Reps and warranties

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Overview

Representations and warranties.

In complex commercial transactions, buyers and sellers may make specific representations and warranties to each other.

In common parlance, these are known as "reps and warranties." These are statements by which one party gives certain assurances to the other, and on which the other party may rely.

In this context, a representation is commonly a declaration of a specific fact that can be verified to be true or not, e.g., "seller represents that it is a corporation duly organized and validly existing under the laws of the state of Delaware."

Here, a warranty may be more of an assurance, e.g. "supplier warrants that all of its employees working on this project will be subject to confidentiality agreements that include the ability of supplier to seek injunctive relief for breach."

Often there are specific remedies or consequences specified if the representations and warranties are not accurate or are not fulfilled.

For example, a seller may represent and warrant that is has full ownership title in the item being sold, and that there is no legal impediment to the seller proceeding with the transaction. Should it turn out that the seller did not have complete title or was subject to another agreement that restricted the sale, and should these facts impact the buyer's ownership or cause it expense, the buyer would have remedies under the agreement to seek relief from the seller.

Parties to these transactions typically seek representations and warranties to cover issues over which they are concerned. Because of the consequences of making representations and warranties, parties will typically try to limit the extent of any that they make. The tension between these two points of view will help to shape the negotiations between the parties as to the terms and conditions of the deal.

ASF Model RMBS Representations and Warranties

Some commentators have expressed concerns that originators did not sufficiently mitigate the risk in the loans they were making to borrowers that were later sold into RMBS trusts. Some believe that the lack of "skin in the game" did not provide sufficiently aligned incentives between originators and investors to ensure that the loans underlying RMBS were of adequate credit quality. The risk or "skin in the game" traditionally retained by originators of RMBS is embodied in the representations and warranties that issuers provide with respect to the mortgage loans sold into the securitization trust, which are designed to ensure that the loans are free from undisclosed origination risks, leaving the investor primarily with normal risks of loan ownership, such as the deterioration of the borrower's credit due to loss of employment, disability or other "life events." For the reasons set forth in the RFC, many market participants, including investors and rating agencies, believe that the traditional representations and warranties and their related remedy provisions have not sufficiently provided a means to return defective loans to the originator of the loans. Because of this, the ASF has sought to better align interests in future securitization transactions by enhancing and standardizing the representations and warranties as well as developing stronger repurchase obligation provisions. Launched in Summer 2008, the Model Reps were released for comment in July 2009 in direct response to certain challenges currently confronting many RMBS transactions. On December 15, ASF issued a final version of the Model Reps and accompanying release.

Please click here for the final ASF Model RMBS Representations and Warranties.

ASF RMBS Disclosure and Reporting Packages

The ASF believes that the release of the Disclosure and Reporting Packages is an important step forward in restarting the securitization markets. The release is also timely given the increased role President Obama has proposed for regulating financial markets. On June 17, 2009, the Treasury Department released a proposal titled "Financial Regulatory Reform," which states that the "SEC should continue its efforts to increase the transparency and standardization of securitization markets and be given clear authority to require robust reporting by issuers of asset backed securities (ABS)" and that "[i]nvestors and credit rating agencies should have access to the information necessary to assess the credit quality of the assets underlying a securitization transaction at inception and over the life of the transaction, as well as the information necessary to assess the credit, market, liquidity, and other risks of ABS" (See "Administration's Financial Regulatory Reform Proposals," with link below). The ASF believes that implementation of the ASF RMBS Disclosure and Reporting Packages by market participants will achieve the objectives of the Treasury Department proposals.

By increasing data and standardizing available information, institutional investors will be able to better distinguish pools of high quality loans from lesser quality pools. The resulting differentiation will produce greater market discipline, as market forces will serve to reward originators who deliver higher quality packages of mortgage and consumer loans, while penalizing those who do not. By giving owners of outstanding RMBS and potential purchasers of outstanding RMBS more expansive and robust information on the performance of the loans in existing pools, this new transparency should appreciably aid moving distressed assets from troubled institutions to purchasers better able to bear the credit risk of those assets. It will enable more complete and accurate valuations of existing transactions backed by these loans, a necessary condition for generating much needed secondary market liquidity. Moreover, the increased transparency on the underlying assets should also benefit American taxpayers if the government moves forward as a purchaser of outstanding private-label RMBS through programs such as the Legacy Securities Public-Private Investment Program.

