Weak structures can prevent top ratings for RMBS
Residential mortgage backed securities (RMBS) with weak structural frameworks are not likely to earn a Aaa (sf) rating from Moody's Investor's Service even if they have strong prime loan pools and satisfactory originators and servicers. According to a new report "Post Crisis U.S. RMBS Frameworks Yield Various Credit Results" RMBS with provisions that significantly limit originators' obligations to repurchase defective loans, have a narrow thirdparty pre-securitization due diligence scope, or a weak alignment of interests between the sponsor and investors, are not consistent with Moody's Aaa (sf) rating.
In its analysis of RMBS, Moody's weighs the effectiveness of the transaction elements that provide transparency and align interests between issuers and investors: the representations and warranties (R&Ws), the procedures available to investors for the enforcement of R&W breaches, the robustness of the origination process, and the scope of pre-securitization due dili- gence. "The decline of the US housing market that led to investor losses exposed limitations and flaws in many aspects of the RMBS framework ," says Kathy Kelbaugh, a Moody's Vice President and co-author of the report.
For an RMBS to earn a top rating, investors should be protected against the risk of loss due to fraudulent or defective loans, and they should have access to robust and reliable data that provides transparency concerning loan terms, borrower credit and property valuation
The report presents contrasting examples of structural frameworks for RMBS: a strong framework, exemplified by those present in the post-crisis RMBS offered by Redwood Trust, and another consistent with some proposals Moody's has reviewed or discussed with issuers that exhibit weaknesses that would result in an investment grade rating in the A1 (sf) to A3 (sf) range.
The report also adds a brief discussion of one possible scenario under which the framework would be consistent with a rating in the Aa1 (sf) to Aa3 (sf) range.