There’s little evidence to support that new RMBS issuers can, or will want to, repurchase problem bonds under Representations & Warranties provision, according to a Standard & Poor’s report.
The report was published during a particularly busy spell of RMBS issuance. In the last two weeks three new deals were announced, bringing the total of RMBS issuance this year to six deals with nearly $1.8 billion placed with investors, according to Barclays.
Among the deals to come to market are Winwater’s debut transaction (WIN 2014-1) and rare appearances by Citigroup (Citigroup Mortgage Loan Trust 2014-J1) and JP Morgan (JPMMT 2014-2). JP Morgan's deal marks the first ever securitization entirely backed by 15-year mortgages.
S&P, which assigned ratings to two of the deals —JPMMT 2014-2 and WIN 2014-1 — said it is concerned that new issuers lack historical loan performance data and track records for remedying any R&W breaches.
For example the ratings agency called JPMMT 2014-2’s R&W framework “untested and rigid”. “In our opinion, the tests deployed to determine whether a breach has occurred are limiting, potentially restricting legitimate breach claims,” S&P analysts wrote in the report. “The effect of arbitration is limited because the breach reviewer's decision may only be overturned if it is shown that it acted arbitrarily or outside the predefined tests, or if the decision was clearly erroneous.”
The more restrictive R&W framework marks a departure from the American Securitization Forum’s standard framework used in other recent prime transactions. In light of this, the ratings agency said it imposed additional loss coverage requirements for the deal.
For WinWater, a debut RMBS issuer, a lack of historical performance and limited financial capacity are the causes for concern, said S&P.
The WinWater deal pools loans purchased from a number of unrated originators providing R&W’s. In the view of S&P analysts, those lenders “may be financially unable to repurchase loans”
WinWater backstops all originators' R&W repurchase obligations to the extent those originators are financially unable to repurchase but in a severe scenario the issuer may not have the financial wherewithal to buy back troubled loans.
In each deal S&P said that the repurchase risk is partially mitigated by the fact that the deal are backed by high quality collateral. WinWater also includes extra loss coverage adjustments that compensate for the potential R&W repurchase risks.
“We believe it is important for investors and other market participants to evaluate the quality and depth of various factors that mitigate the risk of R&W breaches occurring in U.S. RMBS transactions, including those that would be remedied by new entities with limited histories and the risk that comes with their willingness or ability to do so,” said S&P in the report.
The ratings agency said that “quality and scale of third-party due diligence, the depth of operational reviews, and a transaction's overall expected losses, are critical for assessing the risk of a breach and if a new entity would be remedying it”.
However the ratings agency said that level of third-party due diligence is likely to drop as the U.S. residential mortgage market continues its recovery and securitization issuance volumes increase. Post-2008 new issue U.S. RMBS to date has benefited from 100% loan-level third-party due diligence reviews.
“As loan quality moves further down the credit spectrum and the scope of loan-specific third-party due diligence starts to lessen, we may look for increased credit enhancement for new issue U.S. RMBS to cover projected risks, potentially related to new entrants' lack of experience or financial flexibility”, said S&P.