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Diligence guide

Non-agency RMBS requires multi-layered due diligence: loan file review, appraisal verification, compliance testing, and originator operational assessment. This guide covers each layer and the red flags that should trigger enhanced scrutiny or deal rejection.

Loan file review

Third-party due diligence (TPR) is standard for non-agency RMBS. TPR firms review loan files for documentation completeness, guideline compliance, and data integrity.

Sample selection

Selection Method	Description	When Used
Stratified random	Representative sample across pool characteristics	Standard approach
Adverse selection	Highest LTV, lowest FICO, largest loans	Risk-focused review
Exception selection	Guideline exceptions, high-risk characteristics	Exception analysis
100% review	Every loan reviewed	Small pools, new issuers

Sample sizes by deal type:

Deal Size	Standard Sample	Enhanced Sample
Under $100M	50-75%	100%
$100M-$250M	35-50%	50-75%
$250M-$500M	25-35%	35-50%
Above $500M	15-25%	25-35%

First-time issuers typically require 100% review regardless of pool size.

Critical documents reviewed

Document	What TPR Checks
Note and mortgage	Properly executed, terms match data tape, correct property address
Title policy	Valid first lien, no exceptions affecting priority, correct legal description
Appraisal	Compliant, reasonable value conclusion, property condition
Income documentation	Supports stated income, consistent with program type
Asset documentation	Supports down payment source, reserves
Compliance	TRID, state-specific disclosures, timing requirements

Grading criteria

Grade	Meaning	Typical Action
A	Acceptable, no material issues	Include as-is
B	Minor issues, correctable	Include with cure required
C	Material issues, may affect enforcement	Possible exclusion, price adjustment
D	Critical defect	Excluded from pool

Grade distributions by originator quality

Originator Type	A Grade	B Grade	C Grade	D Grade
Established (3+ years)	85-92%	5-10%	2-4%	1-3%
Growing (1-3 years)	80-88%	8-12%	3-6%	2-4%
New (under 1 year)	75-85%	10-15%	5-8%	3-5%

Red flag: C/D findings above 10% suggest systematic quality issues, not isolated errors.

Common findings by category

Documentation:

• Missing signatures on note, mortgage, or disclosures
• Incomplete loan application
• Missing verifications (VOE, VOD)
• Stale documents (beyond acceptable dating)

Income:

• Calculation errors in bank statement analysis
• Missing months of bank statements
• Expense factor not applied correctly
• Income documents don’t support stated income

Assets:

• Large deposits not explained or sourced
• Asset statements dated more than 90 days from close
• Reserves calculation incorrect

Compliance:

• TRID tolerance violations
• Missing or incomplete disclosures
• Timing errors (Loan Estimate not timely, CD waiting period)

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Appraisal review

Appraisal quality directly affects LTV accuracy and recovery assumptions. Poor appraisals can mask inflated values or undisclosed property conditions.

Types of review

Review Type	Description	Cost	When Used
Desk review	Data analysis, comparables review, AVM reconciliation	Low	Standard
Field review	Appraiser drives by property, verifies condition and characteristics	Medium	Flagged loans
Full re-appraisal	Complete new appraisal with interior inspection	High	Material value concerns

AVM reconciliation thresholds

Variance	Action
Appraisal within 10% of AVM	No concern
Appraisal 10-15% above AVM	Flag for review
Appraisal 15-20% above AVM	Enhanced review, possible field review
Appraisal 20%+ above AVM	Likely exclusion or value adjustment

Why appraisals exceed AVMs:

• Recent renovation (AVM doesn’t capture)
• Unique features (AVM can’t value)
• Local market knowledge (appraiser is correct)
• Appraiser inflation (problematic)
• AMC pressure (problematic)

Property condition issues

Issue	Detection Method	Impact
Deferred maintenance	Photos, condition rating	Severity increase
Environmental (flood zone)	Flood map review	Insurance cost, marketability
Structural concerns	Photos, repair requirements	Value adjustment
Rural/unique property	Comp availability	Marketability risk
Condo issues	HOA review	Special assessments, litigation

Appraisal compliance

HPML (higher-priced mortgage loans) require specific appraisal practices:

• Appraiser independence from lender
• Written appraisal provided to borrower
• Second appraisal for certain transactions

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Compliance review

Non-QM loans face heightened compliance scrutiny because they lack QM safe harbor protection.

