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Investors raise concerns on reps and warrants as RMBS market improves

S&P says rep & warrant debate will determine future of private market

As the residential mortgage-backed securities market continues to make its comeback and the number of issuers grows, it will be important for investors to hold an understanding of variations in representations and warranties, analysts claim.

The re-emergence of the RMBS market is also rapidly evolving as participants try to strike a balance between the interests of originators, securitization sponsors and investors, according to Standard & Poor’s.

“RMBS transactions generally contain a set of R&Ws provided to investors by the mortgage loan originators, arrangers, or other parties in the transaction,” said Jacques Alcabes and Sharif Mahdavian of S&P.

They added, “These R&Ws and the associated procedures for remedying breaches are intended to protect investors from exposure to loans with underwriting or other defects such as unverified incomes or unenforceable titles. The differences in these R&Ws can have a significant effect on the risks to which each party in a transaction is exposed.”

Securitization platforms do – and will likely continue to – differ in terms of the scope of the reps and warrants provided.

While some securitization documents include broad reps and warrants, others contain more restrictive coverage, such as limitations on the amount of time the reps and warrants are enforceable against the provider. 

“Many of these differences are because of the different sizes and types of originators and arrangers involved,” S&P analysts explained.

They added, “For instance, a seller of mortgages that controls the origination process may be more willing to provide stronger R&Ws than aggregators that purchase whole loans from a wide variety of small originators.” 

Although standardizing reps and warrants would be a step towards improving transparency in the RMBS market, the new issue jumbo market has shown diversity even with relatively few recent transactions.

Overall, investors remain concerned that breaches encompass a broad spectrum of loan defects and the securitization sponsors demonstrate a varying appetite for broad reps and warrants coverage.

“Investors displayed relative uniformity in desired standards,” according to S&P analysts.

They concluded, “In contrast, given recent publicity surrounding R&Ws, some arrangers debated whether efforts to limit liability were worth the adverse publicity, given the overall high quality of today’s U.S. RMBS collateral and the desire for market stability.”

As the market continues to move forward and new transactions are created to serve a wider variety of credit quality borrowers, the debate of rep and warrants will become increasingly important. 

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