Tag Archives: RMBS

Happy New Year for Mortgages?

Posted on by

S&P has posted How Will Mortgage Loan Originators, Borrowers, And RMBS Securitization Trusts Fare Under The New Ability-To-Repay Rules?  This research report finds that

  • The ATR [Ability to Repay] and QM [Qualified Mortgages] standards under TILA [the Truth in Lending Act] will require loan originators to make a reasonable, good faith determination of a borrower’s ability to repay a loan using reliable, third-party written records.
  • If violated, originators and assignees can face liabilities and litigation brought on by borrowers during foreclosure proceedings and even outside of foreclosure proceedings. However, they can be protected from some of these liabilities if a loan meets the QM standards.
  • Depending on the loan’s status, increased loss expectations resulting from additional assignee liability, longer liquidation timelines resulting from borrower defenses in foreclosure proceedings, and additional loan modification experience can affect securitization trust performance.
  • Sensitivity testing using the damages outlined in the rule suggests that additional loss experience will generally be mild for prime jumbo backed securitizations even under conservative assumptions for litigation risks. Trusts backed by loans with higher credit risk, lower balances, and originated by unfamiliar or below-average originators will be at risk of higher losses than prior to the rule.
  • We expect that while the rule will prevent underwriting standards from loosening towards the more risky mortgages originated during the 2006 and 2007 financial crisis, it may also limit credit access to borrowers and make it more difficult to obtain a mortgage loan. (1)

I think that only the last two points are really newsworthy, particularly the last one. Whether the credit markets tighten too much from the new rules is the $64,000 question.

S&P appears to be arguing that the rules will constrain good credit too much. Time will tell if that is the case, as lenders fill the QM sector and the non-QM sector. The non-QM sector provides, for example, interest-only mortgages. There was a lot of bad lending involving interest-only mortgages, so it will be interesting to see what that market sector looks like as it matures over the next few years.

Doing Justice with the $13B JPMorgan Settlement

Posted on by

I have posted a couple of items on this massive settlement (here and here).  This should be my last one. Perhaps I am ungrateful, but the Statement of Facts agreed upon by the Department of Justice and JPMorgan Chase left me with an empty feeling. Recovering $13 billion for homeowners, investors and the government is certainly a key aspect of the justice done in this case. But the law can and should have an expressive function — it should make a statement about the difference between right and wrong behavior. Unfortunately, the Statement of Facts almost completely fails as an expressive document.

It only makes it clear at one point that JPMorgan, Bear Stearns and Washington Mutual did something very wrong:

employees of JPMorgan, Bear Stearns, and WaMu received information that, in certain instances, loans that did not comply with underwriting guidelines were included in the RMBS sold and marketed to investors; however, JPMorgan, Bear Stearns, and WaMu did not disclose this to securitization investors. (1)

The Statement of Facts provided a couple of facts that made clear what JPMorgan did wrong (see page 2), but I could not even parse the sections of Bear Stearns and WaMu to tell you what they did wrong. This is about as strong as it gets:

in 2008, internal WaMu reviews indicated specific instances of weaknesses in WaMu’s loan origination and underwriting practices, including, at times, non-compliance with underwriting standards; the reviews also revealed instances of borrower fraud and misrepresentations by others involved in the loan origination process with respect to the information provided for loan qualification purposes. (10)

You can’t tell from such language whether WaMu was acting intentionally, recklessly or negligently.  You can’t really tell whether this behavior was endemic, frequent, occasional or rare. You can’t tell whether it was the fault of some low-level employees or of upper management. Just about the only thing you can tell from the WaMu section (and the Bear Stearns section, for that matter) is that it was not JPMorgan’s fault:

The actions and omissions described above with respect to WaMu occurred prior to OTS’s closure of WaMu and JPMorgan’s acquisition of the identified WaMu assets and liabilities. (11)

No doubt, JPMorgan tried to control the PR and legal liability to third parties that this Statement of Facts could engender. But Justice could have held the line on the expressive aspect of the settlement just as it did with the monetary aspect. In the long run, that could turn out to be just as important.

