New-issue, private-label MBS backed by either recent vintage or seasoned loans funded since the downturn have generally had some type of mechanism to enforce and/or clarify parameters for repurchases, a Moody’s Investors Service analyst said.The trend has resulted from a slew of repurchase disputes that have risen as deals from the 2005-2007 period of loose underwriting have aged and underperformed.
The lack of such a mechanism is considered negative, according to a recent Moody’s report.
Generally, the repurchase mechanism has taken the form of an agreement to enter arbitration in new-issue deals backed by recent originations — but it could also be a situation where the parameters for repurchases are detailed and clearer than they historically have been, said the analyst who authored the report, Moody’s vice president Kathy Kelbaugh.
Teeth in Reps and Warranties
During the heyday of the RMBS market, sellers started reducing the "teeth" in the representation and warranty process to the point where it became almost meaningless.
"The whole idea of the representation and warranty is that the seller of the loan is saying that they represent and warrant that loan is a good loan and meets the underwriting requirements of the buyer. If it turns out that it wasn't, then the seller agrees to buy it back," said one market source.
If the loan goes bad over something other than a credit issue and it is a reason like "the borrower should have never got the loan in the first place," then the investor under the terms of the representation and warranty will ask the originator to buyback the loan.
However, there are grey areas in underwriting. "It's an art, not a science and there are things like debt ratios where you can use compensating factors like higher down payments, which cloud the issue on whether the terms of the investors were met," the market source said. "When a loan goes bad, the originator can say that it disagrees and it can go back and forth. The only way to resolve that is to file a lawsuit and go through an 18-month process, no one wants to do that for one loan."
The Redwood Trust deals introduced an enforcement mechanism for the reps and warranties. In their post-financial crisis RMBS structures under their Sequoia Trust RMBS series. The structuring included an agreement of "binding arbitration" so that in the event that there is a buyback issue between investors and the originator of the loan, the issue goes to an arbitrator. This mechanism speeds up the resolution of the problem and if the originator is ordered to buy back the loan that money is passed through the trust and investors get paid.
In the recent March Credit Suisse prime RMBS deal called CSFB Mortgage Securities 2012-CIM1, the MetLife loans that were securitized under the structure did not have binding arbitration to them.
"It could be why Fitch [Ratings] felt that the subordination level needed to be increased to offset that negative," the market source said. "Standard & Poor's didn't seem that concerned with it."
Fitch said that its analysis of the deal took into consideration the representation and warranty enforcement mechanisms. The lack of binding arbitration can result in extended resolution timelines and higher costs should MetLife decide to contest repurchase requests.
"A consideration in our rating analysis was a review of the enforcement mechanisms," said Kevin Duignan, head of U.S. structured finance for Fitch.