KBRA assigns a rating of ‘BBB- (sf)’ to each of the Series 2019-VF1, Series 2020-PIAVF1 and Series 2020-SAVF1 Variable Funding Notes issued by FMC GMSR ISSUER TRUST, a master trust issuer of Freedom Mortgage Corporation (FMC). These notes are backed by participation certificates evidencing participation interest in mortgage servicing rights (MSR) and servicer advance receivables on loans underlying Ginnie Mae guaranteed mortgage-backed securities. KBRA’s rating on the notes is primarily dependent upon the rating of FMC (KBRA Rating: BB+/Negative), the repurchase obligor under a repo facility in support of the MSRs and advance receivables. Revisions to FMC’s issuer rating will likely result in a commensurate rating movement to the rated notes.

Key Credit Considerations

KBRA’s original Series 2020-GT1, Series 2021-GT1, Series 2021-GT2, Series 2022-GT1 and Series 2022-GT2 term note rating reports for the previously-rated term notes describe the rating rationale which is also generally applicable to the rating for the currently outstanding Variable Funding Notes for a which a rating is now provided, with some distinctions as described herein.

As with the previously-assigned Term Note ratings, the ratings on the variable funding notes (VFN) are primarily dependent on the credit rating of FMC as repurchase obligor under a repo facility in support of the Issuer’s rights granted by Ginnie Mae to FMC and advance receivables due to FMC, with certain transaction features providing one notch uplift on the rating of the notes.

In addition to the VFNs listed above, 12 other series/classes of notes were also previously issued by the master trust totaling $2.57 billion in initial note balance. Those series/classes are listed in a table at the end of this release.

Credit Considerations for Variable Funding Notes and Distinguishing Features

Series 2019-VF1

These notes are backed by the same participation interests created in the underlying MSRs that support the previously issued term notes. They are also subject to the same risks, including extinguishment, presented to the term note holders subject to the priority claims of GNMA.

From a credit perspective the VFN stands in a somewhat preferential position relative to the term note holders, as the VFN will be paid down by the issuer to cure periodic borrowing base deficiencies, while the term notes are not paid prior to maturity unless certain events occur. These events include early amortization of the term notes when the amount funded against the VFN falls below $30.0 million. As described in our previous reports, this creates an alignment of interest between the VFN holder(s) once the holder reaches a minimum amount of lending exposure. Furthermore, in the event of default, the VFN holders share payments pro rata with the term noteholders.

The advance rate for the 2019-VF1 is 72.0%, which from an effective leverage perspective is approximately the same effective advance rate as the 60.0% advance rate provided to the term notes. This is because the underlying repurchase agreement with the VFN holder is already subject to an advance market value haircut prior to inclusion in the master trust. As described in the underlying term note reports, any holder of the 2019-ADV1 Note may only be transferred to a party that has a direct or beneficial interest in the Series 2019-VF1 Notes. The unrated 2019-ADV1 VFN is available to allow the VF1 holder to fund advances in the event the FMC fails to do so, allowing the Indenture Trustee to preserve its rights under the Acknowledgement Agreement with GNMA. As is expected, absent an event of default, the 2019-ADV1 note has never been drawn upon to fund such advances as FMC has performed its advancing obligations.

Series 2020-PIAVF1 and Series 2020-SAVF1

The Series 2020-PIAVF1 and Series 2020-SAVF1 Notes were issued in July 2020 to finance servicer advance receivables (”servicer advances”), which are separate and distinct from the MSR rights being financed by the term notes and the Series 2019-VF1. The participation interests for the 2020-PIAVF1 Notes are backed by servicer advances which have been earned and are due for principal and interest advances (“MBS Advances”). The participation interests for the 2020-SAVF1 Notes are backed by servicer advances which have been earned and are due for advances of taxes and insurance (“Escrow Advances”) and property preservation and disposition expenses (“Corporate Advances”).

Servicer advances are generally recoverable at the top of the payment waterfall to a servicer from proceeds either from general collections on all GNMA mortgage loans serviced by a servicer (typical for MBS Advances) or from loan specific recovery proceeds prior to any recovery to the related mortgage lien holder (typical for Escrow Advances and Corporate Advances). MBS Advances and Escrow Advances are generally recovered at close to par value, subject to some debenture interest reimbursements amounts short of the applicable note rate, while Corporate Advances benefit from more limited reimbursement rates according to agency specific practices and applicable reimbursement rates.