TRID (TILA-RESPA Integrated Disclosure)

Requirement	What to Check
Loan Estimate timing	Delivered within 3 business days of application
Loan Estimate accuracy	APR, loan amount, fees within tolerance
Closing Disclosure timing	Delivered at least 3 business days before consummation
Closing Disclosure accuracy	Final terms match LE or within tolerance
Changed circumstances	Properly documented if fees changed

TRID tolerances:

Fee Type	Tolerance
Zero tolerance (lender fees)	No change allowed
10% cumulative tolerance	Recording fees, required third-party services
Unlimited	Services borrower can shop for, prepaid items

State-specific requirements

State	Key Requirements
California	Specific disclosures for ARMs, foreclosure process
New York	Pre-foreclosure notices, mortgage recording tax
Florida	Intangibles tax, title insurance regulations
Texas	Home equity lending restrictions, constitutional provisions
Illinois	Consumer Fraud Act considerations

HPML testing

HPML Trigger	Consequence
APR > APOR + 1.5% (first lien)	Escrow required, additional appraisal requirements
APR > APOR + 3.5% (first lien jumbo)	Same as above
APR > APOR + 3.5% (subordinate lien)	Same as above

Most non-QM loans trigger HPML status due to pricing above conforming rates.

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Originator operational review

Capital providers conduct operational diligence on the originator, not just the loans. This assessment determines whether the originator can maintain quality as volume grows.

QC process review

Element	What to Evaluate
Pre-funding QC sample rate	Should be 10%+ of funded loans
Post-closing QC sample rate	Should be 10%+ of funded loans
Defect tracking	Documented findings, trends
Remediation	How defects are cured
Underwriter feedback loop	Findings communicated and addressed

Pre-funding vs post-closing:

• Pre-funding catches issues before funding (better)
• Post-closing catches issues after funding (necessary but reactive)
• Both are required for comprehensive QC

Technology and systems

System	Evaluation Criteria
Loan origination system (LOS)	Completeness, audit trail, edit checks
Document management	Secure storage, retrieval, imaging quality
Data integrity	Tape accuracy vs file content
Compliance tools	Automated testing, exception flagging
Reporting	Performance tracking, exception reporting

Underwriting oversight

Area	What to Review
Delegated authority	Who can approve, at what loan size, what exceptions
Exception process	How exceptions are documented, approved, tracked
Underwriter training	Certification, ongoing education
Compensation	Incentives aligned with quality (not just volume)
Turnover	High turnover suggests training/culture issues

Financial stability

Metric	Threshold
Net worth	Adequate for warehouse lines and repurchase obligations
Liquidity	3-6 months operating expenses
Warehouse availability	Sufficient for planned volume
Concentration	Not over-reliant on single warehouse lender

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Red flags

Loan-level red flags

Red Flag	Concern	Action
EPD in first 6 months	Fraud or underwriting failure	Exclude, investigate originator
Undisclosed liabilities	Application misrepresentation	Exclude
Inflated income	Fraud	Exclude, investigate
Stale appraisal (120+ days)	Value may have changed	Require update or exclude
Multiple guideline exceptions	Guidelines don’t reflect reality	Enhanced review
Occupancy misrepresentation	Fraud (investment labeled as primary)	Exclude

Pool-level red flags

Red Flag	Concern	Action
C/D grades above 15%	Systematic quality issues	Pool needs cleaning
EPD rate above 3%	Fraud or severe underwriting failures	Pricing impact, possible pass
Repurchase rate above 2%	Quality control failures	Enhanced originator review
Exception rate above 15%	Guidelines not reflecting practice	Review guidelines vs practice
Geographic concentration above 50%	Market risk	Pricing adjustment

Originator red flags

Red Flag	Concern	Action
Rapid volume growth (100%+ YoY)	Quality may suffer	Enhanced monitoring
High underwriter turnover	Training gaps	Review process controls
QC sample rate below 10%	Insufficient oversight	Require improvement
No pre-funding QC	Catching issues too late	Require implementation
Financial covenant breaches	Stability concern	Enhanced monitoring
Multiple warehouse events of default	Serious concern	May pass

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Third-party due diligence firms

Firm	Specialties
AMC (CoreLogic)	Full-scope TPR, compliance, all product types
Clayton (Covius)	Legacy leader, comprehensive TPR
Opus	Growing non-QM presence, technology-forward
Canopy	Technology-enabled, faster turnaround
Inglet Blair	Compliance-focused, regulatory expertise
Recovco	Document retrieval, file completion

Selecting a TPR firm

Factor	Consideration
Product expertise	Do they understand non-QM, DSCR, RPL?
Turnaround time	Can they meet deal timeline?
Reviewer quality	Experience level, error rates
Technology	Data delivery, finding management
Cost	Per-loan pricing, minimum fees
Reputation	Rating agency acceptance

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Related topics

• Non-QM lending — documentation types and compliance considerations
• Deal structures — warehouse and securitization terms
• Key participants — TPR firms and legal counsel
• Servicer selection — servicing diligence