The American Securitization Forum's Project RESTART, an industry initiative to renew investor confidence in the mortgage and securitization markets, took several big steps forward in mid-July, including requesting comment on model RMBS representations and warranties.
At least as important will be their enforcement mechanisms, the project's next step, and a system to identify individual loans in securitizations that will begin by summer-end.
On July 15, the ASF issued the final release of a disclosure package to be provided by issuers prior to the sale of private-label RMBS transactions, and another package to be updated monthly by RMBS servicers throughout the life of a transaction. On July 21, the ASF also tapped Standard & Poor's Fixed Income Risk Management Services (FIRMS) analytical unit to create a new loan numbering system and a central loan-data repository.
Attaching unique loan identifiers to the mortgage loans in RMBS is aimed at providing investors with a tool to better understand the risk, collateral and credit of securitized loans.
In fact, S&P, which maintains other financial-data repositories, such as the American Bankers Association's CUSIP numbers that identify securities, plans to release the loan identifications by mid-August. "We don't want to wait. We want to help the market unfreeze now," said David Goldstein, managing director of structured finance ratings at S&P.
Project RESTART began in July 2008, shortly before the credit markets went into a deep freeze following the collapse of Lehman Brothers, and it's anticipated to be finalized by next December. That's a ways off, so S&P's efforts may provide a kick start, although much depends on how quickly other market participants adopt the new information and adapt their technology.
Customers will be able to access the service either through a data-rich direct feed or the ABS Exchange, an S&P Web site that currently services trustees and is being broadened to provide the loan identification information. Goldstein noted that the numbers will enable investors to drill down to analyze the loans comprising individual securities to retrieve more information about them on their own, as well tap "insight from various third-party players." He pointed to credit bureaus such as Experian, Equifax and Transunion and providers of automated property-valuation models such as Veros and Fiserv as examples.
A major contributor to the recent credit crisis has been investors' inability to retrieve adequate information about RMBS's underlying loans when they purchase the securities to perform proper due diligence, leaving them with troubled portfolios even though the securities carried high ratings. More easily identifying the assets comprising the securities should improve due diligence, but the quality of the information provided by issuers is also crucial.
Project RESTART's recently issued disclosure requirements aim to define and standardize that information so that servicers and investors not only obtain richer data at the origination of the security but can compare apples to apples. Standardization is also key for reps and warranties, since they outline when a security can be returned to the issuer in the form of a buyback when it is defective and reps and warranties are breached.
Tom Deutsch, deputy executive director of the ASF, said issuers often provided reps and warranties with seemingly similar ends but using different formats and wording. "That creates questions about whether they really mean something different, so standardization is critical," Deutsch said, adding, "If I want to buy a big pack of loans and there are standards, it simplifies the analysis."
The proposal issued July 15 describes six models for reps and warranties. Deutsch said the most significant one is fraud. The proposal noted that with the economic and housing crises showing few signs of abating, instances of mortgage fraud have become prevalent, increasing realized losses on issued RMBS. Deutsch noted that a careful balance must be struck, however, since too broad a definition of fraud would result in nearly certain buybacks every time, alleviating any investor risk.
Other models include income, employment and asset verification; who occupies the property; and the mortgage loan schedule, to make sure the information in the disclosure package is the same as the originator's records and that certain terms of the loan are true and correct in all material respects.
Deutsch said he has seen no data indicating whether investors have increasingly sought to exercise reps and warranties, although there has been plenty of anecdotal evidence. "There have been some investors who have taken entire lists of delinquent loans in a pool and sent that list to the issuer requesting buybacks of all the loans," Deutsch said.
He added that the issuer typically responds that it requires additional evidence of violations of the reps and warranties, and the investor replies that it has no access to the original loan file to provide that evidence. Although RMBS in volume exploded in the last 10 years, such conflicts were few and far between, in part because profits were still rolling in and buyback requests were comparatively few.
That, of course, has changed in the current economic and credit crisis. Deutsch said the ASF believes improved disclosures and reps and warranties should ultimately reduce the number of buybacks, since problem loans will more likely be identified before entering a securitization, and investors' due diligence efforts should be more accurate. However, there must be enforcement of the reps and warranties, the next step in the RESTART project that may be the most important and controversial one.
Jordan Schwartz, a partner at Cadwalader, Wickersham & Taft and an outside counsel to Project RESTART, said corporate governance, or enforcement, "really worked on an honor system, a system that worked reasonably well when there were few breaches of reps and warranties." Corporate governance, he said, will aim to ensure that the parties in a securitization understand what their roles and responsibilities are. "There needs to be some way for investors to get factual information, whether or not there were problems with the reps and warranties. There were no mechanisms for that," Schwartz said.
Investors contacted by ASR declined to comment for the record about Project RESTART's progress, but concerns were evident. "Unless an easy methodology for pursuing claims is implemented, it really doesn't mean a hill of beans what the reps and warranties are," one investor said.
The comment request for the enforcement stage is anticipated to arrive later this year. Deutsch said a key question is "what additional information should investors have access to if they believe a loan should be bought back," without providing undue cost to the servicer or issuer. The more information that is accessible, however, the more incentive for issuers to detect fraud when the loan is originated.
Much will also depend on the fraud rep that emerges after industry comments are digested by the ASF. Many investors believe that issuers should provide a flat fraud rep covering any and all fraud occurring in the origination process, but some issuers believe that investors should accept fraud risks alongside other risks associated with the loans, the proposal notes.
Deutsch said there is plenty of ground in between those two poles for a solution that still elevates incentives for issuers to detect fraud. The definition of fraud, however, must give little wriggle room. Investors remain skeptical. "If the seller can forever argue as to what is fraud, what does the buyer have to do to prove it's fraud?" The model for fraud covers any fraud by any party to the origination, including originators, borrowers and appraisers.