REO-to-Rental Securitization Credits Below Triple-A: Fitch

Fitch Ratings would “likely cap its ratings at the ‘A’ level” for REO-to-rental securitizations. That is because single-family home rental assets still haven’t surmounted the challenges for gaining higher investment grade ratings.

Blackstone and Deutsche Bank are likely to begin marketing the first securitization of single-family home rental properties before the year’s end. The deal is expected to garner a senior rating that is rumored to be as high as a triple-A, according to several market reports.

Fitch, however, believes that it’s too soon to talk triple-A for the asset class despite the “near-record low rates and investor yield requirements” driving demand for the underlying SFR assets in the short term.

“Insufficient history along with a number of structural challenges prevents Fitch from considering AAA ratings on single-family rental securitizations at this time,” analysts said in a report Tuesday.

The ratings agency reiterates the same points it highlighted in an Aug. 2012 report. The issue still at hand is the lack of performance history for the asset class and business models/strategies that “have not been tested under a down cycle.”

“Although some firms have a few years’ operating history, most do not have a proven track record managing outside their footprint or on a large-scale basis,” says Fitch.

A number of operators have concentrated their investments in a handful of states and metropolitan statistical areas, Fitch says. This level of targeting by institutional buyers “and the inelasticity of rents” makes transactions “highly vulnerable to unknown variables that could potentially impact the cash flows and yields.”

Another concern is that under stress scenarios the asset class might be exposed to refinancing risk. “If liquidations are needed to pay off a bond at maturity, retail sales may be the only exit strategy,” said Fitch. “The impact of a large scale listing at the neighborhood level could have a significant impact on market clearing prices.”

Fitch also believes investors' security interest in the SFR homes could impact recovery upon enforcement.

Mortgages provide investors with first lien and perfected security interest in the actual homes. On the other hand, an equity pledge structure, which would be used for REO-to-rental securitization, limits recovery to the sponsors' equity in their investment.

“Should a transaction underperform or face refinancing challenges at maturity, sponsors subject to potential enforcement may be more likely to consider bankruptcy protection,” said Fitch. Under this scenario, if the sponsor is allowed “to incur post-petition debt secured by the properties, the value of the sponsors' equity and investors' recovery prospects diminishes.”