Fitch Ratings plans to require additional credit enhancement on residential mortgage backed securities backed by either qualified mortgages with higher interest rates or non-qualified mortgages.

The ratings agency last week finalized its criteria for analyzing loans securing U.S. RMBS under the Bureau of Consumer Financial Protection’s (CFPB) qualified mortgage (QM) standards and Ability-to-Repay rule.

The rule applies to all mortgages made on or after Jan. 10, 2014. It requires lenders to make a reasonable determination of a borrower’s ability to repay the loan at the time of consummation.  The rule also provides creditors varying degrees of protection against borrower disputes.

RMBS backed by loans that do not meet the new QM standards will face a higher cost to achieve a Fitch ‘AAA’ ratings. Fitch did not indicate how much additional credit enhancement would be required.

However the rating agency said it will also require additional credit enhancement in such deals to offset the additional litigation risk for both higher coupon QM and non-QM loans. at least in cases where litigation expenses are to be paid from available trust funds.

However, Fitch will not adjust its loss expectation for structures that deduct expenses from the mortgage pool’s net weighted average coupon because this provision does not affect the trust’s ability to pay contractual amounts due.

“We expect some defaulted borrowers will likely challenge the rule, but a lack of legal precedent could make the first few cases high profile and prone to significant legal costs,” Suzanne Mistretta, senior director at Fitch, stated in a press release. 

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