MBIA accuses Credit Suisse of ‘pervasive and material misrepresentations’

The battle between the bond insurers and the investment banks — as regards who knew what about mortgage-backed securities — intensified on Monday.

MBIA, once the mightiest of the monolines, filed a lawsuit in Manhattan court against Credit Suisse that accuses the bank of making “fraudulent misrepresentation” about MBS. These misrepresentations caused the insurer to have to cough up more than $290m in claims, according to the complaint.

More from Bloomberg:

"The complaint against Credit Suisse Securities (USA) LLC, filed yesterday in New York State Supreme Court in Manhattan, also names as defendants two other units of the bank, DLJ Mortgage Capital Inc. and Select Portfolio Servicing Inc.

Credit Suisse made “pervasive and material misrepresentations” about a mortgage-backed securities transaction that was sponsored, marketed and serviced by the Credit Suisse units and insured by MBIA, according to the complaint.

The transaction, involving thousands of residential mortgages in a pool later transferred to a trust formed to issue securities that were to be paid down based on the cash flow from the loans, closed in April 2007, said Armonk, New York-based MBIA Insurance, a unit of MBIA Inc.

“CS Securities fraudulently induced MBIA to participate in the transaction,” MBIA said in the complaint. MBIA said the bank claimed it had “used certain strict underwriting guidelines to select the loans sold into the transaction when in fact it did not.”

Bruce Corwin, a Credit Suisse spokesman, declined to comment.

This is not the first case of the type, and certainly not the first involving MBIA, which is also embroiled in a similar dispute against Merrill Lynch.

MBIA’s lawyers have certainly been busy, because on December 9 the bond insurer filed a breach of contract lawsuit against Rabobank, the Bank of New York Mellon Trust Company and Paragon CDO. That complaint, filed jointly with Lacrosse Financial Products, centres around CDS protection sold against a CDO issued by Paragon.

But as various learned counsel told FT Alphaville, it is not going to be easy for MBIA to win a lawsuit alleging fraudulent misrepresentation, because the benchmark for these types of cases is extremely high.

As one attorney put it:

Bond insurers were supposed to be some of the smartest players on Wall Street. MBIA is going to have to convince a court not only that fraud existed, but that it wasn’t savvy enough to recognise its presence. Bit of a Catch-22 that, since in order for MBIA to succeed, it will have to convince a court that its much-vaunted underwriting and due diligence weren’t actually all that great.

Then again, the fact that the bond insurers are in such dire financial straits does support that contention…

ASF Project "RESTART"

Latest Project RESTART News: ASF Releases Project RESTART Model RMBS Reps and Warranties on December 15, 2009

On December 15, 2009, the American Securitization Forum (“ASF”) released the final version of the ASF Model RMBS Representations and Warranties (collectively, the “Model Reps”). The development of the Model Reps represents an important phase of ASF's Project on Residential Securitization Transparency and Reporting ("ASF Project RESTART" or the "Project"), an industry-developed initiative launched in February 2008 aimed at restoring investor confidence in mortgage and asset-backed securities.

The Model Reps, which are intended to provide substantial enhancements to the traditional representations and warranties provided in residential mortgage-backed securities (“RMBS”) transactions, were developed by a broad-based working group consisting of issuers, originators, credit rating agencies, financial guarantors, primary mortgage insurance companies and institutional investors. The Model Reps are accompanied by a release, which describes their development and (i) how the Model Reps effectively promote risk retention in RMBS, (ii) the enhancements provided by the Model Reps over existing market representations and warranties, and (iii) how the Model Reps provide increased transparency to the RMBS market.

Please click here for the final ASF Model RMBS Representations and Warranties.

Please contact Tom Deutsch, ASF Deputy Executive Director, at tdeutsch@americansecuritization.com and Evan Siegert, Associate Director, Advocacy at esiegert@americansecuritization.com with any questions or comments regarding ASF Project RESTART.

ASF Releases RMBS Trustee Bond-Level Reporting Package RFC on November 10, 2009 On November 10, 2009, the ASFreleased for comment the proposed ASF Project RESTART RMBS Trustee Bond-Level Reporting Package (the “Bond-Level Reporting Package”). The proposed Bond-Level Reporting Package, which consists of a standardized layout containing 28 fields of bond-level information, was developed by the ASF Trustee Subforum and ASF Investor Committee and represents another phase of ASF Project RESTART to increase transparency and standardization in RMBS transactions. Standardization of trustee reports would provide investors and credit rating agencies with consistent fields of information across issuers and enable them to efficiently review bond performance information.

