In regards to representation and warranties provide to RMBS transactions, Fitch Ratings believes that a clear and objective framework, after the Qualifed Mortgage rule goes into effect in January, will help to protect investors and provide incentives to originators and issuers to maintain high-quality originations while upholding guideline compliance.
Consequently, Fitch expects that reps and warrants to indicate that all loans are accurately designated and comply with the QM rule.
The forthcoming ability-to-repay and qualified mortgage rule, therefore, will have direct consequences for the primary and secondary mortgage markets.
Specifically, processes will need to be developed to satisfy secondary market participants, including loan aggregators and residential mortgage-backed securities investors, according to the ratings agency.
“While Fitch initially expects 100% due diligence to be conducted on QM loans originated after 2014, the percentage may potentially be reduced over time through successful originator reviews from strong transaction reps and warrants,” explained Fitch analysts Roelof Slump and Vanessa Purwin.
They added, “Given the increased risk associated with higher-priced QM and non-QM loans, Fitch believes 100% third-party due diligence should be conducted on these loans.”
The Consumer Financial Protection Bureau issued the ATR and QM rule this year as a direct response to the financial crisis so that creditors make reasonable and good-faith determination based on verified documentation that a residential mortgage borrower has the ability to repay their loan.
The rules will be effective at the start of the new year and defines the scope as well as requirements of the law.
The rule entitles borrowers to damages from the lender of the loan in instances of noncompliance, creating risk for RMBS.
Specifically, a borrower may seek damages equal to three years of finance charges and fees paid.
Fitch is currently developing rating criteria related to the rule and will likely focus on compliance with the rule, rather than focus on quantifying the cost of noncompliance.
In addition to reviewing product guidelines, the credit rating agency will focus on originator controls and due diligence results to assess the risk of noncompliance.
Originator reviews will be conducted on any lender that contributes 15% or more of the loans included in the securitization.
Once the rule becomes effective, third-party due diligence reviews will be conducted to verify the loan designation assigned by the lender, including an assessment of a loan’s compliance with the rule and associated QM as well as higher-priced provisions.
“Until the originator is able to effectively demonstrate to Fitch that it’s origination process ensures compliance with the rule, 100% of due diligence reviews will be expected to have been completed on loans included in an RMBS transaction from that originators,” Fitch analysts explained.
On an interesting note, loans complying with the rule that are not designated as QM will be approached cautiously when rated due to the increased liability risk and the potential difficulty in qualifying the cost of borrower differences.
To rate higher-priced QM and non-QM loans, Fitch will likely look to originator reviews, due diligence results and possibly increased loss severity expectations to account for higher compliance risk.