Due to the proliferation of predatory lending legislation, Standard & Poor's announced at press time last week that it would require increased credit enhancement going forward for mortgage securitizations backed by loans in 15 municipalities. While the move has no impact on outstanding transactions, credit enhancement for future securitizations could increase by a variable amount, depending on the number of impacted loans in each pool, foreclosure frequencies, and the jurisdictional distribution of the loans.
"Because of the proliferation of [predatory lending] laws, S&P anticipates that an increased number of loans governed by these laws are likely to be included in transactions it is asked to rate," S&P says in its trade release on the topic. "For some of these loans, the potential assignee liability may exceed the original principal balance of the loan. This assignee liability has to be appropriately factored into the rated transactions. The risk increases for laws that have subjective standards, such as net tangible benefit or vague repayment ability tests."
In all, S&P examined the predatory lending legislation in 40 states over the past year, requiring increased enhancement in 15 of the examined municipalities. The amount of additional enhancement will depend on S&P's assessment of potential losses on the loans in the transaction, which it states can approach 200% severity.
S&P will base its assessment on a loan-level analysis of an entire loan pool, with four main assumptions guiding its analysis: $100,000 loan balance; 360-month loan term; 9% minimum interest rate and no points or fees.
Outstanding securitizations backed by loans deemed as high cost will not need any added credit enhancement, or face any downgrades based on the new criteria, an S&P spokesman confirmed. "These standards [became] effective [last Thursday]; for previously issued deals the previous criteria applies," said Adam Tempkin in the S&P press office.
Tempkin added that these high cost loans make up a small amount of most lenders' total origination volume and are not a major component in many securitizations S&P rates.
S&P did find in its study that the maximum loan loss severity for loans that would potentially require additional enhancement is 196% for Arkansas-originated high-cost loans. The lowest severity found by S&P was the 37% for Ohio-originated covered loans.
For issuers that don't want to pay for the additional credit enhancement, S&P does offer some alternatives, such as a pledge to repurchase affected loans out of securitization trusts.
For issuers looking for loopholes, S&P offers the following advice: "A seller that has an outstanding long-term debt rating from S&P as high as the highest rating of the transaction [typically AAA] may provide credit support by agreeing to buy back the affected loans. Market participants may also want to consider other established means of providing credit support, such as lines of credit, guarantees, or surety bonds issued by appropriately rated entities that meet S&P's criteria."
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