Methodology For Rating And Surveilling U.S. Tax Lien Securitizations

Transcription

1 Criteria Structured Finance RMBS: Methodology For Rating And Surveilling U.S. Tax Lien Securitizations Primary Credit Analyst: Jeremy Schneider, New York (1) ; Secondary Contacts: Mark M Risi, New York (1) ; mark.risi@standardandpoors.com Farooq Omer, CFA, New York (1) ; farooq.omer@standardandpoors.com Criteria Officer - US RMBS: Ted J Burbage, New York (1) ; ted.burbage@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF CRITERIA UPDATE IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION U.S. TAX LIEN TRANSACTION NEW ISSUANCE RATING METHODOLOGY Legal Review Collateral Analysis Redemptions Ratings Analysis Of Property Valuations DECEMBER 16,

2 Table Of Contents (cont.) Environmental Risk Working Capital Account Write-Offs Subsequent Tax Liens Foreclosures Structure Servicing Quality U.S. TAX LIEN TRANSACTION SURVEILLANCE METHODOLOGY Estimation Of Projected Losses Liens On Foreclosed Properties Outstanding Liens Bankruptcy And Forbearance Ratings Adjustment Of The Affected Classes Size Of Funds And Servicer Quality APPENDIX: STANDARD & POOR'S TAX LIEN FORMAT RELATED CRITERIA AND RESEARCH DECEMBER 16,

3 Criteria Structured Finance RMBS: Methodology For Rating And Surveilling U.S. Tax Lien Securitizations (Editor's Note: We originally published this criteria article on Dec. 16, We're republishing it following our periodic review completed on Feb. 12, As a result of such review, we made the following changes: (1) updated paragraph 22 to provide that we "may" review the tax assessor's office for purposes of property valuations in our analysis; (2) updated paragraph 31 to indicate when a working capital account may not be necessary; (3) updated paragraph 37 and the appendix to reference core based statistical areas in lieu of metropolitan statistical areas; (4) updated paragraph 42 regarding our assessment of servicing quality; (5) clarified in paragraph 43 that the servicing fee relates to tax liens; (6) updated paragraph 52 regarding our analysis when lien-level data is not available; and (7) updated criteria references and contact information.) 1. Standard & Poor's Ratings Services is refining and adapting its methodology for rating U.S. tax lien securitizations. We are publishing this article to help market participants better understand our approach to reviewing U.S. tax lien securitizations. This article is related to our criteria article "Principles of Credit Ratings," published Feb. 16, U.S. municipalities impose tax liens on real estate for the non-payment of property taxes, assessments, sewer rents, and water rents. The liens can be removed only when the delinquent tax liens, including all interest and penalties, are paid in full, through: Voluntary redemption by the property owner; Write-off by the tax lien holder; or Foreclosure and liquidation. 3. Typically, the tax lien holder cannot start foreclosing on the property until a set redemption period expires. 4. When a property's tax lien-to-value ratio (LTV) is very low, we believe the property owner has an incentive to repay the tax lien quickly to avoid additional penalties. In periods of economic stress, we have seen that fewer tax liens are redeemed and a larger number are repaid through foreclosure and liquidation. Since tax liens are generally senior to other claims against real property (with the exception of previously imposed federal tax liens), loan servicers would have an incentive to pay tax liens on mortgaged properties as escrow advances to avoid having a tax lien imposed on the property. By avoiding the creation of tax liens, the mortgagee maintains first right to foreclose on the property. 5. Because of the great disparity among jurisdictions regarding how they impose and administer tax liens, both the collateral and legal analysis of tax liens varies greatly by jurisdiction. SCOPE OF THE CRITERIA 6. Standard & Poor's is updating its criteria for U.S. tax lien securitizations to clarify several areas. Notable changes include: We now use historical performance to assess the lien redemption rates. The redemption rates that we previously used in our criteria serve as a cap on our updated redemption rate DECEMBER 16,