Implementation of the Bond-Level Reporting Package is recommended for no earlier than the first quarter of 2011. Comments are requested on the Bond-Level Reporting Package, including the implementation timeline, by December 10, 2009. After review of all comments received, ASF staff as well as the ASF Trustee Subforum and ASF Investor Committee will make any appropriate revisions to the Bond-Level Reporting Package. In addition, it is expected that the bond information contained in the Bond-Level Reporting Package will be integrated with the loan information contained in the ASF RMBS Disclosure and Reporting Packages through a link created between the CUSIP for each bond and the recently announced industry-wide loan identifier, the ASF LINC™. This linkage will enable investors and credit rating agencies to easily acquire information about the specific loans underlying a particular bond.

Please click here for the ASF Project RESTART RMBS Trustee Bond-Level Reporting Package RFC.

ASF Project RESTART Launches the ASF LINC™ on September 24, 2009

On September 24, the ASF announced the launch of a new standardized universal code for identifying critical information about individual loans that are securitized in the mortgage- and asset-backed securities markets. The new global ASF Loan Identification Number Code (“ASF LINC™”) is a sixteen digit identification code that captures underlying loan type, origination date and country of origin, in addition to randomized alphanumeric data, to create a unique ID for a wide range of loans that may be pooled and sold into the capital markets. The ASF announced in July that it is partnering with Standard and Poor’s Fixed Income Risk Management Services (FIRMS), an analytics and research unit separate from S&P’s ratings business, to develop the ASF LINC™.

The code is a foundational component of ASF’s Project RESTART initiative to improve the securitization process and reshape critical information and data flows with market-based solutions. Please click here for ASF’s press release on the ASF LINC™, and here for a sample of the code and a graphical depiction of its structure.

ASF Project RESTART July 15 Releases: Disclosure and Reporting Package Final Releases; Representations and Warranties Request for Comment

On July 15, the American Securitization Forum ("ASF") announced the next phases of ASF's Project on Residential Securitization Transparency and Reporting ("ASF Project RESTART" or the "Project"), an initiative aimed at restoring investor confidence in mortgage and asset-backed securities. As part of the ongoing development of the Project, the ASF has issued (1) a request for comment (RFC) on its new ASF RMBS Model Representations and Warranties; and (2) the Final Release of the ASF RMBS Disclosure and Reporting Packages. The disclosure package is to be provided by issuers prior to the sale of private-label residential mortgage-backed securities (RMBS) transactions and (ii) the reporting package is to be updated on a monthly basis by RMBS servicers throughout the life of an RMBS transaction.

Please click here for the RFC on ASF Model RMBS Representations and Warranties.

Please click here for the Final Release of the ASF RMBS Disclosure and Reporting Packages.

These deliverables and other industry and legislative initiatives were discussed during ASF's Sunset Seminar on July 15 entitled, "Securitization Reforms: Policy and Industry Initiatives," which included panelists from the ASF, SEC, Natixis, Cadwalader, Wickersham and Taft LLP, Moody's and S&P FIRMS.

ASF Project RESTART Background

Many institutional investors and public commentators have observed that some securitizations suffer from transparency related ills; ASF Project RESTART seeks to cure that noted opacity with massive injections of new disclosure and reporting by issuers and servicers on both new transactions, as well as on the trillions of dollars of outstanding private label transactions. The Project has been recognized by senior policymakers and market participants as a necessary industry initiative to improve the securitization process by developing commonly accepted and detailed standards for transparency, disclosure and diligence. By increasing data and standardizing available information, institutional investors will be able to better distinguish pools of high quality loans from lesser quality pools. The resulting differentiation will produce greater market discipline, as market forces will serve to reward originators who deliver higher quality packages of mortgage and consumer loans, while penalizing those originators who do not; Differentiation will also enable more complete and accurate valuations of existing transactions backed by these loans--a necessary condition for generating much needed secondary market liquidity.

