Moody's Investors Service is requesting comments from market participants on its proposed approach to evaluating incremental risks of qualified mortgage (QM) and non-qualified mortgage (non-QM) loans in its ratings of U.S. residential mortgage backed securities (RMBS). The Consumer Financial Protection Bureau (CFPB) issued its Ability-to-Repay (ATR) rules, establishing the QM category. In a new request for comment, “Moody’s Approach to Assessing Incremental Risk Posed by the Ability to Repay Rules in US RMBS,” the rating agency notes that the ATR rules creative incentives that could lead to incremental risks for RMBS trusts.
“The broad scope of the ATR rules allows borrowers to claim they were wrongly given loans that they would not be able to repay,” said Yehudah Forster, Moody’s vice president and senior credit officer. “Moody’s proposes changes to the RMBS methodology that would flag loans at risk for ATR claims and then lays out the framework for assessing that risk.”
Since the RMBS trusts bear the costs of ATR claims raised by borrowers as a defense to foreclosure, the incremental risk for losses increases as the trust covers expenses to defend against the claim, and penalties if the claim is successful. Moody’s new approach will identify potential underwriting flaws that could result in ATR violations or disqualification of loans’ QM status.
“Data discrepancies, or debt-to-income ratios and points and fees close to the QM thresholds would all raise red flags that these loans are at risk of ATR challenges,” cautions Forster. Moody’s will scrutinize the originator or aggregator’s ATR procedures and loan-level third-party diligence reviews for risk of ATR violations, and assess the strength of the representation and warranty structure.
Moody’s will assess non-QM loans in the context of the overall transaction. “Some transactions will contain non-QM loans from high-quality buyers, who pose minimal ATR risk,” adds Forster. However, for transactions containing non-QM loans from non-prime borrowers or Rebuttable Presumption QM loans, Moody’s would incrementally increase loss severity levels to account for the losses resulting from ATR claims.
In the new approach, Safe Harbor QM loans would pose no additional risk to an RMBS transaction because borrowers are less likely to bring ATR claims, and if they do, those claims are easy to defend. “Absent red flags, we do not propose any changes to our risk assumptions for these loans.”