The issue of premium capture continues to cause perhaps the most concern in the securities market when it comes to the developing risk retention requirements for securitized product.
Richard Dorfman, managing director at the Securities Industry Financial Markets Association (SIFMA), at a recent meeting on risk retention singled out the topic as a key concern.
Among other things, if premium capture was easy to define it might be somewhat less of a problem.
But allowing for an attempt at a really rough, relatively brief explanation of something technical, its broad aim seems to be to making sure the securitization sponsor will hang on to the full risk retention amount and not try to fudge it, unless deals are covered by one of the risk retention exemptions out there.
Somewhat more specifically, the concern seems to be related to circumstances where the sponsor sells off at closing some of the spread between the interest that comes in from the underlying mortgages and the interest the bondholders receive.
So say an interest-only tranche/slice of the securitization is sold off to do this. Under premium capture, one would need to put the money from the sale or “premium” in a cash reserve account that would take on losses before they are passed on to any other securitization interest. These losses would be absorbed by the reserve even before what law firm Sidley Austin refers to in a report as the original 5% “base” risk retention.
Securities market participants and observers say this is a problem because it makes it hard to make money off securitizations (except exempted ones) and thus potentially chokes off part of the market. As noted during the SIFMA meeting, it makes it hard for a securitizer to make money on a deal upfront and a long time into its life.
Also, as mentioned previously, folks seem to be having some trouble understanding exactly what premium capture calls for.
Edward Gainor, partner at Bingham McCutchen, told attendees at the SIFMA meeting that uncertainties surrounding some basic definitions of “par value” and “ABS interest” used in premium capture’s wording mean technically it’s unclear exactly how it works.
One of the questions is whether a “servicing fee” is included in the definition of “ABS interest,” he said. He said there is disagreement among attorneys as to whether it is. While he does not think it is, others think the opposite.
He thinks regulators probably did not think about this but probably in the wake of the comment period the rulemaking is going through they will.
Another speaker said during the meeting he currently reads premium capture as including servicing fees, which would require their subordination and result in a situation where “no one is going to sign up to be a servicer in a mortgage securitization again.”
This would make it “impossible” to securitize anything that did not have a “qualified residential mortgage” exemption from risk retention, said Peter Sack, a managing director at Credit Suisse.
As far as setting the qualified residential mortgage definition, Sack suggested one way regulators might want to think about it is where in the secondary market they might want to see the more risky, non-qualified residential mortgage loans end up.
Sack, who is pushing for a broader definition when it comes to qualified residential mortgages, posed the question of whether regulators want banks to be “the repository for all of the Jumbo mortgage risk.”