A HELOC of a Securitization

Posted on by

S&P posted A Look At U.S. Second-Lien And HELOC Transactions Post-Crisis.  In 2008, they announced that “would halt rating new U.S. RMBS closed-end second-lien transactions because loan performance had deteriorated significantly.  [They] haven’t rated any U.S. RMBS second-lien (both second-lien HCLTV [high-combined loan-to-value] and closed-end second-lien) or HELOC [home equity line of credit] transactions since 2007.” (1) They also note that notwithstanding the fact that such securitizations had ended, “HELOC loans continue to be originated, with banks generally keeping these types of loans on their books.” (1)

The report provides a some interesting data on those securitizations.  Let me share one highlight, a table of lifetime loss projections of RMBS with different collateral types. For the 2007/2008 vintage, they performed as follows.

payday loan coloradocash advance loans in gapayday loans minneapolisreal pay day loans

Second-lien  HCLTV:  45%

Closed-end second lien:  58%

HELOC:  42%

Subprime:  49%

Alt-A:  29.25%

Negative Amortization:  43.25%

Prime:  10%

With a bit of understatement, they conclude that “[c]losed-end second-lien transactions may be limited going forward because of limited investor and issuer appetite, given past performance and uneven home price appreciation.” (5) They note that HELOCs are not included in the definition of Qualified Mortgages or Qualified Residential Mortgages [QRM] “so the issuer would most likely have to retain a stake in the deal, increasing issuance costs.” (6)

This seems like a good a good result, if you ask me. Here is a product that performed miserably (with losses of greater than 40%!!!) as a securitization. If the new QRM rules reduce these securitization but banks continue to originate them for their own portfolio, perhaps Dodd-Frank is doing its job in the mortgage markets. Of course, we want to ensure that there is sufficient sustainable credit for HELOCs, but it is good to see that portfolio lenders are stepping in where they see a market that RMBS issuers has exited.

Replacing Rating Agencies

Posted on by

Although rating agencies have been the subject of much criticism, including much from yours truly, (here for instance) there is no clearly superior replacement for the existing business model.  Even worse, there is not even much theoretical work on alternatives. Thus, it is exciting to see that Becker and Opp have posted a new paper, Replacing Ratings, that at least considers a plausible alternative.

Their paper examines “a unique change in how capital requirements are assigned to insurance holdings of mortgage-backed securities. The change replaced credit ratings with regulator-paid risk assessments by Pimco and BlackRock.” (1) But their analysis did not “find evidence for more accurate inputs to regulation.” (3, emphasis removed) Indeed, their “empirical analysis reveals that the old system was better able to discriminate between risks. As a result, the old system based on ratings not only provided higher levels of capital, but also ensured that capital was more appropriately related to risks.” (3-4)

By the end of their analysis, they believe that “the new system only recognizes current (expected) losses, but does not provide any buffer against possible future losses. Our results are consistent with regulatory changes being largely driven by industry interests.” (21)

They find the new system is worse than the old system and that the new system benefits the industry.  So why should we care about this research at all?  For at least three reasons:

  1. it identified a change in the insurance industry that has implications way beyond that industry;
  2. it compared how two different MBS evaluation systems performed; and
  3. it identified the drawbacks of the new system.

This is how we begin to build a body of knowledge about “viable alternatives to ratings.” (2) But, of course, there is much more work to be done.

 

MBS Representations Regarding Ratings Based on False Data Are Actionable

Posted on by

In Capital Ventures International v. UBS Securities LLC et al., No. 11-11937 (D. Mass. July 22, 2013), Judge Casper held that the inclusion of credit ratings based upon “false data” in offering materials for mortgage-backed securities “constitutes an actionable misrepresentation and omission” under the Massachusetts Uniform Securities Act (the relevant provisions of which are substantively similar to those of the Securities Act of 1933). (11) The Court also held that UBS’ “representation that a certain [ratings] process will be used is an actionable statement of fact.” (12)

