Amherst's Goodman: Risk Retention Fails to Address Conflicts in Re-Emerging Securitization
While talk of reforming the securitization process focuses on better disclosure and credit risk retention, these solutions fail to address the real issue of inherent conflicts of interest that plague the securitization process, according to commentary by Amherst Securities Group. "[P]roposals for risk-retention and increased disclosure do not 'solve' the problems," writes Laurie Goodman, head of the Amherst MBS strategy group. "In fact, many of the problems are inherent to the securitization process; buyers must simply be aware of them and price for it." "Moreover, proposed risk-retention requirements are anticompetitive, limiting future deal sponsors to only those able to retain a 5% vertical slice of the transaction." The Amherst team recommends pursuing third-party enforcers of representations and warranties as a step to avoid conflicts of interest. Disclosing servicers' invested interests in other parts of the deal could also eliminate conflicts of interest. Additionally, Goodman recommends that first lien investors approve second liens at the time of acquisition and at any given time the borrower wishes to add a second lien. If borrowers can't obtain permission to take out second mortgages, the only option would be a refinance of the first. These steps would help strengthen the transparency of the securitization process at a time when the machine is just beginning to restart. According to Amherst, there are three stages to restarting the securitization process. First, the supply of legacy securities must be cleared up. Second, unwanted legacy loans sitting on balance sheets that would trade below par must be cleared up. And finally, the securitization of new originations must become economic. Goodman writes that the first and second events have already occurred, and the third is close. The recent volume (illustrated below) of re-securitized mortgage investment conduits or, re-REMICs, helped clear up these legacy securities. In re-REMICs, Goodman writes, many of the underlying securities were originally purchased with a triple-A rating, which investors took to mean little or no credit risk. As the underlying mortgages collapsed and the securities were slashed below investment grade, they became ineligible investments for many market participants. According to Amherst, re-REMICs, when structured properly, can repackage those securities and reallocate cash flows into new, sufficiently enhanced triple-A securities. The second part of the restarting process, the securitization of legacy securities, has been relatively slower than the re-REMIC push. Ongoing entities are reluctant to sell loans at a discount and take losses, Goodman writes, and often legacy loans are assumed directly by other entities when regulators shut down depository banks. The last step, securitization of new originations, may be off to a slow start now that Redwood Trust (RWT) broke the ice with the first private-label RMBS since 2008. Amherst expects securitization in Q2 or early Q3 2010. "We believe subprime securitization will resume, but it will take years," Goodman writes. "There is a need for mortgage credit availability for borrowers who do fit into the GSE box, but the price of that credit will be higher than it was in the 2007 and earlier period." Write to Diana Golobay. Disclosure: the author holds no relevant investments.