Investors could benefit more from third-party loan reviews than from representations and warranties, a ratings agency report says.
Prior to the financial crisis, third-party reviews provided little benefit because they were generally used to protect underwriters from securities law liability.
But nowadays, such reviews help investors identify many of the problems that representations an warranties are intended to address.
The benefits of third-party loan reviews were discussed in ResiLandscape July 2014 from Moody’s Investors Service.
The New York-based company said that due diligence reviews, and, to a lesser extent, custodial receipts have an advantage over representations and warranties in residential mortgage-backed securities transactions because they review many of the defects covered by representations and warranties.
The reviews can identify loans with problems related to property valuation, data integrity, underwriting and legal compliance, while custodial receipts can identify loans with missing collateral documents.
But relying on representations and warranties can make remedying more difficult because the problems are addressed later in the life of the deal, when defects could be more difficult to prove or remedy.
In addition, the lender could be out of business.
Reviews identify problems up front — enabling the lender to cure the issue or remove the loan from the pool
The investor can also choose to adjust the price for a security to account for a disclosed risk.
But representations and warranties can only address the problems if the party in charge of reviewing the loan can prove the breach, the enforcement mechanisms work, and the provider of the representations and warranties has the financial resources to fix the problems or repurchase the loans.
Moody’s noted, however, that reviews don’t carry the degree of legal coverage that representations and warranties do. Reviews also could inadequately disclose problems or miss well-hidden fraud.
