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Moody's Not On Board With Making Mortgage Securitization Fun Again

passfail.comFebruary 26, 2013

A primary goal of financial engineering is to confuse the bejeezus out of Them while remaining crystal clear to Us. There's no point to it if it doesn't in some way confound the expectations of some Other, whether that Other is the tax authorities, bank capital regulators, rating agencies, customers, or markets generally. But the worst possible outcome is for a product to be unpredictable to whoever built it, mostly because, if it was any good, they built a lot of it, and if it blows up on them it'll hurt.

There is an obvious tension here: complicated products serve well to confuse Them but are more likely to end up acting up on Us as well. One fruitful approach is for Us to be just a bit smarter than Them. Another approach, lovely when it works, is to build a product that is so beautifully simple that anyone can understand it, but that has one simple conceptual twist that falls right in the particular blind spot of one particular targeted Them.

You can bracket the question of whom residential mortgage backed securitizations were designed to confound, and just take a moment to realize: they kind of screwed the banks that did them, no? I mean, compared to what? I guess imagine if Countrywide had done all the lending it actually did, but kept everything on its balance sheet but the fact that BofA has eighty zillion dollars in putback liability must be discouraging for whoever's left there on the securitization desk. Like: the whole idea was to put some loans in a box and sell the box to investors; the investors, not you, now own the credit risk on the loans. You own nothing. The loans have nothing to do with you. Sure you signed a piece of paper saying some stuff about the loans, just before you waved goodbye to them, but why would you have read that? Those are just reps and warranties; those are for the junior law firm associates to haggle over. You sold the loans, it's done, right?

Totally wrong. Doubly wrong: not only are you responsible for loans where your reps were wrong in a way directly related to why the loan defaulted, but you're also responsible for loans where the reps were wrong and it had nothing to do with the default. If the reps were wrong a lot, and they seem to have been, then you end up on the hook for a surprising amount of the credit risk. You thought you sold the loans and would never see them again. Instead, you've got yourself a covered bond.

That's bad! One way to fix it in future deals would be to make sure the reps and warranties are true but there are important reasons why that's not a great solution. Another way is to revise the terms of securitizations to say basically:

We sell you loans.

You've gotten used to getting reps and warranties, so we'll give you reps and warranties.

But we don't mean them, and if they turn out not to be true we'll have various technicalities that prevent us from repurchasing the loans.

Here you can read a Bloomberg article about how Moody's has decided not to fall for that:

Home-loan securities without government backing probably will be able to get rankings only as high as Moody's Aa tier limits are placed on when and how repurchases can be forced of mortgages that fail to match their stated quality, the New York-based firm said today in a report.

The Moody's report is wonderful. I like it, but I'm pretty far from an expert in RMBS documentation; I assume some RMBS structurer is going through it with a checklist and saying, excellent, there are still two traps they missed. Here are a few they caught:

The risk of loss is higher for RMBS whose R&Ws contain materiality standards that allow loans that are clearly riskier than originally disclosed to remain in the pool because they still fall within the originator's underwriting or program guidelines or because another factor besides the breach caused or contributed to the loans' default or loss. For example, a breach reviewer examines a defaulted loan with an initially disclosed LTV of 60% and determines that the appraisal was faulty and the true LTV is 80%. Under an expanded materiality clause, so long as the originator's program guidelines permitted an 80% LTV, the twenty point difference in LTV would not be material and no breach would have occurred.

So we can take loans up to 80% LTV, but weighted average LTV is 60% means weighted average LTV might be 80%, good luck.

An enforcement protocol that allows borrower life events, such as divorce, death, or job loss, to render the breach immaterial or prevent the review of a loan for R&W breach will negate the breach review process for many defaulting.

Back to February 2013 Archive

CFLA was founded by the Nation's Leading Foreclosure Defense Attorneys back in 2007 to serve the Foreclosure Defense Industry and fight pervasive Bank Fraud. Since opening our virtual doors, CFLA has rapidly expanded to become the premier online legal destination for small businesses and consumers. But as the company continues to grow, we're careful to hold true to our original vision. For us, putting the law within reach of millions of people is more than just a novel idea—it's the founding principle, just ask Andrew P. Lehman, J.D.. With convenient locations in Houston and Los Angeles, you can contact Our National Account Specialist and General Manager / Member Damion W. Emholtz at 888-758-2352 for a free Mortgage Fraud Analysis or to obtain samples of work product, including cutting edge Bloomberg Securitization Audits, Litigation Support, Quiet Title Packages, and for more information about our Nationally Accredited and U.S. Department of Education Approved "Mortgage Securitization Analyst Training Certification" Classes (3 days) 24 hours for approved CLE & MCLE Credit (Now Available Online).

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