US residential mortgage-backed securities (RMBS) backed by non-qualified mortgages will incur higher loss severities on defaulted loans than those backed by qualified mortgages (QM), according to a new report by Moody’s Investors Service. The key driver of the loss severities will be the higher legal costs and penalties for non-QM securitizations, says Moody’s in the report, “Non-QM US RMBS Face Higher Risk of Losses Than QM, but Impact on Transactions Will Vary.”
On 10 January 2014, the Consumer Financial Protection Bureau will begin to phase in new rules requiring that lenders make a reasonable determination of a borrower’s ability to repay a residential mortgage loan. The rules, which implement the Ability-to-Repay (ATR) sections of the Dodd-Frank Act, give lenders protections from liability if they originate loans classified as “qualified mortgages.”
“In non-QM transactions, a defaulted borrower can more easily sue a securitization trust on the grounds that the loan violated the ATR rule,” says Moody’s Senior Vice President Kruti Muni, a co-author of the report. “ Some QM loans will also be subject to a greater risk of penalty than others.”
The extent of the risks for RMBS will vary depending on the mortgage originators’ practices and documentation, the strength of the transactions’ representations and warranties, and whether the transactions include indemnifications that shield them from borrower lawsuits.
“The degree to which RMBS will need additional credit enhancement to account for the increased risk of losses from non-QM and rebuttable presumption QM loans will depend on the strength of originators’ compliance practices and the trust mechanisms protecting against lawsuits,” says Moody’s Muni.
Of the two types of QM loans, those with a “safe harbor” from ATR challenges and those with a “rebuttable presumption,” the safe harbor loans will be less likely to incur penalties.
“Borrowers of safe harbor loans will have grounds to sue only if they can successfully challenge the loan’s QM status,” says Moody’s Vice President Yehudah Forster, also a co-author of the report. “The specificity of most QM requirements, such as the prohibition of some affordability products as well as excessive points and fees, will make challenging the QM status difficult for borrowers.”
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