Fitch: Underwriting & Fraud Significant Drivers of Subprime Defaults; New Originator...

Fitch: Underwriting & Fraud Significant Drivers of Subprime Defaults; New Originator ReviewsNEW YORK--(Business Wire)--Recent vintage residential mortgage-backed securities (RMBS),backed by pools of subprime mortgages continue to substantiallyunder-perform initial expectations, which has resulted in significantratings downgrades and heightened risk of losses to principal. Fitch'sanalysis of subprime defaults suggests that lax underwriting and fraudmay account for as much as one-quarter of the underperformance of the2006 vintage of Subprime RMBS transactions. Fitch will be utilizingthe insights from its research to improve its RMBS rating process. The very high delinquency and default performance of recentvintage subprime RMBS has a variety of causes, including declininghome prices and the prevalence of high-risk mortgage products such asstated-income loans and 100% combined-loan-to-value loans. Fitch hascommented extensively on these drivers of mortgage default, mostrecently in the special report 'Drivers of 2006 Subprime VintagePerformance', dated Nov. 13, 2007. However as noted in the report,these factors do not fully account for the large number of earlydefaults that are occurring. Many industry observers have noted thatpoor underwriting, together with borrower/broker fraud, also appear tobe playing a role in high defaults. While some degree of early defaults are to be expected in subprimemortgage pools, the extraordinarily high level of defaults encounteredby the 2006 vintage cannot be explained by home price declines alone.It has become increasingly evident that loans originated with laxunderwriting and higher instances of fraud can have a material impacton a securitization. In order to better understand the unexpected highlevel of early defaults in subprime RMBS, Fitch analyzed a smallsample of early defaults from 2006 Fitch-rated subprime RMBS. Fitch's findings from this review include:

--Apparent fraud in the form of occupancy misrepresentation; --Apparent fraud in the form of occupancy misrepresentation;

--Poor or lack of underwriting relating to suspicious items on --Poor or lack of underwriting relating to suspicious items oncredit reports;

--Incorrect calculation of debt-to-income ratios; --Incorrect calculation of debt-to-income ratios;

--Poor underwriting of 'stated' income loans for reasonability; --Poor underwriting of 'stated' income loans for reasonability;

--Substantial numbers of first-time homebuyers with questionable --Substantial numbers of first-time homebuyers with questionablecredit/income. 'In the absence of effective underwriting, products such as 'nomoney down' and 'stated income' mortgages appear to have becomevehicles for misrepresentation or fraud by participants throughout theorigination process,' said Fitch Managing Director Diane Pendley.'During the rapidly rising home price environment of the past fewyears, the ability of the borrower to refinance or quickly re-sell theproperty prior to the loan defaulting masked the true risk of theseproducts and the presence of misrepresentation and fraud. With homeprices now falling in many regions of the country, many loans thatwould have paid off in prior years remain in the pool and are morelikely to default.' Fitch believes that high risk products and poor underwritingcombined have had a substantial impact on defaults. For example, foran origination program that relies on owner occupancy to offset otherrisk factors, a borrower fraudulently stating intent to occupy willdramatically alter the probability of the loan defaulting. When thisscenario happens with a borrower who purchased the property as ashort-term investment, based on the anticipation that the value wouldincrease, the layering of risk is greatly multiplied. If the sameborrower also misrepresented his income, and cannot afford to make thepayments, the loan will almost certainly default and result in a loss,as there is no type of loss mitigation, including modification, whichcan rectify these issues. Fitch's research notes that in order to detect and prevent poorunderwriting and fraud, a combination of technology and basic riskmanagement is needed not only before, but also during and after theorigination of a loan. 'There are several effective fraud indicationtools available to originator/issuers; however, no process or tool canidentify all instances of misrepresentations of fraud,' said FitchRatings Managing Director Glenn Costello. 'Through our enhancedoriginator review program it is our objective to help mitigateexposure to these kinds of risks in rated RMBS.' Enhanced Originator/Issuer Reviews for U.S. RMBS: In light of its research, Fitch believes that it is important toreassess the risk management processes of originators, conduits and/orissuers for product being securitized going forward. Beginning inJanuary 2008, Fitch U.S. RMBS rating process will incorporate a moreextensive review of mortgage origination/acquisition practices,including a review of originator/conduit/issuer due diligence reports,and a sample of mortgage origination files. Additionally, Fitch isstudying how a more robust system of representation and warrantyrepurchases could help to provide more stable RMBS performance.. Fitch will conduct enhanced originator/issuer reviews for allsubprime transactions. Fitch will not rate subprime RMBS withoutcompletion of the review process. Fitch also intends to conductenhanced reviews for Alt-A RMBS; however, these will be phased-inbased on Fitch's view of the risk of particular Alt-A programs.High-risk programs include Pay-Option Arms and programs exhibitingsubstantial risk-layering. Such programs will be high priority forreview. Fitch's originator/conduit/issuer review process will feature thefollowing elements: 1. Receipt of information package from originator/issuercontaining:

--Operational Questionnaire --Operational Questionnaire

--Portfolio Statistics --Portfolio Statistics

--Due Diligence Reports --Due Diligence Reports

--Other Supporting Documentation, as Required --Other Supporting Documentation, as Required 2. On-site Discussion with originator/issuer's senior managementand risk management based on Fitch topics list including:

--Sourcing - control processes, level of due diligence, if not --Sourcing - control processes, level of due diligence, if notdirectly originating

--Underwriting - guidelines, exceptions, and controls over --Underwriting - guidelines, exceptions, and controls overunderwriting decision process

--Property Valuations - guidelines, exceptions, and controls over --Property Valuations - guidelines, exceptions, and controls overdetermination of value process

--Risk Management - audits and compliance to policies and --Risk Management - audits and compliance to policies andprocedures 3. On-site file reviews:

--Targeted sample of mortgage origination loan files --Targeted sample of mortgage origination loan files

--Review conducted to confirm Fitch's understanding of --Review conducted to confirm Fitch's understanding oforiginator/issuer's control environment Fitch will provide a more detailed discussion of theoriginator/issuer review process in the form of a criteria report.Fitch will be communicating directly with originators, conduits, andissuers regarding reviews to be conducted in the interim. Fitch's new report, 'The Impact of Poor Underwriting Practices andFraud in Subprime RMBS Performance', is available on the Fitch RatingsSubprime market page at www.fitchratings.com/subprime. Fitch's rating definitions and the terms of use of such ratingsare available on the agency's public site, www.fitchratings.com.Published ratings, criteria and methodologies are available from thissite, at all times. Fitch's code of conduct, confidentiality,conflicts of interest, affiliate firewall, compliance and otherrelevant policies and procedures are also available from the 'Code ofConduct' section of this site.Fitch Ratings, New YorkM. Diane Pendley, +1-212-908-0777Glenn Costello, +1-212-908-0307Mary Kelsch, +1-212-908-0563Sandro Scenga, +1-212-908-0278 (Media Relations)Copyright Business Wire 2007

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