There’s no question that, in the future market for non-agency securitizations, due diligence is going to take on greater importance. Three of the four rating agencies — S&P, Moody’s and Fitch — have published comprehensive guidelines for third party reviews before they rate future mortgage backed securities (MBS). The Securities and Exchange Commission (SEC) has also weighed in on this subject as part of its recommended changes to Reg. AB II.
The new guidelines go into great detail on what the agencies are expecting in terms of sampling, review scope, loan level review process, results reporting and the qualifications of due diligence firms. The results of the due diligence review will also be provided directly to the rating agency.
The agencies will also require due diligence firms to “attest” to their work, the way public company executives have to attest to their financial reporting. This signed documentation will indicate that the results accurately reflect the findings of the review and that there was no outside influence or coercion during the process.
Going forward, I think you’ll see more statistically validated random sampling, which may require larger sample sizes if exceptions appear or if data quality is weak. Historically, less than 5% of the loans in a securitization structure were subject to due diligence examination.
For the future, there will also be much greater emphasis placed on the qualifications and independence of due diligence firms working on securitizations. Due diligence firms will be required to demonstrate sufficient experience and that their information systems and infrastructure can be relied upon to produce satisfactory loan-level due diligence.
New recommendations for additional data disclosure coming out of the Securities and Exchange Commission (SEC) and the Asset Securitization Forum (ASF) will mean that investors in the future will see the volume of information they are receiving go from a trickle to a flood. The ASF Disclosure Package reporting format, for example, provides an extensive and standardized table of data points for investors to utilize in their investment decisions. Working with a credit risk manager will help investors make sense of this information and act on the insights provided.
My prediction: In the new securitization paradigm, surveillance will be a standard risk management tool for all deals.