Advance rates are correspondingly higher for certain servicer advances. The advance rate percentages for the applicable advance types as set forth in the Series 2020-PIAVF1 and Series 2020-SAVF1 Indenture Supplement are as follows:

Note that periodic valuations, which influence borrowing base calculations, do not apply to the servicing advances which are assigned a par collateral value which is then discounted at the above advance rates to measure borrowing base sufficiency. Prior to full amortization, only MBS advance and escrow and corporate servicer advance recoveries are applied to pay down the Series 2020-PIAVF1 and Series 2020-SAVF1 notes, respectively. There is only limited cross-collateralization to the extent there is an event of default in which case any shortfalls in the Series 2020-PIAVF1 and Series SAVF1 notes after application of the MBS advance and escrow and corporate advance recoveries, would be paid from all available trust proceeds, including those from MSR value realization.

Given the generally predictable recovery expectations, servicer advances are largely spared the volatility associated with MSR valuation. It is commonly recognized in servicer advance-backed transactions which take a structured finance-style cash flow recovery approach that the timing of recoveries is a critical liquidity consideration. Outstanding servicer advances do not accrue interest and the negative carry associated with such advances, as well as state-specific recovery timelines and servicer expertise will impact present value calculations. By contrast, this master trust is subject to monthly borrowing base calculations such that FMC is obligated to continually maintain advance rate minimums and serves as a buffer to noteholder losses.

Consistent with the approach taken to rating MSR-backed transactions, relying primarily on the issuer rating of the related servicer or applicable guarantor to back scheduled interest and ultimate principal payments, KBRA is providing a one notch uplift relative to the issuer rating of FMC as obligor by taking a holistic view of the collateral available in the event of non-performance.

Rating Sensitivities

It is noted that while FMC still maintains an issuer rating of BB+ from KBRA which was affirmed on September 29, 2022, the Outlook was revised from Stable to Negative. That change was driven by FMC’s increased leverage associated with its MSR acquisition strategy.

A more efficient than expected reduction in corporate leverage, with the maintenance of a consistent liquidity profile and stabilized operating performance could result in a return to a Stable Outlook. An unexpected further deterioration in profitability, potentially limiting the return to a less leveraged profile, together with any diminution of liquidity profile, would likely facilitate a downgrade.

ESG Considerations

KBRA typically analyzes Environmental, Social, and Governance (ESG) factors through the lens of how management teams plan for and manage relevant ESG risks and opportunities. More information on KBRA’s approach to ESG risk management in financial institution ratings can be found here. Over the medium-term, financial institutions will need to prioritize ESG risk management and disclosure with the likelihood of expansions in ESG-related regulation and rising investor focus on ESG issues.

Environmental Factors

There were no environmental factors that had a material impact on FMC’s issuer rating, though we note that natural disasters have the potential to impact delinquencies and asset quality metrics. Providing mitigation for the potential of natural disasters is that the FMC’s servicing portfolio is well diversified by state.

Social Factors

There were no social factors that had a material impact on this rating.

Governance Factors

An ESG factor that has a meaningful impact on this rating is an effective risk management framework. KBRA has reviewed elements of FMC’s risk management practices with respect to operational risk and have found the company’s applicable framework consistent with industry peers. With respect to interest rate risk, FMC’s practice of not hedging its MSR investment with financial instruments offers an increased element of risk.

To access ratings and relevant documents, click here.

Related Publications

• KBRA Affirms Issuer Rating for Freedom Mortgage Corporation and Revises Outlook to Negative

• Finance Company Global Rating Methodology
• Corporate Instrument Notching Global Methodology
• Global Structured Finance Counterparty Methodology
• ESG Global Rating Methodology

Disclosures

A description of all substantially material sources that were used to prepare the credit rating and information on the methodology(ies) (inclusive of any material models and sensitivity analyses of the relevant key rating assumptions, as applicable) used in determining the credit rating is available in the Information Disclosure Form(s) located here.

Information on the meaning of each rating category can be located here.

Further disclosures relating to this rating action are available in the Information Disclosure Form(s) referenced above. Additional information regarding KBRA policies, methodologies, rating scales and disclosures are available at www.kbra.com.

About KBRA

Kroll Bond Rating Agency, LLC (KBRA) is a full-service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. Kroll Bond Rating Agency Europe Limited is registered as a CRA with the European Securities and Markets Authority. Kroll Bond Rating Agency UK Limited is registered as a CRA with the UK Financial Conduct Authority pursuant to the Temporary Registration Regime. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus. KBRA is also recognized by the National Association of Insurance Commissioners as a Credit Rating Provider.

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