4 assumptions. We are introducing redemption haircuts when the historical performance is worse than our cap on redemptions. We base the haircut on the 'B' rating scenario on the historical redemption performance. We apply new rating scenario multiples to the redemption haircuts. We have updated the redemption bucket balance thresholds to account for our estimate of inflation. We now use the tax lien's historical performance to assess the lien write-off rates. The write-off rates that we previously used in our criteria are now a floor for our updated write-off rate assumptions. The minimum size of the working capital accounts we look for now depend on the rating scenario. We introduce new broker price opinion (BPO) haircuts that are tied to the underlying property value. We clarify our minimum ratings for liquidity providers. We clarify our approach to minimum servicing fees and the inclusion of backup servicers. SUMMARY OF CRITERIA UPDATE 7. This article supersedes,"tax Lien Rating Criteria Developed," published Sept. 25, 1995; "Tax Liens Revisited," published Oct. 18, 1996; and "New Assets 1998: Securitizing Municipal Revenues," published March 1, IMPACT ON OUTSTANDING RATINGS 8. These criteria changes could either have no impact or increase the minimum loss coverage levels for some transactions, depending on the historical performance information that we receive. EFFECTIVE DATE AND TRANSITION 9. These criteria are effective immediately for all new and outstanding tax lien transactions. U.S. TAX LIEN TRANSACTION NEW ISSUANCE RATING METHODOLOGY 10. Standard & Poor's considers the following factors when analyzing tax lien securitizations at issuance. Legal Review 11. For each tax lien securitization, Standard & Poor's reviews the laws applicable to the pool, including, but not limited to, laws relating to tax lien redemption; tax lien transfer and collection; the foreclosure process; bankruptcy proceedings; statutes of limitations; notification requirements; homestead laws; and tax appeals. 12. If the pool of tax liens under review includes tax liens from multiple states, Standard & Poor's will review the laws of each of the relevant states. DECEMBER 16,

5 Collateral Analysis 13. Our analysis of the collateral includes a projection of the tax liens that we believe will be: Redeemed in full; Written off for anticipated environmental issues or because the balance of the tax lien is very low; or Foreclosed upon and liquidated. 14. We assume that all the tax liens that are neither redeemed nor written off will be foreclosed. Redemptions 15. Based on our review, we believe the following factors influence the likelihood of redemption before foreclosure: lien-to-value; balance of the tax lien; age of the tax lien; and property type. When analyzing a pool, Standard & Poor's divides the pool into six buckets. We place each tax lien into a bucket according to its combined lien-to-value ratio, balance, and age. Before placing a tax lien into a bucket, we stress the combined lien-to-value ratio to take into account our projected market value decline for the specific rating scenario. Tables 1 and 2 show the buckets for residential and commercial properties, respectively. We have updated the balance thresholds for buckets 1-3 and added buckets 5 and 6. Table 1 Tax Lien Buckets For Residential Properties Bucket Age (months) CLTV after market value decline stress (%) Balance ($) Comment 1 <=36 <=10 >1,500 All three conditions required 2 <=60 <=20 >1,500 All three conditions required 3 <=96 <=35 >750 All three conditions required 4 >96 >35 N/A Either of the two conditions required 5 N/A >50 N/A 6 N/A >65 N/A CLTV--Combined lien-to-value. N/A--Not applicable. Table 2 Tax Lien Buckets For Commercial Properties Bucket Age (months) CLTV after market value decline stress (%) Balance ($) Comment 1 <=36 <=5 >1,500 All three conditions required 2 <=60 <=15 >1,500 All three conditions required 3 <=96 <=25 >750 All three conditions required 4 >96 >25 N/A Either of the two conditions required 5 N/A >50 N/A 6 N/A >65 N/A CLTV--Combined lien-to-value. N/A--Not applicable. 16. Each bucket includes tax liens that have different risk profiles and, as a result, exhibit different levels of expected DECEMBER 16,

