriting is tight and many potential buyers do not qualify for mortgages. Other buyers have stayed on the sidelines, waiting for home prices to stabilize.

"Large numbers of displaced homeowners who have defaulted on their mortgages have no choice but to rent," Muni said.

Fitch estimates that, in the non-agency sector alone, distressed inventory -- properties covered by loans that have been delinquent for 60 days or more -- totalled 1.13 million units in June, while government-sponsored entity delinquencies of 60 days or more plus real estate-owned inventory at the end of the first quarter totaled roughly 1.3 million.

OPPORTUNITY KNOCKS?

With the primary private label RMBS market stalled, the financing of family rental properties may provide an alternative investment opportunity for non-agency RMBS buyers.

Several real estate and private equity investors, including a subsidiary of Colony Capital and Waypoint Homes, have started buying blocks of foreclosed properties in the hope of becoming sponsors of such deals. Meanwhile some securitized-debt investors, particularly those who have already bought non-performing loan bonds, have expressed interest in the offerings, the ratings agencies say.

One of the main challenges to completing a rated transaction is clarity on the criteria used by the individual management firms to choose which tenants will live in the transformed properties.

"With FICO scores dropping from foreclosure proceedings, managers are going to have to think outside the box about a tenant's ability to pay," said Jon Van Gorp, a partner at law firm Mayer Brown.

Given their recent record with residential mortgage products, the agencies are cautious before issuing an actual rating, Van Gorp said.

"Rating agencies must work hard to earn back the trust they lost during the credit crisis."

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