At the End of the Day, Sunset Provisions a Worry

WE’RE HEARING…sunset provisions have been on originators’ wish lists for some time and have generally been welcomed by them, but they are increasingly being included among analysts’ recent representation and warranties-related liability concerns in jumbo mortgage-backed securities.

The concern seems not to be solely that a deal’s documents specify a point in time at which originator liability is limited, so much as that such a provision could contribute to a larger context of structural weaknesses. In other words, the risk may be less of a problem in and of itself than when it is layered on top of others in the terms of a private-label deal. (As previously noted in this blog, some think agency sunsets might be warranted, but when it comes to JMBS they may be a different story.)

As far “layered” risks to look out for in this context, one set analysts are watching for is whether there is not only a sunset provision, but also a lack of “alignment of incentives.” In some cases, recent issuers have not retained any risk from the transaction.

Sunset-related risk can not only be layered but, conversely, offset—by particularly strong origination quality, some analysts have suggested.

Certainly, both origination quality and reps and warrants as a whole do appear to be better than they were pre-crisis.

There is a marked shift in the attitudes of originators and companies who ranked highly in this publication’s latest annual loan volume survey, for example. At one time pre-crisis origination salespeople often perceived their roles as being at odds with those of underwriters and other operational staff members charged with maintaining loans’ soundness, whereas currently there appears to be more interest in and acknowledgement of a partnership approach.

There also seems to be some consensus, as new agency sunset moves suggest, that after a certain point it becomes more difficult to tie problems with the loan that occur way down the road to the original underwriting decision.

Investors as well as rating agencies should carefully weigh all these potential risks and offsets when sizing up residential MBS deals with sunset provisions in them.

Quincy Tang, DBRS senior vice president, RMBS, structured finance, suggests investors sizing up the possible risks do so by getting the answers to questions like, “Are R&W allowed to sunset regardless of the loans’ performance status?” and “Will the sunset period extend and how [will it extend] when a loan is delinquent or has derogatory payment history?”

Bonnie Sinnock is managing editor of National Mortgage News and editor of Origination News. She has been covering the mortgage industry since 1995.