Two Harbors Investment Corp.’s next offering of residential mortgage bonds features a new kind of risk: some of the loans used as collateral failed to comply, at least initially, with a “Know Before You Owe" consumer disclosure rule that went into effect in October.

In almost every other way, the $332 million mortgages backing Agate Bay Mortgage Trust 2016-2 are consistent with the collateral for Two Harbors’ recent transactions, according to Fitch Ratings. All are 30-year, fixed-rate loans to borrowers with strong credit profiles, low leverage and large liquid reserves. The pool has a weighted average FICO score of 773 and an original combined loan-to-value ratio of 67.6%.

There are 43 loans (9% of the mortgage pool) that are subject to the new rule, a combination of the former Truth-in-Lending and the Real Estate Settlement Procedures acts commonly known as TRID.  And a high number of them, 32, initially failed to comply. However, Fitch feels the overall risk of to investors of this noncompliance is “immaterial,” in part because the percentage of loans subject to the rule is low, but also because of the low limit on statutory damages and the good-faith efforts to resolve the issues identified.

Therefore, the rating agency did not adjust its expectations for losses to the collateral.

TRID was meant to help consumers understand the total costs of a home loan. Because there are hundreds of variables to account for on the forms, compliance has become a near-impossible task. As a result, many investors are refusing to purchase loans without further guidance from the Consumer Financial Protection Bureau.

Issues identified in 32 noncompliant loans backing Agate Bay 2016-2 included handwritten figures that were not legible and errors in contact information for the seller, lender or broker. All of the compliance failures were addressed through either “redisclosure” or reimbursement, according to Fitch. These loans received compliance grades of ‘B.’ The 11 loans originally in full compliance received grades of ‘A.’

Fitch assumes RMBS investors will only be exposed to statutory damages of $4,000 plus attorney’s fees for claims arising in defense of foreclosure in judicial states when a borrower is already working with an attorney. Borrowers will be unlikely to proactively hire attorneys to seek damages under the rule; thus, the risk of defensive claims in nonjudicial states or affirmative claims in any state is viewed by Fitch as remote.

Fitch does not consider actual damages as a potential risk as actual damages are difficult to prove. Class action lawsuits, due to a relatively low limit on rewards, are also viewed as unlikely.

Failure to comply with TRID is far from the biggest risk to the deal. The biggest factor cited as a rating driver in Fitch’s presale report is the geographic concentration of the loans in California, where approximately 48% of the collateral is located. This was a slightly less concentrated that Two Harbor’s previous transaction, completed in January, and its 2015 transactions, however.

All the loans are subject to the ability-to-repay rules and are eligible for a legal safe harbor.

Fitch assigned preliminary ‘AAA’ ratings to the senior tranches of notes to be issued by the trust, which benefit from credit enhancement of 12.3%.


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