New Disclosure Rules Require Substantial Preparation for ABS Participants 

The Securities and Exchange Commission (SEC) has had a busy year adopting new rules for asset-backed securities (ABS) with significant emphasis on mortgage and auto deals.  Originators, aggregators and issuers of RMBS are dealing with an abundance of regulatory change. On the heels of ATR/QM, the industry has been levied with QRM/risk retention rules,pre-securitization due diligence reporting, and rigorous disclosure requirements under Regulation AB.


Summary This rule is effective as of June 2015, making it one of the first of the new disclosure rules to become operative and is part of the new SEC rules pertaining to the Nationally Recognized Statistical Rating Organizations (NRSROs); better known as Rating Agencies.  This rule requires either the sponsor or rating agencies to make publicly available the scope, findings, and conclusions of any third-party due diligence report obtained by the issuer or underwriter for any ABS that is rated and has repurchase covenants for representation and warranty (RW) breaches. While the disclosure form itself (Form ABS Due Diligence-15E) is straight-forward and completed by the due diligence firm; the disclosure of an excessive number of loans with exceptions to underwriting and appraisal guidelines is likely to have a profoundly negative effect on investor confidence and, in turn, the pricing and perhaps even salability of the ABS. Recommendation In order to avoid third party diligence findings, originators and aggregators of mortgage, auto, and other loans must have clearly written underwriting guidelines. In the case of mortgages, they must also have clearly written property valuation procedures. The underwriting guidelines must be easily interpreted by due diligence firms such that there is little ambiguity as to which loans breach guidelines.  Furthermore, originators and aggregators should have robust policies, procedures and quality control functions that ensure loan underwriters across the organization perform consistently, and materially follow the guides.


Summary Risk retention rules for RMBS go into effect in November 2015 and for all other ABS in November 2016.  In an effort to better align issuer and investor interests, the risk retention rule requires sponsors’ RMBS and other ABS private label securities to retain a 5% interest in RMBS/ABS backed by non-exempt loans. The retained interest may be a vertical, horizontal, or any combination of both provided that the retained assets total is at least 5%.  Exempt loans include, but are not limited to, loans purchased or guaranteed by the GSEs and other federal entities, state housing finance agencies, and notably, Qualified Residential Mortgage (QRM)[2] and Qualified Commercial Real Estate loans (QCRE). Those Sponsors of ABS securities (backed by non-exempt loans) electing to hold a horizontal interest must disclose the valuation methodology used to determine fair value, such as discounted cash flow analysis, comparable market data, vendor pricing, or internal-model based analysis.  To the extent models are utilized to determine the fair value of the horizontal interest, sponsors must also disclose all the inputs and assumptions used, including disclosures on discount rates, loss given default (recovery rates), prepayment rates, default rates, the lag time between default and recovery, the basis of forward interest rates used, along with a summary of any reference data set or other historical information used to develop the key inputs. Further, sponsors of RMBS pools exempt from the risk retention rules backed by QRM loans are on the hook to repurchase any loan that is determined not to meet the QRM definition by inadvertent error after the closing of the securitization transaction.  The regulators believe this requirement helps ensure that sponsors have a strong economic incentive to ensure that all mortgages collateralizing a QRM securitization satisfy all of the conditions applicable to QRMs prior to closing of the transaction. Recommendation Sponsors should begin validating and documenting all model inputs, outputs, algorithms, and assumptions to ensure accuracy and to prepare for required disclosures for horizontal interest retention.  Sponsors, aggregators, and originators should review credit policy, policy and procedure, and QC/QA processors around QRM and non-QRM lending to be sure loan underwriters are within guidelines in order to reduce the chance of repurchase of inadvertent non-QRM loans. Aggregators and sponsors that retain the risk on behalf of their sellers (originators) must have a good handle on their sellers’ origination quality as benchmarked against the industry as well as the aggregator’s book of business.


Summary This is effective November 2016 and presently only applies to publicly issued RMBS, CMBS, and Auto ABS securities. The SEC made clear that it may, at its discretion, subject privately placed securities to the same requirements at some point in the future.  The significant change for sponsors is the requirement to provide additional loan level information, both static and dynamic, in XML format under Reg AB. Originators and aggregators will need to collect data to satisfy the final requirements for RMBS, which are set forth in Item 1 of Schedule AL of the Rule. However, most of the rating agencies already require even more fields to conduct their credit analysis.  The RMBS loan level data set calls for 270 data points. The bigger shock pertains to the loan level disclosure for Auto loans and leases that the final rules will require. Issuers will be required to provide 72 data points for ABS backed by auto loans and 66 data points for ABS backed by auto leases. Both the Auto ABS and RMBS data sets require disclosure about the property/automobile, the obligor’s creditworthiness, original and current mortgage terms, and loan performance information. Recommendation Review the new fields and train the relevant personnel concerning data integrity and consistency. Additionally, the new data fields and associated valid values must be defined, built, captured and tested within 24 months. Commence building the data migration routes from the loan origination and servicing systems to the capital markets asset delivery systems now. Don’t let the quantity and magnitude of operational and technological changes overwhelm your resources. RiskSpan is here to help with industry experts that provide knowledgeable guidance, technology solutions and personnel to get you through it.  Call us today. [1] Office of the Comptroller of the Currency, Treasury (OCC); Board of Governors of the Federal Reserve System (Board); Federal Deposit Insurance Corporation (FDIC); U.S. Securities and Exchange Commission (Commission); Federal Housing Finance Agency (FHFA); and Department of Housing and Urban Development (HUD).  [2] QRM is defined the same as QM, which generally requires points and fees less than or equal to 3% of the loan amount; no negative amortization, interest-only, or balloon loans; maximum loan term less than or equal to 30 years; debt-to-income ratio of 43% or less. All GSE-eligible loans are considered QMs.
Kathy Kelbaugh is a 25+ year veteran of the residential mortgage industry with significant strategic and tactical expertise in all facets of the sector. Her unique skill set combines a deep appreciation for technology, processes (six sigma green belt) and people involved in mortgage origination with high proficiency in secondary mortgage markets and credit risk management. She is an accomplished senior leader with extensive experience in loan origination, whole loan sales and securitization, credit and counterparty risk management, and data management pertaining to all types of mortgage products including Government, Agency, Non-Agency Jumbo, Alt A, and Subprime loans. Prior to RiskSpan, Kathy was Vice President and Senior Analyst at Moody’s where she helped design post-crisis blueprints for residential mortgage origination practices, R&W frameworks, and due diligence reviews. Previous to Moody’s, among other positions, Kathy was the Managing Director and SVP of GMAC Mortgage Direct Lending origination platform and Customer Retention Strategies, and SVP of Capital Markets for GE Capital Mortgage. Download RiskSpan Insight-November 2014