Panelists at the Securities Industry and Financial Markets Association’s (SIFMA) regulatory reform summit discussed the implications of the newly passed financial reform bill on the securitization industry. The gathering was held yesterday in New York.
Securitization industry experts seemed to look kindly on certain aspects of being regulated, one of which is that regulation serves as an impetus for change.
“Going forward, it’s an opportunity to fix some of the wrongs that have become so apparent in securitizations,” said William Sidford, senior vice president at AllianceBernstein.
LTV ratios, Sidford said, need to be more realistic, adding that failures are likely when borrowers are underwater. “Second liens are going to have to take a hit,” he said.
He also discussed the significant amount of fraud involved in the mortgage markets as investors, who were once content to rely on trustees and servicers, have taken a much more active role, citing the creation of investor-only trade associations in the past year.
Tom Hamilton, head of securitized product trading at Barclays Capital, finds a benefit in some of the risk retention aspects of the new regulatory reform bill. He cited the flexibility granted by lawmakers on the disbursement of risk. “Regulations now give some leeway to allocate risk between the issuer and underwriter,” he explained.
On a further note of encouragement, Hamilton assured the attendees that most people are aware that securitization is a viable option for risk transfer and that the industry will rise to the occasion in adapting to the new regulatory environment, though he admitted that the current economic climate, in light of the reform bill, may force securitizers to “do less, more efficiently.”
He said that, while disclosure is necessary and has benefits for the industry, it will require dealers to hire more IT, regulatory, and reporting staff. He stressed the importance of coordination in moving toward the next six to nine months and added that “in bills like this, the devil is often in the details.”
The Details
Laurie Goodman, senior managing director at Amherst Securities Group, said the reform consisted of three parts: the financial reform bill itself, the Securities and Exchange Commission (SEC) proposals, and the Federal Deposit Insurance Corp. (FDIC) rules.
All three of these aspects, she said, share risk retention and increased disclosure as common threads.
She is supportive of the disclosure provisions outlined under SEC Rule 17g-5, but doubted that risk retention would have any affect aside from limiting securitizations to the nation’s largest financial institutions.
Goodman identified seven major conflicts of interest in the securitization industry. For one, the fact that originators are also portfolio lenders may lead to an adverse selection of loans for securitization, she said.Underwriters, she noted, will practice adverse selection as much as they can.
Addditionally, she said that while trustees are responsible for enforcement of certain rules, servicers are the only ones who can identify whether or not those rules are being broken.She said there are often cases where the borrower pays on the second mortgage but not on the first when the servicers promise to modify the first lien in exchange for payment on the second.
In the same vein, she noted that servicers have additional items on their agenda that might not necessarily align with the stated goals of securitization, and that the goals of different investor groups may also not be aligned.
Finally, she said that rating agencies are paid by issuers, leading to what she called a “race to the bottom.” She expressed her approval of SEC Rule 17g-5, which permits unsolicited ratings.
Specifically on Risk Retention
David Lukach, a partner at PricewaterhouseCoopers, discussed the implication of risk retention. Higher capital standards, he said, will need to be aligned with risk and leverage should also be addressed in coming months. He was critical of the push for fair value as the prime indicator in financial reporting. “It’s not clear if that’s what the world wants,” he said.
“Securitizations were done so that essentially all risk had been transferred, so no one felt accountable for the vehicles,” Lukach explained. “But risk retention moving forward should not be 5% across.”
He suggested the need for a vertical slice in risk retention to avoid certain firms from structuring deals where the bottom 5% has no value.
The Future
Who would likely take charge of enforcing the new rules? Edward Gainor, partner at Bingham McCutchen, suggested that the SEC and FDIC, due to their demonstrated interest in the securitization market, would likely dominate the process.
Additionally, he highlighted the fact that rules previously enforced by the SEC as requirements for shelf-offering eligibility for ABS issuance, including the filing of periodic reports and certain risk retention requirements, will now become mandatory across the board, causing the SEC to reevaluate their eligibility requirements in the future.
In terms of the bill's impact on various sectors, Hamilton, speaking on the mortgage markets, expressed his doubts that non-agency players would return anytime soon.
Goodman stated that prime jumbo RMBS would likely make a comeback, but that subprime loans bear too high a cost to be worthwhile. “There is no room for mortgages where the borrower isn’t documented,” she said.
Meanwhile, AllianceBerstein's Sidford ended on a positive note, saying that the demand for securitization will continue into the future. He cited the thriving markets for auto and credit card ABS. If demand should increase, there will be a need to somehow unload risk. Securitization, Sidford said, is the best way to do that.
