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The (Empire) State of Mortgage-Backed Securities

According to Fitch Ratings, New York’s six-year statute of limitations (SOL) for rep and warranty (R&W) breach claims does not materially increase risk for investors in most post-crisis non-agency U.S. RMBS issued to date due to upfront third-party due diligence.

As Fitch notes, most U.S. RMBS R&W agreements are governed in the state of New York, but if issuers migrate to a smaller upfront diligence sample for future U.S. RMBS, Fitch will place greater significance on the breach review performance triggers to mitigate against the six-year limit.

“Third-party due diligence prior to the transaction close is expected to mitigate much of the risk of the six-year SOL for most post-crisis RMBS,” Fitch says. “The average sample size on Fitch-rated transactions since 2010 is approximately 90% of the mortgage pool (with most issuers providing due diligence results on 100% of the mortgage pool), which significantly reduces the risk of loans with R&W breaches being included in the securitized pool.”

Fitch views an automatic delinquency review trigger as a strong mitigating factor to a reduced upfront due diligence sample size. Fitch assumes more than 75% of borrower defaults occur within six years of origination. Additionally, defaults that occur after year six are more likely to be the result of life events and less likely to be related to underwriting defects at origination that could be eligible for a repurchase.

By contrast, non-prime RMBS transactions by contrast have weaker breach review triggers and are consequently more dependent on upfront due diligence to identify manufacturing defects. Non-prime RMBS transactions do not include an automatic review trigger for delinquent loans. As such, they typically only require a review when a realized loss is related specifically to an Ability-to-Repay claim. All other breach review actions rely on a bondholder vote.

"All Fitch-rated Non-Prime RMBS issued to date have had 100% upfront diligence to help mitigate the risk," Fitch adds. "Additionally, Fitch increases credit enhancement on any transaction without an automatic breach review trigger to further protect investors."

About Author: Seth Welborn

Seth Welborn is a Reporter for DS News and MReport. A graduate of Harding University, he has covered numerous topics across the real estate and default servicing industries. Additionally, he has written B2B marketing copy for Dallas-based companies such as AT&T. An East Texas Native, he also works part-time as a photographer.

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