6 redemptions. We generate expected redemption rates for each rating scenario, where the highest rating scenario assumes the lowest redemption rate, thereby forcing a higher number of tax liens to foreclosure and liquidation. We base our expected redemption rates upon historical redemption information for a cohort of tax liens that are under the same jurisdiction and serviced in the same manner. We consider a tax lien as being redeemed if the full redemptive value, as well as any interest or penalty, is paid. 17. For each pool, Standard & Poor's will request historical performance information so that we can assess our expected redemption rates. We request performance information for tax liens in the same jurisdiction and serviced by the same servicer as the tax liens that will serve as collateral for the proposed transaction. We also request that the historical performance history covers a period that is at least as long as the redemption period plus the typical foreclosure time for the specific state. If all of this information is not available, we will review the information provided and take what we consider to be a conservative approach that takes into account the extent of the data available. The Appendix shows a template of the data we request so that we are able to conduct our analysis. 18. The difference between the historical performance and the maximum redemption rates for the 'B' rating will determine the haircut for the 'B' rating category. We then apply rating category multiples to the haircuts, and we compare them to our caps (see table 3). Table 3 Haircut Multiples By Rating Category Rating category Multiple AAA 7.0 AA 5.0 A 4.0 BBB 2.5 BB 2.0 B For example, if the historical redemptions for bucket 1 show that only 90% of the lien balances have been redeemed, and since the 'B' maximum redemption rate for bucket 1 is 100%, the haircut on the 'B' is 10% and the 'B' redemption rate 90%. 20. Since the 'AAA' haircut multiple is seven times the 'B' haircut, the 'AAA' haircut is 70%. The resulting redemption of 30% is lower than the maximum redemption of 85%, so we would use a 30% redemption rate for the AAA category (see table 4). Table 4 Maximum Redemption Percentages By Rating Category Maximum redemption percentages (%) Bucket Rating category AAA AA A DECEMBER 16,

7 Table 4 Maximum Redemption Percentages By Rating Category (cont.) BBB BB B We do not give credit to tax liens from borrowers who are in bankruptcy proceedings, because we believe the outcomes of those proceedings are unpredictable. Ratings Analysis Of Property Valuations 22. If the property valuation given is based on the municipality's tax assessment, Standard & Poor's may conduct a review of the tax assessor's office. We will review the following factors, among others: Frequency of the property assessment; Type of information collected; Valuation methods; Internal audit procedure; and Assessors' qualifications. 23. Depending on the results of our ratings analysis, we might also seek independent valuations. 24. In the past, Standard & Poor's discounted the BPOs by 5% to 25% to account for the subjective nature of BPOs. More recently, we have analyzed historical BPOs and compared them to sale prices. Our study showed that lower value properties, as determined by the BPO, exhibited a greater disparity between the property's BPO and its ultimate sale price. To account for this, we will apply haircuts that depend on the property value to BPOs. Consistent with our analysis of nonperforming collateral, we only use BPOs that are less than six months old. Table 5 shows the haircuts for each BPO. Table 5 Haircuts By Broker Price Opinion (BPO) BPO ($) Haircut (%) Over 150, , , Under 50, If the type of property valuation provided was neither an assessment made by the municipality that created the lien nor a BPO, we will assess the quality of the methodology used and the resulting haircut on a case-by-case basis. Environmental Risk 26. If the servicer forecloses on property on behalf of the trust and the trust takes title to a property that carries a tax lien, the trust may become liable for any potential environmental damages. Standard & Poor's ratings analysis will expect DECEMBER 16,

