Investors may finally be ready to take another look at residential mortgage-backed securities (RMBS), which would give lenders a pathway to liquidity and growth. At the same time, Fannie Mae and Freddie Mac have consolidated their securitization infrastructure. Taken together, this spells more stringent oversight of the loans that will be pooled for securitization in the near future. We sat down with John Hillman, CEO of Nationwide Title Clearing, to talk about what this may mean for the industry.
Why do you see due diligence changing for loans pooled by securitization?
HILLMAN// Both the GSEs and the ratings agencies have signaled they will be taking a much closer look at the loans that make up the pools that enter the securitization process. Fitch Ratings and Moody's Investor Service have updated their prime RMBS ratings criteria for seasoned loans. The industry is awakening to the fact that there is a much higher risk posed by problems hiding in the collateral file when loans are already in portfolio. If these problems are identified pre-securitization, the loan can be pulled out of the pool. If these problems are found post-transfer, it becomes a much more problematic and expensive prospect to correct.
What changes do you anticipate this will bring about within the industry?
HILLMAN// We're already seeing the changes. Companies perform due diligence for lenders and investors are paying more attention to the collateral file before loans are sold, transferred, or pooled for securitization. Lenders must find any problems first and correct them before moving forward. The downside risk is too high to do otherwise.
Between 2011 and 2013, Fannie Mae and Freddie Mac issued buyback requests for over $81 billion in loans. The settlements that have come from these requests have kept investors from re-entering the market and slowed the industry's overall growth. That's driving change and giving rise to a new level of required due diligence.
While the fact that the ratings agencies are updating their RMBS ratings criteria is good news for investors, the only way the industry can benefit is by making sure all loans meet the agencies' criteria. Traditionally audits have focused on loan origination issues. However, we have found that document handling post-closing is as important - or even more important - because handling this function poorly allows risk to hide in the collateral file when loans are later released, securitized, or servicing is transferred.
What are the downside risks for companies that aren't prepared for these changes?
HILLMAN// We have worked with clients who, after a detailed portfolio review, found the vast majority of the seasoned loans in their portfolio had significant collateral file problems. These problems were so serious that the loans could not be included in a pool for securitization, to say nothing of forcing the client to sell off the loans for a discounted price. This risk is significant for the industry and cannot be ignored.
Is there a solution to this problem?
HILLMAN// There is a solution. It involves, first, a commitment to problem prevention and then, when required, performing title work to perfect the collateral file.
Prevention involves conducting a collateral documentation review and mortgage/assignment chain audit as part of the servicer's due diligence process. This is typically a two-part process that involves an audit phase and a corrective process for exceptions or deficiencies.
In cases where problems already exist and the servicer is fortunate enough to uncover them before the loans are transferred or pooled for securitization, curative action must be taken. There are many ways to do things incorrectly, but generally only one way to do them correctly. When corrective actions are necessary, they may be more complex than doing the job right the first time, and in many cases, the services of a professional are required.
Taking the long view, will this make it easier or more difficult to raise money through securitization?
HILLMAN// We anticipate the securitization market will certainly change and has to change if domestic and international investors are to be wooed back to the market. Deeper forensics and tighter controls on the front end are essential and must become part of the process. That can be difficult or significantly easier, depending on which partner is chosen.
This article was published in the December 2014 issue of TheMReport. You can find the article online by clicking here.