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FDIC Banking Review

Vol. 8 No. 3 - Article I - Published: February 1996 - Foot Notes

Reps and Warranties
by Penelope Moreland-Gunn, Pete J. Elmer and Timothy J. Curry

Penelope Moreland-Gunn is national claims administrator at the Resolution Trust Corporation. Peter J. Elmer and Timothy J. Curry are senior economist and financial economist, respectively, in the Division of Research and Statistics, Federal Deposit Insurance Corporation. The authors would like to thank Leslie Bowie, Cheryl Hatch, James Wagner and Jack Reidhill for their extensive comments, suggestions and assistance.

Footnote 1
For purposes of this discussion, securitization will be treated as a type of loan sale because securitization causes the sale of loans to a trust that is not owned or operated by the RTC.

Footnote 2
Table 2 contains the R&W claims for only a sample of sales because such an approach provides a flavor for the variation in claims at the sale level while illustrating a number of common relationships. Aggregate claims statistics are shown in Table 3.

Footnote 3
The UPB of a loan is also referred to as the "par" value. Table 2b contains a comparison of approved claims versus denied and other types of claims.

Footnote 4
While Table 2b shows more repurchases in multi-family mortgages than in single-family mortgages, many factors cause repurchases for both types of assets. For example, repurchases may be required because a loan was prepaid shortly before sale, a loan was accidentally substituted for another loan during servicing transfer, or the delinquency status was not correctly transmitted to a buyer.

Footnote 5
Claims not approved include those withdrawn, denied, or pending as of December 31, 1994.

Footnote 6
In most loan sales the originating institution retains the right to service the loans in return for a servicing fee, for example, 0.25 percent of the monthly cash flows collected. %-2 Servicers normally give R&Ws on the entire UPB %0 of loans sold and later serviced. If the servicing rights are sold to a new servicer, the R&W liabilities typically travel to the new servicer. Firms that buy servicing may limit their risk by requiring backup R&Ws from the sellers.

Footnote 7
A thumbnail estimate of costs for single-family mortgages may be made from the cure cost shown in column 2 of Table 2b. Given an average cure cost of $2,000 per claim, and an average UPB of $60,000 for the three sales shown (see Sketchbook of RTC Securities, December 1994), the average cure cost for the three sales shown is three percent of the UPB, which is only one-fifth of the 15 percent upper bound cost assumption. The 25 percent multi/commercial/other securitization upper bound is justified by the notion that related claims costs in column 3 of Table 3 (20 basis points) are about 67 percent higher than the single-family securitization costs (12 basis points). Increasing the 15 percent upper bound used for single-family securitizations by 67 percent approximately yields 25 percent as an estimate of the upper bound of multi/commercial/other securitization repurchase costs.

Footnote 8
R&W costs are more likely to occur in the first several years following a sale than in later years. Because the majority of the RTC's sales occurred prior to 1994, the R&W claims began declining in late 1994. Therefore, a doubling of the claims costs as of December 31, 1994, provides an ad hoc, but nevertheless reasonable, estimate of total claims costs anticipated over the life of the RTC's R&Ws

Footnote 9
The 200-to-300 basis point estimate of the benefits of granting R&Ws for single-family mortgages does not apply to servicing rights. In fact, the total sales price for mortgage servicing rights is typically on the order of 100 to 200 basis points of the UPB serviced.

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