Wednesday, March 27, 2013

JP Morgan's New Incarnation of Non-Agency RMBS Weakens Provisions from Pre-Crisis Version

By Tim Dulaney, PhD and Tim Husson, PhD

Last week, the Wall Street Journal covered the first non-agency residential mortgage-backed security (RMBS) offering from JP Morgan since the financial crisis.  This particular RMBS is a collateralized mortgage obligation (CMO) which is "supported by 752 jumbo mortgage loans [...] made to borrowers with high credit scores and with about 35% of their own money in a down payment for the property."  JP Morgan originated nearly half of the mortgage pool (48%) and First Republic Bank originated approximately 41% of the remaining loans.

In what could be considered a product of the multitude of misrepresentations by originators and mortgage sellers leading up to the financial crisis, JP Morgan has now decided to weaken the embedded repurchase provisions of the RMBS.  Fitch specifically stated that while the
transaction benefits from strong [representation] providers, Fitch believes the value of the [Representation and Warranty] framework is significantly diluted by qualifying and conditional language that substantially reduces lender loan breach liability and the inclusion of sunsets for a number of provisions including fraud. While the agency believes that the high credit quality pool and clean diligence results mitigate the [Representation and Warranty] risks to some degree, Fitch considered the weaker framework in its expected loss estimation and credit enhancement analysis. 
For comparison, we obtained the prospectus for a similar structure issued prior to the financial crisis.  The JP Morgan Mortgage Trust 2007-S3 was a $1.83 billion CMO backed by a mortgage pool with a weighted-average-maturity of just over 23 years, a weighted-average loan-to-value ratio of about 72% and a large geographic concentration in California.  In the prospectus, JP Morgan states that the "Originator or the Seller will be obligated to purchase or substitute a similar mortgage loan for any Defective Mortgage Loan" where a "Defective Mortgage Loan" is defined as
[a]ny Mortgage Loan as to which there exists deficient documentation or as to which there has been an uncured breach of any such representation or warranty relating to the characteristics of the Mortgage Loan that materially and adversely affects the value of such Mortgage Loan or the interests of the Certificateholders in such Mortgage Loan.
On the other hand, the Kroll BondRatings report on the JP Morgan Mortgage Trust 2013-1 notes that 
The originators will only be responsible for curing loans where the Reviewer has determined that the breaches were a material factor in the loss experienced on the loan and that certain borrower events, such as a death, disability, illness, divorce or job loss, were not the cause of the loss.
So if, for example, an originator misrepresents the details of a mortgage (borrower credit score, documentation, etc.), but the borrower loses their job after the securities are issued and the loan subsequently defaults, JP Morgan would likely argue that the default was a result of the life-event and independent of the misrepresentation.  As a result, the mortgage would not be replaced in the pool and investors would be on the hook for the losses.

For ratings agencies views on this deal, here is the announcement from Kroll, as well as a similar announcement from DBRS.  The full Kroll report can be found here (PDF) and the Fitch report is available here (PDF).  Matt Levine of Dealbreaker has additional commentary on this subject.

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