More than a decade since the U.S. housing crisis, the mortgage market still faces key hurdles managing documents – such as representations and warranties – that determine loan ownership and who takes losses when borrowers default.
That’s a challenge Wilmington Trust aims to resolve using blockchain technology in an initiative that could bolster the private-label RMBS market.
Wilmington Trust is piloting a prototype blockchain service which will provide real-time, distributed-ledger access to information — such as representations & warranties — between parties, including mortgage originators, servicers, trusts and MBS investors.
The notion of bringing blockchain technology to the mortgage market is not new, but so far no solution has emerged to automate guidelines.
Patrick Tadie, a senior vice president who heads Wilmington’s structured-finance division, said Wilmington’s prototype attaches a copy of the origination and servicing guidelines to the mortgage-loan statement. The distributed ledger technology immutably seals it in a blockchain, making it immediately available to all relevant parties.
The concept of blockchain technology originated with the bitcoin cryptocurrency that emerged during the 2009 financial crisis, which was instigated by mortgage defaults that cascaded into woes in the mortgage-backed bond market.
Blockchain provided a safe haven from risks seen as inherent in fiat currencies by cryptographically storing blocks of the digital currency’s transactional data in chains distributed via electronic ledgers to participants.
Governed by its own set of rules, the blockchain distributed ledger cannot be changed without altering subsequent blocks, creating an immutability that has been expanded to data in a wide variety environments—now the mortgage market.
Tadie said Fannie Mae and Freddie Mac have been receptive to the initiative because, as both originators and servicers, they frequently change those guidelines, and putting that information on a distributed ledger automates the process.
RMBS investors would be major beneficiaries, Wilmington believes, since finding the proper guidelines and reviewing them for violations, a process often involving litigation, can take months and even years, while the property’s interest accrues and value declines.
That would include the crucial step of establishing representations and warranties (R&Ws) that determine which party owns it when the borrower defaults.
Understanding ownership at that point is critical to investors in the residential mortgage-backed securities market (RMBS) and whole loans, since violations of the R&Ws can mean market participants further up the chain, such as the loan originators or services, take the loss instead. Violations range from a faulty appraisal to an inaccurate loan-to-value (LTV), or a servicer failing to maintain a property after borrowers stop making payments.
“If a borrower lies on his application that it’s primary residence but never lives there, then the loan should be bought out by whichever institution originated the loan or owned it and put it into a securitization pool,” said Tadie.
Tadie said that the prototype also gives investors access to loan servicers’ notes about borrowers’ ability to make mortgage payments. In addition, servicers must perform certain actions at specific times after a borrower defaults; for example, a servicing agreement can require getting a broker’s price opinion (BPO) after 60 days to estimate the property’s value, or maintain the property.
“So we’re also proposing that information is added to the blockchain, so investors would have access to servicers’ detailed notes, to make sure they’re following timelines in those agreements," he said.
Tadie noted that the process for maintaining servicing guidelines and especially underwriting remains very manual and can be complicated by originators and servicers changing underwriting guidelines over time, requiring sifting through numerous versions to find the correct one for a specific mortgage. In the wake of the housing crisis and the flood of mortgage defaults, finding those guidelines to determine whether there was a violation of R&Ws and which party owned a loan—and its losses—often took months or longer.
Tadie said the ratings agencies have agreed to look at how this feature could lower credit-enhancement requirements somewhat, given a potential reduction in loss severity as a result of a much quicker determination of who is at fault, if any entity, but said they would require significant data to back up policy changes.
Reducing credit enhancement would benefit issuers, enabling them sell more bonds in the higher rated classes, in turn benefitting the Wall Street firms structuring and distributing those deals. Tadie describes the initiative as a win also for other mortgage-market participants in the mortgage market, such as servicers who would see reduced costs.
“Mortgage insurance companies should like this as well, since it would speed up determining who is at fault and whether they have to make a payment or not,” Tadie said.
Unlike public blockchains such as bitcoin and ethereum that are open to all comers, Wilmington Trust, a part of M&T Bank, would administer a private, enterprise version for a fee.
Tadie said the company has applied for a patent that’s currently under review by the U.S. Patent Office, and it is seeking a partner to help finance the project as well as a technology vendor to build out the version to take to market.
