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Fitch says too soon for top rating on SFR deals

Charles Williams and Adam Tempkin
Tuesday, 29 Oct 2013 | 11:59 AM ET

NEW YORK, Oct 29 (IFR) - Fitch said Tuesday that it will not consider giving its highest AAA rating to securitized products based on single-family rentals (SFR), as the first such deal gets ready to come to market.

With institutional investors buying up large swathes of single-family properties in the wake of the financial crisis, the rating agency has received numerous inquiries about transactions underpinned by these properties.

Blackstone is marketing the very first such deal - an ABS backed by home-rental income - starting on Wednesday. Deutsche Bank (structuring lead), Credit Suisse and JP Morgan will be pitching the deal at investor meetings in New York, Boston, and Los Angeles this week.

The US$500m Invitation Homes 2013-SFR1 transaction will be rated by Kroll, Morningstar and Moody's, and will receive at least one Triple A rating - a fact that shocked some investors relying on numerous rating agency reports over the past year that indicated a first-time REO-to-rental deal would never reach a rating higher than Single A.

Fitch, which was not ultimately chosen to rate the transaction, stuck to its guns, asserting that such deals do not deserve a Triple A.

"While near-record low rates and investor yield requirements are likely to drive demand for the underlying SFR assets in the short term, Fitch reiterates that several notable challenges would prevent the agency from assigning high investment grade ratings to transactions backed by SFR collateral," the agency said in a new report.

"Fitch would more likely cap its ratings at the A level."

The agency also noted that there were also concerns about investors buying up single-family properties en masse in just a handful of states and metropolitan areas.

"Because of the specific demographic targeted by these institutional buyers and the inelasticity of rents, transactions are highly vulnerable to unknown variables that could potentially impact the cash flows and yields. Among them include repair and maintenance expense, capital expenditures, rising property taxes, homeowners association restrictions, or the potential for municipality involvement."

In stress scenarios, the rating agency expressed apprehension over refinancing risk or the absence of a bulk purchaser.

Fitch said that if liquidations are needed to pay off a bond at maturity, retail sales might be the only exit strategy. The impact of a large scale listing at the neighborhood level could have a significant impact on market clearing prices.

Many participants believe a decline in rental demand would be offset by an increase in retail buyer demand, but Fitch believes it is difficult to say that this would be the case with enough certainty to warrant a AAA rating.

In addition, Fitch also says that while some participants have the wherewithal to withstand declining rents or rising costs, none have fully demonstrated their commitment to this asset class as yet, and that could leave investors shouldering a disproportionate amount of risk.

While mortgages provide investors with first lien and perfected security interest in the actual homes, an equity pledge structure limits recovery to the sponsors' equity in their investment.

According to Fitch, "Should a transaction underperform or face refinancing challenges at maturity, sponsors subject to potential enforcement may be more likely to consider bankruptcy protection. If a bankruptcy court allows the sponsor to incur post-petition debt secured by the properties, the value of the sponsors' equity and investors' recovery prospects diminishes."

Given the incremental risk associated with transactions secured only by the sponsors' equity, Fitch would likely cap ratings at the BBB category, absent mitigating factors.

(Reporting by Charles Williams and Adam Tempkin; Editing by Marc Carnegie)