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ResiLandscape Summary – December 2013

Core Content Overview

This document provides an analysis of the U.S. residential mortgage-backed securities (RMBS) market in December 2013, focusing on risk factors, legal implications, and market outlook for 2014. It includes insights from Moody's Investors Service on the performance of different types of RMBS transactions, the impact of the Ability-to-Repay (ATR) and Qualified Mortgage (QM) rules, and the evolving role of third-party originations and servicers.

Main Points and Key Information

1. Non-QM vs. QM RMBS Risk

• Non-QM loans are more prone to higher loss severities due to:
  • Increased legal costs and penalties from borrower lawsuits.
  • Greater vulnerability to legal challenges under the ATR rule.
• QM loans are generally less risky, with:
  • A presumption of compliance with ATR requirements.
  • Two types: "safe harbor" (conclusive presumption) and "rebuttable presumption" (challengeable).
• Rebuttable presumption QM loans carry some risk of legal challenges, but less than non-QM loans.
• Legal costs and foreclosure timelines are key contributors to higher losses in non-QM transactions.

2. ATR and QM Rules

• Effective 1 January 2014, the CFPB will implement new rules requiring lenders to make a reasonable determination of a borrower's ability to repay.
• Qualified mortgages (QM) are defined by the absence of certain risk features and are protected from liability if ATR is satisfied.
• The eight underwriting factors include:
  1. Current or reasonably expected assets or income
  2. Current employment status
  3. Monthly mortgage payment
  4. Other mortgage payments
  5. Mortgage-related obligations
  6. Debt obligations, alimony, and child support
  7. Debt-to-income ratio or residual income
  8. Credit history
• QM loans must be based on the highest payment in the first five years.

3. RMBS Market Outlook for 2014

• The private-label RMBS market will slowly rebuild due to:
  • New regulations.
  • Rising interest rates.
• Collateral quality may decline as a result of:
  • Low refinancing volumes.
  • Strong demand for whole loans by banks.
• Risk-sharing structures from Fannie Mae and Freddie Mac are expected to remain common.
• Single-family rental transactions are gaining interest from investors.

4. Outstanding RMBS Transactions

• Borrower credit profiles are improving due to:
  • A recovering housing market.
  • A stronger economy.
• Default rates are slowing as:
  • Loan-to-value (LTV) ratios decrease.
  • Borrowers build equity.
• Pool loss severities are expected to remain stable in early 2014 due to a large number of severely aged properties in foreclosure.
• After servicers liquidate foreclosures, loss severities will decrease.
• Rising interest rates will slow prepayment rates, increasing extension risk and reducing loss protection from excess spread.

5. Servicer Quality and Practices

• Non-bank servicers are more aggressive in loss mitigation than banks.
• Servicer transfers may cause cash flow disruptions due to:
  • Operational challenges.
  • Changes in modification and loss mitigation policies.
• Foreclosure timelines are still long due to:
  • Complicated cases in servicers' backlogs.
  • Judicial states' slower processing.
• Servicer costs are expected to rise due to compliance with new CFPB rules.

6. Third-Party Originations

• Third-party originations (TPOs) have improved in performance compared to pre-crisis years, due to:
  • Tighter lender and regulatory controls.
  • Reduced risk of fraud and underwriting defects.
• Broker-sourced loans historically have the highest fraud risk, as:
  • Brokers and borrowers may collude to misrepresent financial information.
  • Brokers control the flow of information to originators.
• Correspondent lenders have also improved, with originators now:
  • Underwriting credit and appraisal twice.
  • Directly accessing IRS data to verify income.
  • Limiting purchases to loans sourced through their own retail channels.

7. Housing Market Recovery

• The housing market is tipping towards undersupply, which, combined with stronger demand, will drive recovery.
• Existing-home sales and new-home sales have improved slightly.
• House price appreciation has been strong and is expected to stabilize.
• Negative equity has decreased to about 10 million households.
• Household formation and demand are outpacing supply, indicating a strong future for homebuilding.

Summary of Key Risks and Outlook

• Non-QM and rebuttable presumption QM loans carry higher legal and operational risks.
• Legal challenges will influence loss severities, with successful cases potentially leading to penalties and costs.
• Third-party originations have become less risky due to tighter controls, but remain vulnerable under economic stress.
• Servicer quality is improving, but transfers and regulatory changes pose challenges.
• The U.S. housing market is expected to recover in 2014, driven by supply constraints and stronger fundamentals.

Key Contacts

• Managing Editor: Debash Chatterjee
• Editor: Alexis Alvarez, Laura Kahn
• Analysts:
  • Peter McNally (Vice President - Senior Analyst)
  • Yehudah Forster (Vice President - Senior Credit Officer)
  • Kruti Muni (Senior Vice President/Manager)
  • Debash Chatterjee (Associate Managing Director)
  • Linda Stesney (Managing Director)
  • Gene Berman (Assistant Vice President - Analyst)
  • Jonathan Corwin (Associate Analyst)
  • Jayesh Joseph (Analyst)
  • Hassan Shamji (Associate Analyst)
  • Kathryn Kelbaugh (Vice President - Senior Analyst)

Additional Resources

• Primary RMBS Ratings Methodology
• RMBS Surveillance Methodology
• RMBS Deals Update
• RMBS Dashboard
  • Proposed $4.5 Billion JPMorgan Settlement
  • Servicing Transfers Update
  • Resi Stats
  • Moody's RMBS Loss Tracker
  • Ratings Activity

Exhibits Mentioned

• Exhibit 1: Cumulative default rates for Fannie Mae and Freddie Mac loans.
• Exhibit 2: Distribution of Fannie Mae loans by source (retail vs. third-party).
• Exhibit 3: Vacant homes for sale, rent, and held off the market.