SCOTTSDALE, Ariz. - In light of the impending "recession" this year, the issues impacting the mortgage-related and subprime ABS sectors are quality control, increasing fraud in the borrowing process (such as no documentation provided for borrowers), issues of credit quality, servicing transfers, the effect of the GSEs' entry into the subprime space, job layoffs, and, perhaps most disturbing but least talked about, the risks involved with lender-paid mortgage insurance (lender-paid MI).
Especially in the subprime sector, lender-paid mortgage insurance is becoming more prevalent, according to Moody's Investors Service."There is a risk that when a claim is submitted to these insurers, depending upon what is submitted, if some things don't meet guidelines, they may not pay the full amount of the claim," said Pramila Gupta, a managing director at Moody's. "There is definite criteria for what they will or will not pay. These are still untested waters."
There are two types of insurance in the subprime sector: transactions wrapped by a monoline for the aggregate amount of a pool, and lender-paid mortgage insurance, which is wrapped at the loan level.
There is always a certain amount of credit support for a monoline, but if it falls below that level of credit support, the monoline is on the hook. But the loan-based focus for lender paid MI means that any decrease in credit support will eat into the lowest enhancement.
"A good loan doesn't offset a bad loan," Gupta said. "The question is, will they still pay the claims?"
Another factor affecting the subprime sector is that the GSEs are creaming off the top of the better-quality borrowers, Gupta said. As Fannie Mae and Freddie Mac go further down the credit spectrum, the GSE pools will be better, while the pools that remain will be weaker in credit quality, especially for A-minus and Alt-A mortgages.
Lastly, the deterioration in credit quality is perhaps the most significant issue that subprime ABS will have to deal with this year. In an attempt to approve loans as fast as possible, often there is no documentation for subprime loans. Additionally, the spectre of fraud casts a shadow over the industry.
"No two appraisals are the same," Gupta said. "But despite this, lenders do not seem all too concerned."