8 the servicer, before foreclosing on property, to review a third-party Phase I environmental assessment to evaluate whether the trust is protected from such an eventuality; and we expect that a servicer will not foreclose on property on behalf of the trust if the servicer expects expenses to exceed collections. 27. Since a Phase I environmental inspection involves what we consider to be a significant cost, Standard & Poor's will typically look for either a minimum rating on the servicer or a working capital account. If the transaction relies upon liquidity provided by the servicer, we expect the servicer's rating to be consistent with the standards set forth in our counterparty criteria, "Counterparty Risk Framework Methodology And Assumptions," published June 25, According to these criteria, for a direct support counterparty to participate in a 'AAA' rated transaction, the minimum rating is a short-term rating of 'A-1' or a long-term rating of 'A+', if it has no short-term rating. 28. If the servicer's rating is not consistent with our counterparty criteria, then we will typically seek hard credit support in the form of a working capital reserve fund to cover the expenses. Working Capital Account 29. The servicer might determine that some administrative expenses are necessary to pursue collection, foreclose, maintain (real estate owned) REO properties, or maintain the seniority of a tax lien. We consider whether a working capital account is large enough to cover administrative expenses that we project may arise, including: Court filing fees; Property inspections and appraisal costs; Phase I environmental cleanup costs; Title and lien search fees; Notification expenses; Maintenance and insurance costs; Legal costs and fees; and Referee fees. 30. Standard & Poor's will ask for an estimate for the administrative expenses related to a tax lien, and compare it with our estimated foreclosure costs, which are based upon those used in our loss severity assumptions for U.S. residential mortgage-backed securities (RMBS) plus the cost of a Phase I environmental clean-up. 31. We are also introducing rating category-specific stresses to the working capital calculation. Under each rating category stress, we assume that a certain percentage of a pool's tax liens will be redeemed, written-off, or going through foreclosure. The projected administrative expenses under each rating category stress are cumulative over the life of the transaction. The result represents our estimate of the amount necessary if the working capital account is not replenishable. We will compare this number to the proposed size of the working capital account. If the working capital account is replenishable, we will assume the maximum expense in any single period as a percentage of the cumulative lifetime expense to assess the size of the working capital account (see table 6.) We also consider the applicability of a working capital account. An account may not be necessary if the servicer agrees (subject to nonrecoverability) to advance amounts needed to pursue monetary recoveries from the liens. DECEMBER 16,

9 Table 6 Maximum Expense By Rating Category Rating category Maximum expense in any single period (%) AAA 75 AA 60 A 50 BBB 40 BB 30 B 25 Write-Offs 32. From each tax lien servicer in a transaction, we will request historical write-off experience, which we will compare to our floors. Each bucket, as defined in tables 1 and 2, has a floor that reflects its risk profile. For example, in our view, the existence of an environmental issue could be an incentive not to redeem the tax lien, so the write-off percentages are higher for the lower quality redemption buckets (see table 7). Table 7 Write-Off Percentages By Bucket Bucket Write-offs (%) Subsequent Tax Liens 33. Each jurisdiction has its own way of handling subsequent tax liens. These include: The older the tax lien, the more subordinate it is; The older the tax lien, the more senior it is; or All tax liens are pari passu, regardless of when they were assessed. 34. Standard & Poor's takes the policies of a property's jurisdiction into consideration when rating tax lien securitizations. 35. If subsequent tax liens will take priority over the securitized tax liens, we will use the most stressful potential total tax lien liability, pursuant to our assumptions, through liquidation to estimate the foreclosure costs. We use each property's tax rate, assessment frequency, and our assumptions for the length of the foreclosure period to estimate the amount of subsequent tax liens. 36. If subsequent taxes must be paid to preserve the right to foreclose, Standard & Poor's will assume potential delays in the timing of a property's liquidation, and we may look to additional protection in the form of either cash reserves or a liquidity provider that satisfies our counterparty criteria, "Counterparty Risk Framework Methodology And Assumptions," published June 25, DECEMBER 16,

10 Foreclosures 37. For tax liens that we assume will go through the foreclosure process, we assess the risk that the liquidation value will be less than the total foreclosure and liquidation costs. In determining our assumed liquidation value, we first apply market value decline assumptions, which we base on those used in our loss severity assumptions for U.S. RMBS, to the property's assessed values. Our market value decline assumptions are rating category-specific and are more stressful for the higher rating categories. In addition, we assume a core based statistical area (CBSA)-specific housing volatility index, which is also based upon our loss severity assumptions for U.S. RMBS. In some cases, tax liens are placed on vacant land or gas stations. In these cases, we will apply our commercial mortgage-backed securities (CMBS) market value decline assumptions for land, which are the most stressful. 38. In addition to our assumed liquidation value, we estimate the total accrued tax lien liability and the foreclosure costs. Our estimate of the total accrued tax lien liability takes into account the potential subsequent tax liens that would rank senior or pari passu to the securitized tax lien, as well as the interest accrued on the securitized and subsequent tax liens through liquidation. We base our estimate of the value of accrued tax liens upon each property's tax rate and frequency of tax assessment through liquidation. The foreclosure costs are state-specific and are based upon those used in our loss severity assumptions for U.S. RMBS plus the cost of a Phase I environmental assessment. Again, if the historical expenses per tax lien are higher than our base case assumption, we will use the higher expenses. 39. If we estimate that the liquidation of the property may result in a loss, our ratings analysis will look for a corresponding increase in the credit enhancement for that rating scenario. Structure 40. We analyze the structure proposed by the issuer under our various rating stresses. For pro rata structures, we apply additional stresses to account for the leakage of principal payments to subordinated notes. 41. Since tax liens do not provide a source of scheduled payments for the trust, we will evaluate the transaction's ability to pay timely interest on the bonds in the absence of the recovery of tax liens, either through the use of a reserve fund or a liquidity provider. If a transaction relies upon a reserve fund to pay timely interest on the notes, we expect that the fund will be sized to cover at least three months' worth of interest at the time of closing or six months of current interest. If the timely payment of interest is guaranteed by an advancing facility from an institution, we consider whether the institution satisfies our counterparty criteria, "Counterparty Risk Framework Methodology And Assumptions," published June 25, Servicing Quality 42. Standard & Poor's assesses and reviews the adequacy of the operational capabilities of the servicer as part of its rating analysis for tax lien transactions. For any transactions for which we have not already reviewed the servicer, we may conduct a review of the servicer's operations. We also consider the tax lien securitization's operational risk, including DECEMBER 16,

