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American Securitization Forum’s New RMBS Rep and Warrant Guidelines

The American Securitization Forum’s Project Restart team released new guidelines for RMBS reps and warranties on December 15. These guidelines are perfectly in line with what the industry needs to adopt.

The suggested reps and warranties address fraud on a level never heard of before. The subordinate investor was always known as the “fraud investor,” and a specific fraud rep was a rare thing.

In truth, and as the ASF team admits, a fraud rep can only do so much. I was an auditor for a major accounting firm, and one thing we knew to be true was that if the client intended to defraud us, they could. An auditor simply can’t shake every box in inventory to see if it rattles or test every gallon in every storage tank to verify that it is oil, not water. If a borrower intends to defraud the lender at origination, it can be done. Still, having a fraud rep would significantly raise the standards of RMBS and would give investors a much stronger case for putting their money into these bonds again.

Other reps of significance that the ASF suggests touch on property valuation, appraisal validity, data validity and verification of income and assets. These are all critically important to investors and help achieve the RESTART team’s goal of making these bonds appealing to investors once again. Every one of these recommendations should have been in place long ago. Investors should note these are only suggestions. What actually transpires will be the subject of individual negotiations among sellers, issuers, investors and rating agencies, when securitizations return to the marketplace.

More importantly, the RESTART team acknowledges in its final paragraphs in the December 15 announcement that reps and warrants are of little use if investors can’t enforce them. ASF promises to address the matter of enforceability of reps and warrants early this year.

Those of us who deal with repurchases and repurchase defense every day know that this is one of the most significant issues addressed in these recommendations. Years ago, the subordinate bondholder could demand his or her rights be enforced, and that demand usually did not have to go through the trustee. In fact, the trustee was often the last to know and was only involved once the repurchase had been negotiated, when the trustee was advised of the final results. Now, the trustee is the gatekeeper, and the investor faces insurmountable resistance when trying to enforce rep and warranty claims. An entire industry has sprung up to help investors try to get past the trustee and enforce claims.

The ASF Project RESTART guidelines are a great start. But they, alone, will make little difference. The industry needs to come together and decide: Will investors be asked to put a bag over their heads and buy bonds on blind faith that originators will stand behind the loans they sell, or will investors be given the teeth they need to enforce their rights with originators that aren’t trustworthy.