Despite the lack of new deal flow, rating agencies are hard at work making improvements to their evaluation processes in hope of luring back investor confidence and restarting new issuance.
Last week, Moody's Investors Service rolled out an overhaul of its RMBS ratings methodology, specifically regarding its originator assessments and rating criteria for evaluating independent third-party loan level reviews and representations (reps) and warranties in U.S. RMBS. These changes, which have been in the works for over a year now, are aimed at enhancing third party accountability while also bringing new deal transparency.
In September 2007, the rating agency published proposed industry enhancements for enforcing breaches in reps and warranties, and also suggested changes to the data used in its ratings. In March 2008, Moody's furthered its review, making proposals for increased loan level data, stronger reps and warranties, independent third party pre-securitization and post-securitization forensics reviews, more comprehensive originator assessments, and enhanced data before the close of a securitization, along with monthly performance data.
Data enhancements, such as increased loan level data, are currently expected to be published in early 2009.
The rating agency also tapped market participants including investors, due diligence firms and issuers, and ABS industry organizations such as the American Securitization Forum and the Securities Industry and Financial Markets Association for feedback during the process.
A Push for Standardization
The most recent changes in Moody's approach to rating U.S. RMBS include enhanced originator assessments. Previously, discussions with originators occurred more on an ad hoc basis. With the new enhancements, the rating agency will ask for a reporting package submitted on a quarterly basis. The reports are to be more standardized and will contain a lot more detail from the originators, said Kathryn Kelbaugh, vice president and senior analyst at Moody's. New requirements include reporting on detailed loan production characteristics and performance by loan program, changes in underwriting guidelines, underwriting and program exceptions, audited financial statements, repurchase activity, audit findings and significant IT initiatives, among other pertinent data that will provide Moody's with the information it needs to better assess originator quality.
In most cases, the rating agency said it plans to conduct on-site reviews every 12 to 18 months for originators, in addition to the quarterly supplements the originators provide to Moody's. Similarly, Moody's expects to publish comprehensive originator reports every 12 to 18 months, and if circumstances change materially in the interim, the rating agency said it will consider adjustments to its originator assessment and publish accordingly.
The rating agency also plans to include in its presale reports, published before a deal issued, its assessments of the different originators participating in the deal, and adjustments to credit enhancement levels based on these assessments.
In addition to using the assessments in the rating process itself, Moody's also plans to publish its originator assessments on Moody's.com, placing them in the public, said Debashish Chatterjee, a team leader at Moody's.
The rating agency has also ramped up its criteria for evaluating independent third-party loan level reviews for U.S. RMBS before and after securitization. Previously, the third party loan level reviews were not done on all U.S. RMBS transactions and if they were performed the ratings agencies only received summary reports intermittently. Now the rating agency is requiring an independent third party loan level analysis with loan level reporting for every deal it is asked to rate.
"In the past we sometimes received the summary results, but going forward we will receive a comprehensive report and significant amounts of data on a loan level basis. The whole process is going to be strengthened significantly, said Warren Kornfeld, managing director at Moody's.
Information and analytics companies like Clayton Holdings have traditionally provided these services, but the industry could see new entrants into this market once increased third party reviews are required, Kornfeld said. The third-party review company's processes and experience, however, will be a heavy focus for the rating agency.
Based on Moody's new criteria, these third-party loan review companies are to report an overall summary of their loan level assessments along with a description of what they were asked to review by the issuer or underwriter for the deal and how they conducted this review, Kelbaugh said. "We want to make sure that a grade 'A' rating is really a grade 'A' rating and a grade 'C' rating is really a grade 'C' rating," she said.
Initially, there will be an independent assessment of the loans prior to any feedback on the review from the originator. This is a change from past practice where originators could provide feedback before the third party review findings were released.
Originators will still be able to provide a rebuttal to the third-party reviewer's findings, with loan level reporting of the changes to be provided in what Moody's is calling a reconciled third-party review report. This is to give an originator the opportunity to express its view as to any errors, misrepresentations and misinterpretations it believes were made by the review firm.
The rating agency will also require a confirmation from the reviewer that it was not coerced, and that the reviewer was able to conduct the review and audit data free from banker or originator constraints.
Getting the Right Sample
Another new requirement for rating new U.S. RMBS transactions is that the sample size reviewed by the third-party review firms is not less than a specified minimum size. The sample size is to be determined based on the product type - subprime or non-prime - as well as the strength of the originator assessment, among other factors such as achieving certain confidence levels, precision levels and estimated sample error rates. The higher the credit quality of the loans and the assessment of the originator, the lower the estimated sample error rate will be.
There is also an update to Moody's baseline set of reps and warranties. There will now be stronger fraud reps and warranties; stronger early stage defaults, where a loan that goes 60- plus days delinquent within the first three months would have to be bought back; and an increased focus on how the income is being determined and what process the originator uses to determine the income, occupancy and valuation.
In addition to loan level reviews before securitization, the rating agency is now also asking for a third-party forensic reviewer to look at loans that become 120 days or more delinquent after securitization.
Moody's criteria calls for monthly securitization remittance reports to include the number of loans that breached the reps and warranties, the way in which they breached these reps and warranties, and how many of the loans were repurchased.
Moody's is also strongly encouraging that the information from the third-party servicer be provided to market participants, particularly investors.
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