Per the direction of their conservator and regulator, the Federal Housing Finance Agency (FHFA), Fannie Mae and Freddie Mac were instructed not to conduct loan-level residential mortgage-backed securities (RMBS) reviews for technical compliance with the Consumer Financial Protection Bureau’s (CFPB’s) TILA-RESPA Integrated Disclosure Rule (TRID) when conducting their credit-risk transfer transactions.
This guidance has the potential to expose future GSE credit-risk transfer transactions to the risk of some incremental losses for lender compliance violations, according to a new report from Moody's Investors Service. However, the report cautions that the frequency of violations will be high at first.
“The lack of diligence related to TRID compliance will likely cause future credit-risk transfer transactions to incur some incremental losses for lender compliance violations,” said Moody’s SVP, Yehudah Forster. “However, we expect overall losses owing to TRID violations to be fairly small, though the number infractions is likely to be high at first.”
Moody's stated that it expects lender representations and warranties (R&Ws) and the GSEs' ability to remove defective loans from the transactions will likely mitigate some of these losses. "While the CFPB has indicated that it will be lenient on lenders that make a good faith effort to comply with the rule, such guidance does not protect against borrower claims," the report stated.
TRID went into effect on October 3, 2015 and the rule applies to loans whose borrowers submitted applications on or after this date.
As of now, Fannie Mae and Freddie Mac only verify that the right forms are included with the loan file, and Moody's says this will not detect incorrect information, which could violate the rule.
"Such violations could cause losses on loans backing GSE CRT transactions if borrowers successfully claim TRID violations as a defense to future foreclosures or if attorneys bring class action lawsuits within the first year after loans close," Moody's noted.
Moody's said that a transaction will only realize losses owing to TRID violations if the following conditions occur:
- The borrower defaulted and the loan went to foreclosure.
- The borrower successfully asserted a TRID violation as a counterclaim permitted under state law.
- The loan contained a TRID violation that carries assignee liability (a subset of all potential TRID violations).
- The TRID violation is one that carries statutory damages (a subset of TRID violations that carry assignee liability) or the borrower is able to prove actual damages (unlikely).
- Investors are not otherwise made whole through enforcement of R&Ws or removal of the loan from the transaction.
According to Moody's, future private-label RMBS will be less exposed to TRID violations because these issuers are conducting thorough third-party due diligence for the loans that they purchase. "While the due diligence feedback loop is enabling lenders who sell to private-label issuers to cure TRID violations and fix flawed processes, lenders who sell only to the GSEs do not directly benefit from this feedback and may be slower to improve processes," the report explained.
Click here to view the full report.