Since the public launch of ASF Project RESTART in July 2008, the global credit and liquidity crisis initially triggered by losses in the subprime RMBS market has become more widespread and deeper, resulting in a global economic slowdown, the failure or near-failure of a number of financial institutions and the unprecedented intervention by the U.S. government, the Federal Reserve and other governments and central banks in the financial markets, including direct investment in major financial institutions. All of these developments underscore the need for continued efforts by market participants, under the auspices of the Project, to enact fundamental changes to the securitization process to improve asset-level transparency to investors and credit rating agencies, increase the level and quality of due diligence performed on those assets and strengthen the governance process for removing assets from securitizations that should not have been included. ASF expects that the significantly improved data inputs to these evaluative models will help investor capital to flow back into mortgage securitization and, over time, return institutional capital to the mortgage markets, ultimately increasing the supply and lowering the cost of mortgage credit to the consumer through a liquid secondary market. ASF further expects that the added transparency, due diligence and governance mechanisms imposed by market participants will create strong disincentives to the origination of poorly underwritten loans or loans having features that make them unsuitable for investment by institutional investors.

Evolution of the Project and Next Steps

Concurrently with the public announcement of ASF Project RESTART in July 2008, the ASF issued a request for comment (the "Initial RFC") on one of the initial deliverables of Phase 1 of the Project, a proposed disclosure package for use at the initiation of RMBS transactions (the "ASF RMBS Disclosure Package"), consisting of 135 data fields of pool and loan-level information. The initial ASF RMBS Disclosure Package was designed to enable investors to more easily compare loans and transactions across all issuers and perform necessary and sufficient loan-level analysis, while aiding credit rating agency evaluations by enhancing the quality, consistency and comparability of information relating to securitized assets. In February 2009, the ASF released for further comment a revised version of the ASF RMBS Disclosure Package plus the related deliverables, which took into consideration over thirty sets of comments received from securitization market participants. Additionally, the Project issued a set of recommended fields for manufactured housing securitizations, as well as a recommendation for a file naming convention for the Disclosure Package.

In addition to the release of the revised ASF RMBS Disclosure Package, the ASF issued for comment in February 2009 the second deliverable of ASF Project RESTART, consisting of a proposed package of data fields to be updated on a monthly basis by RMBS servicers throughout the life of an RMBS transaction (the "ASF RMBS Reporting Package"). The monthly updating of critical loan-level information will enable investors to better value outstanding securities, which is especially important given a number of serious proposals for the U.S. government to become a major investor in outstanding RMBS. The ASF RMBS Reporting Package contains standardized data elements for pool and loan-level information which can be updated by servicers on a monthly basis throughout the life of an RMBS transaction and made available to investors and credit rating agencies. This allows investors to compare updated data files across issuers and to track the performance of a mortgage loan throughout its life in the secondary market, regardless of who the owner or servicer is at any point in time. The ASF RMBS Reporting Package was developed to flow directly from information presented in the ASF RMBS Disclosure Package. The Project has also developed a file naming convention for the Reporting Package which is similar to the recommendation for the Disclosure Package.

Specific areas that are addressed in the two packages include:

  • Significant expansion of public and investor reporting of loan modification activity by mortgage servicers nationwide;
  • Disclosure standards for securitization or resecuritization of mortgage loans that have previously been modified in the loss mitigation process;
  • Uniform national standards for the secondary market definition of a "full documentation" loan;
  • Proposed mechanism for owners of 1st lien mortgages to immediately know a 2nd lien mortgage has been originated on the subject property;
  • Methods to address higher rates of fraud in new originations and in modifying loans; and

Recommendations for universal loan identification system for mortgage and consumer loans.

On July 15, 2009, the ASF released finalized versions of both the ASF Project RESTART Disclosure and Reporting Packages and related documents, including a public release explaining the need for these packages and the announcement of its partnering with Standard & Poor's Fixed Income Risk Management Services (FIRMS), an analytics unit separate from Standard & Poor's ratings business, to implement an industry-wide unique mortgage loan identification system and mortgage loan database as called for in the ASF RMBS Packages. The ASF has proposed implementation dates involving new issuance loans under the Disclosure Package of February 1, 2010, and ongoing monthly reporting under the Reporting Package of August 1, 2010 (trial) and November 1, 2010 (permanent).

Additionally, on July 15, 2009, the ASF released an RFC for the development of standardized RMBS Model Representations and Warranties as part of ASF Project RESTART's Phase II work stream. The ASF is requesting that comments be submitted on this initial draft by September 4, 2009. Additionally, the ASF will begin developing stronger repurchase obligation provisions that allow investors to enforce buybacks of defective mortgages as a critical part of the same work stream.

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