11 operational risk related to the servicer (see "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published Oct. 9, 2014). 43. Since we believe that few servicers are capable of servicing securitized tax liens, Standard & Poor's will assess the risk that a replacement for the servicer will need to be found. We will consider whether the transaction documents provide for a backup servicer and whether the servicing fee is sufficient relative to our minimum standard of 1% per annum of the outstanding collateral. We will also take into consideration the quality of the collateral, the LTV, and the number of liens, to assess whether the servicing fee should be higher than 1% (applicable to tax lien securitizations) to service the pool properly. If a backup servicer is in place, we consider the backup servicer's operational capabilities, as per our approach outlined for the primary servicer in paragraph 42. U.S. TAX LIEN TRANSACTION SURVEILLANCE METHODOLOGY 44. Standard & Poor's follows these guidelines when reviewing previously rated U.S. tax lien securitizations. (The underlying assumptions are predominantly the same as those for the new issue criteria.) We remove liens that are redeemed and liens that have finished the foreclosure and liquidation process from the analysis. We treat liens on properties where the foreclosure process was started separately. We assume that liens in bankruptcy or under forbearance will be written-off at the trust's expense. We treat REO liens the same as we treat liens in foreclosure. We update property values to account for historical changes in price. We then further stress them at what we consider to be the appropriate market value decline assumptions to assess the impact on the adjusted LTV. We continue to use the first lien date in our analysis. This increases the age of the unredeemed liens which, in turn, could result in the migration of a lien to a bucket with higher stresses and lower redemption rates. We review the adequacy of the working capital account, liquidity providers, and reserve fund given the current pool of assets. We consider the operational risks associated with any servicer or backup servicer as outlined for new issues in paragraphs 42 and 43 above. Estimation Of Projected Losses 45. We estimate losses on the outstanding liens based on the status of the liens in the pool. We exclude liens that have been redeemed, written-off, or have already gone through the foreclosure process from the analysis. 46. For all outstanding liens, we adjust the property values to reflect the average price decline from initial deal closing to the time of review. We also consider updated property values if they are available. In addition, we apply the BPO haircut based on the size of the underlying property value as stated earlier. Further, we stress the value of the property at the appropriate rating category level market value decline assumption. We then compare this adjusted property value to the current lien value to obtain the updated LTV. 47. Next, we divide the lien into buckets using the criteria explained above. To determine lien age we use the initial or first lien date. The longer a lien stays outstanding, the greater its age. Consequently, a lien might migrate to higher stress buckets. On the other hand, as a lien pays down, its LTV goes down and it might migrate to a lower stress bucket. DECEMBER 16,

