In light of the recently solidified criteria for Qualified Mortgages (QM), Moody’s Investors Service has come out with a proposed methodology for mortgage-backed securities.
Under the approach, released today, the highest enhancement levels for a deal to be rated investment-grade will be applied to deals backed by riskier, non-QM deals. The next highest investment-grade hurdle will face what is known as QM Rebuttable Presumption loans.
QM is based on the Ability to Repay (ATR) rules, which went into effect Jan. 10. The ATR rules allows borrowers to claim they were given loans they could not repay.
Moody’s new approach distinguished between QM and non-QM loans as well as the sub-categories within those rubrics.
QM is split between Safe Harbor loans and Rebuttable Presumption loans. The former has a “conclusive presumption” that it complies with the ATR rules. A borrower needs to first get the loan disqualified as QM before she or can challenge compliance with ATR. Rebuttable Presumption QMs have “only a presumption” that they comply with ATR rules. By definition they also bear higher rates at least 150 basis points or more more over the average offer rate if a first-lien and 305 basis points or more over if a second-lien.
The prevailing view seems to be that Safe Harbor QM offers more legal predictability and swifter resolution than Rebuttable Presumption QM.
Moody’s will now be searching for “red flags” in deals backed by QMs that could potentially turn them into non-QM loans.
“Data discrepancies or debt-to-income ratios and points and fees close to the QM threshold would all raise red flags that these loans are at risk of ATR challenges,” Moody’s senior credit officer, Yehudah Forster, stated in the report. DTIs close to the QM threshold might indicate an originator is doctoring the numbers to qualify.
A borrower making an ATR claim would lead to an increase in the loan’s loss severity. The RMBS trust holding the loan would have to assume that cost.
QM deals with red flags would require more enhancement that those with no red flags.
Absent any red flags, in Moody’s view, Safe Harbor QMs would “pose no additional risk to an RMBS transaction."
But deals securitizing Rebuttable Presumption QM will need more enhancement than the Safe Harbor variety, though less than the riskiest variety of loans: non-QM lent to non-prime borrowers.
Moody’s will assign a qualitative assessment of level 1, 2, 3, based on originator or aggregator’s ATR procedures and any potential ATR issues.
To see how the levels system operates and how much enhancement is required at each ratings category for and non-prime QM loans and Rebuttable Presumption QMs see the tables below.
As for non-QM attached to very high-quality borrowers, the ATR risk is “minimal,” Moody’s said.