WE’RE HEARING…that despite early industry efforts to establish recommended industry standards for private-label residential mortgage-backed securities representations and warranties, some issuers are trying to diversify their approaches.
“We’re seeing this in light of some of the transactions that we didn’t rate and in terms of proposals that issuers are thinking about,” Fitch analyst Suzanne Mistretta tells us. “They were included in deals [where we were] aware of some provisions but did not rate the transaction.
“There seems to be a lot of variability,” she said, commenting on a recent Fitch report on the trend she contributed to. “It’s not as though one or two things are changing.”
Mistretta said this appears to reflect issuers’ interest in tailoring deals in line with their individual “appetites for risk.”
Some of the diversification in these reps and warrants in particular reflects concern about having repurchase liability extend out “for the life of the loan.”
By having a “sunset feature,” such as the agencies have been planning, some would-be or existing issuers not rated by Fitch have been trying to “reduce the uncertainty” associated with repurchase risk by having the period of liability end after, for example, less than 36 months.
When asked if the agencies’ rep and warrant reform has influenced the diversification in the private market, she said, “I do think that that’s had an impact.”
However, she noted that the two markets are not comparable in this regard, as there is “less leverage in the private label space.
“It just weakens the private label space a little more relative to the GSEs,” Mistretta said.
Other variations in reps and warrants have included differing or missing definitions of “life events” mentioned in the reps and warrants.
To address the diversification in reps and warrants, “We have to look at each transaction and each proposal” using “a holistic approach” in looking at each individual deal and its operational risk.
In some cases, where the rep and warrant weaknesses are “significant…there may be instances where we can’t get comfortable with a high investment grade,” Mistretta said.
She said Fitch plans to watch reps and warrants closely, “particularly down the road” if deals are done “without 100% due diligence” by third parties. She noted that a due diligence review is “a very strong step in reducing operational weakness in the loans.
“If you have a third-party firm who has that expertise going in and checking [adherence to underwriting guidelines]…it reduces operational risk exposure,” she said, noting that analysts want to ensure originators “remain incentivized to maintain high-quality standards and make sound underwriting decisions” in reviewing reps and warrants, as well as other operational risks.
Even if there are some weaknesses in reps and warrants, if there are “other considerations” such as a binding arbitration provision, analysts may be able to “gain more comfort” with the level of operational risk in a deal.
These may include having “an independent reviewer named to review the loans for breaches when a delinquency threshold is met” or “greater transparency allowing investor access to third party or ongoing due diligence results.
“The more transparency that’s present, the greater likelihood of reducing operational risk exposure,” she said. “It helps align the interests [of the parties in a deal] and that, I think, is a key goal.”