12 Liens On Foreclosed Properties 48. We stress liens on foreclosed properties separately. We assume that there will be no recovery once the foreclosure process has started. We apply stresses that are consistent with a full foreclosure process for a particular jurisdiction. We assume that liens on properties that are in bankruptcy or under forbearance will be written-off at the trust's expense. These will increase our projected losses. Outstanding Liens 49. For the remaining liens (unredeemed and not foreclosed) we apply the same stresses that we do at the time of initial issuance. For each pool, Standard & Poor's will ask to review historical performance information at closing, to assess the redemption rates. At the time of review, we will ask for the transaction's performance information since closing. If we find that actual redemption rates for a transaction are worse than our initial expectation adjusted for seasoning, we will lower the redemption rates appropriately and look for increased enhancement levels. Bankruptcy And Forbearance 50. We assume that liens on properties that are in bankruptcy or under forbearance will be written-off at the trust's expense. As mentioned above, we believe the bankruptcy process can be unpredictable. We discuss our approach on forbearance plans in the article titled, "Methodology For Loan Modifications That Include Forbearance Plans for U.S. RMBS," published July 23, Typically, we treat both the amounts in bankruptcy and under forbearance as losses to the trust. 51. We calculate the total loss as the sum of the losses due to the foreclosure process, the loss estimate on other outstanding liens, and the losses due to liens in bankruptcy and under forbearance. Ratings Adjustment Of The Affected Classes 52. Using the process described in the section on estimation of projected losses, we calculate losses at each rating category level. Then we conduct a breakeven analysis to assess the appropriate rating for each bond. The available enhancement at each rating category level needs to be what we consider adequate to support the rating. We adjust the outstanding ratings accordingly. Furthermore, if lien level data is not available, our assessment of the pool will entail the following: The loan pool information from the closing of the transaction is used and the lien bucketing assessment is performed by assuming that the liens that no longer remain in the pool (based on pool factor) were from the lowest risk bucket, and No additional adjustments are made to the property values where property values have generally been increasing in the CBSAs represented. DECEMBER 16,

13 Size Of Funds And Servicer Quality 53. We consider whether the size of the reserve fund and the working capital fund (or evaluation of the liquidity provider) continue to be consistent with the criteria discussed in the section on the working capital account. We may also review any operational risks associated a servicer as outlined in paragraphs 42 and 43 above. 54. If the funds are undercapitalized for two consecutive pay periods, depending on our assessment of the operational risk of the servicer, we may put all the outstanding classes from the affected transactions on CreditWatch negative and analyze the impact in greater detail. APPENDIX: STANDARD & POOR'S TAX LIEN FORMAT Standard & Poor's U.S. Tax Lien Format Field Collateral tape information Description 1 Lien ID 2 City 3 County name 4 State 5 Zip code or CBSA 6 Redemption period 7 Priority of subsequent liens See possible values below* 8 Property type See possible values below 9 Property detailed description 10 Property value 11 Property value type Assessment provided by the municipality, BPO, etc. 12 Date of property valuation 13 Lien balance 14 Lien creation date 15 Tax lien certificate accrual rate 16 Number of open liens 17 Combined LTV Including all known open liens 18 Combined balance Including all known open liens 19 Bankruptcy flag Y=Yes, N=No 20 Foreclosure start date Any foreclosure already started on the property (initiated because of previously open liens or mortgages, for example) In addition, for the analysis of historical performance we will ask for: 21 Current status See possible values below 22 Total collections to date 23 Date of collection 24 Latest property value If available 25 Date of last property valuation If available DECEMBER 16,

14 Standard & Poor's U.S. Tax Lien Format (cont.) CBSA--Core based statistical area. BPO--Broker price opinion. *Priority of subsequent liens: P--Pari passu. J--Junior. S--Senior. Property type: R--Residential. C--Commercial. G--Gas station. I--Industrial. A--Agricultural. V--Undeveloped/vacant. Current status: R--Redeemed. W--Written off. L--Foreclosed upon. P--Foreclosure in process.o--outstanding. RELATED CRITERIA AND RESEARCH Global Framework For Assessing Operational Risk In Structured Finance, Oct. 9, 2014 Counterparty Risk Framework Methodology And Assumptions, June 25, 2013 Principles Of Credit Ratings, Feb. 16, 2011 Methodology For Loan Modifications That Include Forbearance Plans for U.S. RMBS, July 23, 2009 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. DECEMBER 16,

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