Fate of Private-Label MBS Market Rests on Two Pillars

Federal Housing Finance Agency Acting Director Edward J.rnDeMarco told members of Congress last week that increased transparency in mortgage backed securities (MBS) and the implementation of Dodd-Frank Risk Retentionrnregs were top priorities in the process of enticing investors back into the private-label MBS market.  DeMarco’srnremarks came during testimony to the House Subcommittee on TARP, FinancialrnServices and Bailouts of Public and Private Programs hearing on “Transparencyrnas an Alternative to Risk Retention.”</p

DeMarco said a significant contributor to the financialrncrisis was the poor quality of single-family mortgages originated from 2005 torn2008 and securitized by private label issuers and the GSEs. In the  meltdown private investors fled the non-agency MBS market.  Only two small private label securitizationsrnhave been completed in the last 13 months; almost all mortgage issuancernin the country is executed through Fannie Mae, Freddie Mac, or Ginnie Mae. </p

Risk retention, he said, seeks to protect investors andrnreduce information asymmetries by requiring that issuers of securities tornhave a disincentive to acquire poor quality loans because they will be requiredrnto hold a portion of the credit risk rather than passing it on (for example, keep more reserves on balance sheet).  This should make securitizers more carefulrnwith the quality of loans they buy/originate. In return for higher-quality loan paper, private investors are expected tornbe more willing to provide funding capital for non-agency mortgages and other types of loans, thusrnfacilitating the return of private capital to the markets.</p

Uncertainties will also be reduced by giving investorsrnmore information on the credit characteristics of the mortgages in thernunderlying pools.  At the time of the crisis investors typicallyrnhad access only to aggregated pool-level data instead of the kind of detailedrnloan-level data necessary for in-depth independent risk assessments. </p

The Securities and Exchange Commission (SEC) regulates assetrnbased securities (ABS) and has recently proposed changes to Regulation AB whichrncodifies requirements for registration, disclosure, and reporting for allrnpublicly registered ABS.  Some of thernmajor changes will require an issuer to provide standardized information aboutrnloans in the pool in computer readable format at the asset level (except forrncredit cards) at the time of securitization, even when new assets are added to thernpool.  Therncomputer program to access the information must be accessible on the SEC’srnwebsite.   Five days will be required forrnthe investor to consider the information rather than the almost immediate salernof ABS currently allowed.  The newrnregulations will also repeal the requirement for an investment grade rating inrnorder for the issuer to be eligible for shelf registration. </p

MBS guaranteed by thernGSEs are exempt from the disclosure requirements of Regulation AB however thernEnterprises have worked to make their disclosures parallel those of thernSEC.  However, neither GSE discloses allrnof the information required by the revisions. rn For example, both in the case ofrndocumenting how a loan amortizes and providing indication of the borrowers’rnability to repay, the GSE’s provide loan level data but not in the detailrnproposed by the SEC.  The proposedrnregulation would also require the GSEs to report on modified loans; Freddie Macrnprovides limited information on such loans. rnSimilarly while both GSEs disclose information on delinquent SFM in thernMBS pools they do so at the pool level; Regulation AB will require loan level information.</p

DeMarco said while awaiting Congressional action on housingrnreform and the resolution of the GSEs, FHA and the GSEs are taking concreternactions that will enhance the mortgage market’s operation regardless of thernparticular legislative course taken. rnThese include developing uniform standards for data reporting onrnmortgage loans and appraisals and the recent announcement of the JointrnServicing Compensation Initiative to consider alternatives for future mortgage servicingrnagreements.  Three weeks ago FHFA directedrnthe GSEs to align their guidelines for servicing delinquent mortgages.</p

Still on FHFA’s agenda, DeMarco said, is enhancingrnloan-level disclosures on GSE MBS both at the time of origination and throughoutrnthe security’s life.  This will helprnestablish consistency and quality of such data and contribute to an environmentrnin which private capital has the information needed to efficiently measure andrnprice mortgage credit risk, shifting of this risk away from the government andrnback into the private sector.</p

DeMarco said his agency views risk retention and enhancing transparency of the mortgages backing MBS as complementary reforms.  There is also value in moving the GSEs overrntime toward the loan level disclosures that the SEC changes to Regulation ABrnwill require.

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