Fate of Private-Label MBS Market Rests on Two Pillars
Federal Housing Finance Agency Acting Director Edward J. DeMarco told members of Congress last week that increased transparency in mortgage backed securities (MBS) and the implementation of Dodd-Frank Risk Retention regs were top priorities in the process of enticing investors back into the private-label MBS market. DeMarco's remarks came during testimony to the House Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs hearing on "Transparency as an Alternative to Risk Retention."
DeMarco said a significant contributor to the financial crisis was the poor quality of single-family mortgages originated from 2005 to 2008 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 securitizations have been completed in the last 13 months; almost all mortgage issuance in the country is executed through Fannie Mae, Freddie Mac, or Ginnie Mae.
Risk retention, he said, seeks to protect investors and reduce information asymmetries by requiring that issuers of securities to have a disincentive to acquire poor quality loans because they will be required to 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 careful with the quality of loans they buy/originate. In return for higher-quality loan paper, private investors are expected to be more willing to provide funding capital for non-agency mortgages and other types of loans, thus facilitating the return of private capital to the markets.
Uncertainties will also be reduced by giving investors more information on the credit characteristics of the mortgages in the underlying pools. At the time of the crisis investors typically had access only to aggregated pool-level data instead of the kind of detailed loan-level data necessary for in-depth independent risk assessments.
The Securities and Exchange Commission (SEC) regulates asset based securities (ABS) and has recently proposed changes to Regulation AB which codifies requirements for registration, disclosure, and reporting for all publicly registered ABS. Some of the major changes will require an issuer to provide standardized information about loans in the pool in computer readable format at the asset level (except for credit cards) at the time of securitization, even when new assets are added to the pool. The computer program to access the information must be accessible on the SEC's website. Five days will be required for the investor to consider the information rather than the almost immediate sale of ABS currently allowed. The new regulations will also repeal the requirement for an investment grade rating in order for the issuer to be eligible for shelf registration.
MBS guaranteed by the GSEs are exempt from the disclosure requirements of Regulation AB however the Enterprises have worked to make their disclosures parallel those of the SEC. However, neither GSE discloses all of the information required by the revisions. For example, both in the case of documenting how a loan amortizes and providing indication of the borrowers' ability to repay, the GSE's provide loan level data but not in the detail proposed by the SEC. The proposed regulation would also require the GSEs to report on modified loans; Freddie Mac provides limited information on such loans. Similarly while both GSEs disclose information on delinquent SFM in the MBS pools they do so at the pool level; Regulation AB will require loan level information.
DeMarco said while awaiting Congressional action on housing reform and the resolution of the GSEs, FHA and the GSEs are taking concrete actions that will enhance the mortgage market's operation regardless of the particular legislative course taken. These include developing uniform standards for data reporting on mortgage loans and appraisals and the recent announcement of the Joint Servicing Compensation Initiative to consider alternatives for future mortgage servicing agreements. Three weeks ago FHFA directed the GSEs to align their guidelines for servicing delinquent mortgages.
Still on FHFA's agenda, DeMarco said, is enhancing loan-level disclosures on GSE MBS both at the time of origination and throughout the security's life. This will help establish consistency and quality of such data and contribute to an environment in which private capital has the information needed to efficiently measure and price mortgage credit risk, shifting of this risk away from the government and back into the private sector.
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 over time toward the loan level disclosures that the SEC changes to Regulation AB will require.