Capital Ventures had purchased over $100 million of certificates of RMBS that were underwritten by UBS.  The investors in those RMBS “were not given access to the loan files and had to rely upon the representations in the Offering Materials about the quality and nature of the loans that formed the security for their Certificates.” (2) The offering materials stated that the “rating process addresses structural and legal aspects associated with the Offered Certificates, including the nature of the underlying mortgage loans.” (3, emphasis in the original)

Capital Ventures alleged that “UBS knew the ratings were based on false and misleading data such as owner-occupancy and LTV statistics and underwriting quality and thus knew that the ratings were not the product of a process designed to judge the risk presented by the Certificates (as represented in the Offering Materials), but rather reflect the Rating Agencies’ judgment as to the risk presented by a ‘hypothetical security Capital Ventures was promised, but did not receive.'” (3, quoting amended complaint)

The holding in itself is important, but I am curious as to what effect it will have on representations in deals going forward.  Underwriters may very well give investors the opportunity to review the underlying mortgage loans in order to ensure that they are not exposed to this type of liability. Or perhaps the risk is remote enough that they will chance it again.  Time will tell.

Ain’t Misrepresentin’

Posted on by

According to Wikipedia, the performers in the musical Ain’t Misbehavin’ “present an evening of rowdy, raunchy, and humorous songs that encapsulate the various moods of the era and reflect” a “view of life as a journey meant for pleasure and play.” In U.S. RMBS Roundtable: Arrangers And Investors Discuss The Role Of Representations And Warranties In U.S. RMBS Transactions, S&P does something similar with securitization. It presents the views of industry players as they try to predict and shape the future of the recently emerging private-label RMBS market, in the hopes of “achieving a healthy and sustainable RMBS market.” (2)

ACT I:  Lookin’ Good but Feelin’ Bad

https://fashion.henryfoxrecruitment.com/cats/

The piece contains a lot of important insights, including the following point made by investors: “standardizing R&Ws would be a step towards improving the transparency and their ease of understanding. Smaller investors noted that they can be particularly limited in distinguishing R&Ws given the complexities involved.” (3)

This point encapsulates in so many words the classic market for lemons problem, famously formalized by George Akerlof.  The lemon problem leads us to ask how a buyer is to price a purchase where the buyer has less information about the product than the seller.  Because of this information assymetry, the purchaser will assume the worst about the product and offer to buy it with that in mind.

R&Ws are an attempt to overcome that problem because the RMBS arranger or the mortgage originator promises to compensate the investor for lemons that are contained with a mortgage pool securing an RMBS. Consistent with that view, investors noted that “they expected to be compensated for losses caused by origination defects, rather than legitimate life events.” (2) In other words, origination defects are the lemons that should be borne by the arranger/originator with its superior information about the mortgages. And “legitimate life events” represent the credit risk that the investors have signed up for.

ACT II:  That Ain’t Right

Arrangers and originators made the following points:

  1. [o]ne arranger indicated that the R&W process should be governed only by the contractual obligations negotiated for each deal. (2)
  2. [o]riginators have strict underwriting guidelines and said they take great care to follow those procedures before issuing a loan. Arrangers are also currently subjecting all or almost all loans to a third-party due-diligence review. (2)
  3. arrangers said that standardizing R&Ws will not be an easy task as differences between arrangers and product types will limit the degree to which R&Ws can be homogenized. (3)

These points clearly align with the interests of the seller in a market for lemons.  To restate them a bit, 1. caveat emptor; 2. arrangers and originators don’t sell lemons (!); and (3) it is too hard to come up with provisions that consistently protect investors so don’t bother trying.

ENCORE:  Find Out What They Like

S&P notes that there “was broad agreement that one of the keys to achieving a healthy and sustainable RMBS market is aligning the interests of arrangers and investors.” (2) From that broader perspective, S&P is right that the industry should work toward a state of affairs that “minimizes the cost of unknown risks and ultimately reduces losses and related litigation.” (2) Given the spate of lawsuits over reps and warranties, we had fallen shy of that mark in the past (here, for example).  It remains to be seen if the industry can get it better next time and if the incentives are aligned enough to do so.