U.S. Mortgage-Bond Proposal to Melt 8-Year Freeze Advances

  • Bond funds call for independent `deal agent' as overseer
  • Working with Treasury to boost market that sparked crisis

The market for U.S. mortgage securities without government backing, virtually frozen since the financial crisis that it helped trigger, may get a boost from some of the biggest bond funds on Wall Street.

Heeding calls from the U.S. Treasury Department to help fix the market for the bonds, the funds issued a set of "key principles" on Monday designed to add transparency to the securities. The main initiative calls for an independent firm to act as a "deal agent," likened to a board of directors, with oversight over the other parties in each transaction.

"Many investors have concluded that their interests would be best protected by entrusting the governance of the trust primarily to a party that is subject to fiduciary duties of care and loyalty," according to documents signed by Alessandro Pagani, head of securitized assets at Loomis Sayles & Company, and James Callahan, principal at PentAlpha Global, co-chairs of the authoring committee. 

Deal Agent

The market for U.S. home-loan securities that lack government backing remains almost frozen for a eighth year, limiting options for borrowers. Private mortgage bonds sold today are largely limited to financing home loans to borrowers with the cleanest credit and sales amounted to a fraction of the $1.2 trillion of RMBS issued at the market’s precrisis peak.

“The pre-crisis private label securitization market was rife with conflicts of interest, inadequate investor protections, over-reliance on credit ratings, contractual enforcement failures and a lack of transparency,” Monique Rollins, a deputy assistant secretary at the Treasury, said in prepared remarks, noting the role that mortgage bonds may have in strengthening the housing recovery. That makes it imperative that a market revival “must happen in a reformed and sustainable way,” she said.

The role of the "deal agent," which has taken other names over the years, such as "super trustee," is designed to ensure that the home loans that are bundled into mortgage bonds are exactly as advertised in the securities’ prospectus.

Inferior Loans

In the years after the financial crisis, many investors argued that the home loans packaged into their securities were inferior to what was advertised. They wanted banks who put the bonds together to make them whole.

Banks argued that they shouldn’t be held responsible for the loans’ problems, which were caused by the housing crisis.

Talk of a overhaul have simmered for years after the crisis. In 2014, U.S. Treasury Department Secretary Jack Lew appealed for investors and issuers to meet to develop guidelines to reassure both sides that they wouldn’t be saddled with unfair losses. Government officials have been looking to reduce the mortgage market’s reliance on U.S.-backed companies like Fannie Mae and Freddie Mac.

Devil in Details

"Whether this is successful depends on a confluence of factors, but mainly, what will the footprint of Fannie and Freddie be," Pagani said in an interview Monday at a structured-finance conference in Las Vegas. He said there could be $200 billion to $300 billion sitting on the sidelines today.

For investors, the idea of an outside mediator isn’t new, but it’s the first time that they are releasing their proposed model for the market to consider. Issuers have also discussed coming up with their own proposals, which could then be merged with investor pitches before adopting a uniform framework.

“The devil is in the details," said Michael Dente, a vice president at Goldman Sachs Group Inc. It could be implemented, but there are numerous soft costs that issuers would have to consider in a cost benefit analysis, he said.

Future steps will likely focus on details such as how to oversee the proposed role, said Patricia Evans, a vice president at Wilmington Trust. “Now we just need a deal," she said.

At least one influential mortgage company immediately lent its support to advance the proposal.

"I want to stress this is not issuer-investor combat,” said Eric Kaplan, a managing partner at Ranieri Strategies, an investment firm founded by Lewis Ranieri, who is credited with inventing some of the first mortgage bonds. His firm Shellpoint Partners also specializes in private-label jumbo mortgages.

(Updates with comments in the thirteenth paragraph. An earlier version of this story corrected the amount of cash on the sidelines in the tenth paragraph.)
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