Ratings agencies spar over SFR securitization risk

Fitch Ratings is raising another red flag on single-borrower, single-family rental securitizations in its latest clash with the methodologies of its competitors.

The ratings agency distributed an article last week explaining why it has not yet rated any SFR securities. In the article, titled “US Single-Family Rental Deals Face Higher Refinance Risk,” authored by managing director Daniel Chambers and senior director Rob Rowan, Fitch said it would cap SFR securities with an ‘A’ rating due to “elevated cash flow leverage, refinance risk and dependence on property liquidation for debt repayment.”

Meanwhile, other ratings agencies – most recently Kroll Bond Rating Agency on the latest SFR deal from American Homes 4 Rent last week – continue to award the securities’ top tranches their ‘AAA’ rating.

A critic of the relatively new – but exponentially growing – asset class since its inception in 2012, Fitch has now issued multiple reports and statements warning of the risks of SFR deals. Unlike RMBS, which are typically backed by non-income producing owner-occupied residential properties, SFR securities are backed by income-producing rental homes.

“Unlike traditional RMBS loans, SFR transactions do not fully amortize, exposing issuers to term as well as maturity risk,” Fitch stated. “Term default risk is mitigated by the currently low interest rates and interest rate caps. However, loans with balloon payments will default at maturity if not refinanced.”

Fitch claimed other agencies “justify elevated leverage with current property values and the likelihood of repayment through the foreclosure and sale of the properties,” which “may persuade market participants to materially underestimate maturity default risk and the issuers’ ability to refinance.”

“Given the leverage on SFR transactions, it is unlikely a secured lender would refinance the current debt, absent significant improvement in property cash flow,” it went on.

But that isn’t so, said Nitin Bhasin, a managing director with Kroll Bond Ratings Agency, who noted a range of lenders – and growing interest among them – willing to refinance the deals. In addition, he said Fitch is comparing the SFR asset class to “pure” CMBS and RMBS products, when in fact it is neither.

“This product is truly a hybrid product,” he said. “I think it’s flawed to look at it through a pure RMBS lens and flawed to look at it through a pure CMBS lens. These have risks of RMBS and CMBS, but they also have benefits of both.”

Cash flows do not drive values of rental homes to the extent that they do with commercial assets, he said. And, while the assets may in fact have lower debt yields and not benefit from the same cash flow as some asset types, the residential real estate market is a “larger, deeper more liquid market than CMBS.”

On the same day Fitch blasted the asset class KBRA issued a pre-sale report on the latest SFR deal – the second offering from American Homes 4 Rent, backed by a $513.3m loan – awarding the $314m top tranche its ‘AAA’ rating. The issuance marks the ninth SFR deal and brings the total size of the asset class to more than $4.9bn.

Ironically, while a majority of previous deals did not amortize and were backed by five-year floaters, the latest SFR offering is backed by a 10-year fixed rate loan, at a 68% loan-to-value (vs. a 72-73% average on previous offerings), meaning the loan would ultimately amortize to a 58% LTV, which is by-far the lowest refinance LTV among all the SFR securitizations to date, Bhasin noted.

In addition to Fannie Mae, a growing list of large banks across the country, special refinance companies, and the bond markets are among the lending entities willing to finance SFR properties, he added.

“This is rapidly becoming a deeper securitization market and will afford borrowers the ability to refinance, but should that not occur the loan can be restructured and/or the properties can be liquidated. But liquidation and restructuring are not intended to be the expected case, they are intended to be stress cases, as is generally true with any structured finance transaction.”