Lone Star warns investors of INBS mortgage warranty risks

US private equity firm Lone Star has warned buyers of bonds it sold recently against mortgages issued by the former Irish Nationwide Building Society (INBS) that it cannot stand over original commitments tied to the home loans.

Lone Star, based in Dallas, last month became the first overseas buyer of Irish mortgages to turn to the bond market to refinance these loans. It acquired the loans in 2014 from the liquidators of the Irish Bank Resolution Corporation.

Almost 64 per cent of the €564 million loans were classified as nonperforming, ratings agency Moody’s said last month.

“No assurance can be given that the lending criteria of [INBS] in respect of the mortgage loans were applied at the time of origination of the mortgage loans or that different criteria were not applied,” according to a bond prospectus for a vehicle called European Residential Loan Securitisation 2016-1 DAC, a Lone Star affiliate used to sell the mortgage-backed securities.

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The seller “has no direct knowledge as to whether certain loan warranties (including the loan warranties which relate to the origination process) are correct or not”.

The caveats contained in the prospectus and scale of the soured loans come as the Central Bank of Ireland's inquiry into suspected regulatory breaches at INBS prepares to resume its public hearings.

Warranties typically include a guarantee, among other things, that loans were granted in line with the mortgage provider’s lending criteria, that each loan has the correct documents attached, and that the lender carried out sufficient borrower background checks.

Alleged breaches

Five former INBS directors and senior managers, including former chief executive

Michael Fingleton

and former chairman

Michael Walsh

, face up to seven charges of alleged regulatory breaches between August 2004 and September 2008.

These include failing to ensure that commercial loan applications were processed and later approved in accordance with internal policies.

In addition, the inquiry claims that security, including personal guarantees, was not obtained in advance of loans advanced and that loan-to-value limits were not properly applied by the former building society.

It is also alleged that INBS’s credit committee failed to perform certain functions in accordance with the building society’s rules. The inquiry will hear an application today from Mr Walsh to have the proceedings terminated.

The prospectus says the Lone Star affiliate that sold the loans, Shoreline Residential, and the firm it uses to service the loans, Pepper Asset Servicing, will not monitor compliance with loan warranties following the bond sale.

Sellers of residential mortgage-backed securities (RMBS), such as Permanent TSB in September, typically offer to buy back loans where a material breach of representations or warranties by the seller is subsequently found.

Interest rates

However, Shoreline Residential will not be required to make any such repurchase, according to the prospectus. Nor does it give any assurances that it will have the money to pay any damages for breach of warranty.

Securities issued against the mortgages were priced to carry interest rates of between 1.128 per cent and 6 per cent, according to Bloomberg data, depending on where investors rank in terms of entitlement to income from the portfolio.

Buyers of Irish mortgages in recent years are likely to rely increasingly on the RMBS market to refinance, according to a recent Moody’s report that highlights the risks for investors.

“First, lengthy and volatile enforcement procedures increase uncertainty around the timing of cash flows for recoveries for both unsecured and secured loans,” Moody’s said. “In addition, the quality of the data is often not as good as for performing securitisations, which creates uncertainty around cash flow forecasting.”