Creators and underwriters of asset- backed securities joined bond investors in telling the Securities and Exchange Commission to go further than proposed new rules on sellers’ obligations to take back bad mortgages from future securitizations.
“Our membership felt the SEC proposal didn’t address the real problem,” Chris Killian, vice president of the Securities Industry and Financial Markets Association’s securitization group, said yesterday. “There is a realization on both sides of the disputes in existing RMBS transactions that the current mechanisms, and therefore outcomes, have not been optimal.”
Bond-sponsor and dealer members of Wall Street’s largest lobbying group propose that sellers of at least residential mortgage-backed securities, or RMBS, through shelf registrations be required to appoint independent firms responsible for seeking repurchases of loans whose quality was misrepresented. Sifma expressed the views in a letter to the agency responding to a series of possible new securitization rules.
The SEC wants to restore “investor confidence” that so- called representations and warranties will be enforced in the $1.5 trillion market for home-loan bonds without government backing, according to its April proposal.
Debt owners and guarantors in other parts of the mortgage market may be finding it easier to reduce losses by forcing repurchases and rescinding insurance, leading bondholders to begin to seek greater action. A group with more than $500 billion, coordinating through a Dallas lawyer, sent letters to bond trustees seeking their help. The Federal Reserve Bank of New York also said Aug. 4 it is trying to exercise “our rights as investors” after taking on debt through its bailouts.
Bondholders are concerned that the conflicts of interest of mortgage servicers, which must help identify claims on their behalf and are often owned by lenders, “can cloud the prospect that the interests of investors will be aggressively represented as required,” the Association of Mortgage Investors, a trade group, said in a July 31 comment letter.
The SEC’s 667-page proposal revamping its Regulation AB preceded a broader financial overhaul signed into law last month that requires a number of mostly separate changes to the market in which loans and leases are packaged into bonds after mortgage debt helped cause the worst financial crisis since the 1930s.
Under the agency’s proposal, when lenders or securities issuers refuse to repurchase loans that bond trustees say may violate their contractual representations, they would need to have an independent firm review the decision and investors would have to be informed.
‘Credit Risk Manager’
Both AMI, an investor-only group formed this year that represents bondholders with about $300 billion of asset-backed debt, and Sifma, whose members also include money managers, say the SEC should put aside that plan.
Instead the agency should require deals to include what both groups called a “credit risk manager” that would be able to launch investigations into loan quality either at its own discretion or upon the suggestion of investors, they said. They each recommended allowing investors with less than 25 percent of deals to seek probes only if they offered to cover the costs, which otherwise would be taken out of income from the underlying debt.
Sifma’s proposal in its Aug. 2 letter contrasted with the one offered by the investor group by saying disputes between the credit risk manager and debt sellers on whether repurchases are required should be settled in arbitration. The AMI didn’t address disagreements.
Fighting With Lenders
Bond guarantors including MBIA Inc. (MBI) and Ambac Financial Group Inc. (ABKFQ) are fighting lenders such as Bank of America Corp. (BAC) and JPMorgan Chase & Co. (JPM) units in court over what they call ineligible loans. Items such as faulty appraisals, inflated borrower incomes and missing documentation can trigger contract provisions that require repurchases or void loan-insurance coverage.
The Mortgage Bankers Association’s members involved in residential lending also objected to the SEC’s proposal, though didn’t offer an alternative.
The Washington-based group “is concerned that the proposed requirement could increase the rate of repurchase claims, and possibly generate strategic or frivolous claims,” it said in a comment letter dated Aug. 2. “The cost associated with these additional risks would ultimately be passed on to the consumer.”
The American Securitization Forum suggested that the SEC could exempt deals that use a process similar to what Sifma suggested from the SEC’s proposed rule on appointing an independent firm to review and report on repurchase decisions. The group said it understands that the SEC is reluctant to create rules that aren’t “disclosure-based.”
The ASF, which was affiliated with Sifma until last year and whose members include underwriters, issuers, investors, lawyers and credit-rating firms, said that investors and issuers disagree on what should trigger automatic reviews of loan files by the third-party monitor.
Having such outside parties involved in deals isn’t a new idea. Shelton, Connecticut-based Clayton Holdings Inc., the largest provider of due diligence on loans that Wall Street banks were packaging into bonds before the market froze, was also contracted to look for opportunities to force repurchases and do other “surveillance” on almost $500 billion of debt used in mortgage securities.
In April, in the only non-agency securitization of new U.S. mortgages in more than two years, sponsor Redwood Trust Inc. received stronger rights than found in past deals to seek repurchases of the loans, which were made by Citigroup Inc., according to Moody’s Investors Service. Redwood, which bought the junior-ranked bonds, was a “vested party with an interest in discovering breaches and pursuing them,” Moody’s analyst Navneet Agarwal said then.
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