Lenders don't have to follow the new industry guidelines for representations and warranties about mortgages they sell, but they may save money by doing so — if private securitization ever revives.
The guidelines released Tuesday by the American Securitization Forum are meant to standardize and strengthen the promises lenders make to repurchase defective loans. Buyback requests put several lenders out of business in the early days of the current mortgage crisis, showing that this form of "skin in the game" was not a powerful enough incentive to maintain lending standards.
Rating agency analysts said they would take into account how closely a lender's reps and warranties follow the trade group's standards when evaluating new mortgage securitizations. Qualifying the guarantees — such as by adding the phrase "to the best of our knowledge" after promising the loans in a pool are backed by the borrowers' primary residences — would count against the lender.
"Depending on what we see, we may choose not to rate a deal or not to assign the highest ratings," said Kathy Kelbaugh, a senior analyst at Moody's Investors Service Inc. "It might not get a triple-A or even a double-A rating, depending on how many things are qualified." Investors, in turn, would likely demand a higher yield on the securities to compensate for the lower rating, squeezing the lender's profit on the deal.
Of course, such discussions are prospective, as issuance of private-label residential mortgage-backed securities — those without federal guarantees — remains moribund.
"There has not been a single RMBS transaction completed in well over a year for newly originated mortgage loans," said Tom Deutsch, the deputy executive director at the American Securitization Forum.
By making reps and warranties — which varied widely during the boom years in the middle of the decade — tougher and more consistent, the trade group hopes to restore investor confidence in mortgage securities and jump-start the market. The group also argues that enhancing reps and warranties is a better way to align lenders' interests with those of investors than a provision in a bill that passed the House last week requiring issuers to retain a minimum 5% of the credit risk in any securitized loan.
Joe Garrett, a principal at the consulting firm Garrett Watts & Co., said that currently it is hard to find, let alone compare, the reps and warranties in different securitizations. "Right now I don't believe it's possible to find exceptions that easily," he said. But the House bill would also require the rating agencies to describe how the reps and warranties in securitizations they rate differ from those "in similar issuances."
In some ways, the guidelines could create work for lenders. For example, if a loan applicant says the house being mortgaged will be her primary residence, the guidelines say the lender must evaluate the "reasonableness" of her claim. The lender must consider the distance between the home and the applicant's place of work; compare her mailing address to that of the property; and find out if she owns other real estate.
One of the guidelines, however, might make lenders less vulnerable to chance. Many of the loans that Wall Street firms made lenders buy back in 2006 and 2007 defaulted in the first few months after origination. The buyers could demand repurchases for that reason alone. "The theory behind this covenant is that if a mortgage loan becomes delinquent within a short time after origination, then it is likely that some sort of fraud existed," the trade group said. "However, this theory becomes more tenuous as the loan becomes more seasoned and credit events, such as loss of employment, become a more likely cause of delinquency."
Hence, though the trade group's model covenant says a loan must be repurchased if it goes bad within three months, it carves out an exception for when "material financial or personal adversity" causes the default.