Treasury Department Urges Return of Private Label RMBS | Practical Law

Treasury Department Urges Return of Private Label RMBS | Practical Law

After an eight-year freeze on the market for residential mortgage-back securities (RMBS) issued by private financial institutions, the Treasury Department is attempting to revive its role in the market, and issued a press release urging a responsible return of the private label securitization (PLS) market.

Treasury Department Urges Return of Private Label RMBS

Practical Law Legal Update w-001-4827 (Approx. 4 pages)

Treasury Department Urges Return of Private Label RMBS

by Practical Law Finance
Published on 03 Mar 2016 • USA (National/Federal)
After an eight-year freeze on the market for residential mortgage-back securities (RMBS) issued by private financial institutions, the Treasury Department is attempting to revive its role in the market, and issued a press release urging a responsible return of the private label securitization (PLS) market.
After an eight-year freeze on the market for residential mortgage-backed securities (RMBS) issued by private financial institutions, the US Treasury Department is attempting to revive its role in the market. On February 29, 2016, Treasury issued a press release urging a responsible return of the private label securitization (PLS) market.
In order to facilitate the resurgence of the private label RMBS market, the Treasury Department in 2014 published a Request for Information in the Federal Register seeking public input on the challenges facing the market. As part of the initiative, the Treasury Department also hosted a series of meetings with institutional investors, issuers, servicers, credit rating agencies, due diligence firms, and other key stakeholders regarding the necessary structural reforms that could assist in reviving this market.
According to the release, major flaws in the pre-crisis PLS market led to conflicts of interest, inadequate investor protections, overreliance on credit ratings, contractual enforcement failures, and a lack of transparency.
In the years following the financial crisis, investors argued that many of the home loans that were packaged into their RMBS were inferior to what had been advertised. Investors looked to hold the banks who put the bonds together responsible, while banks argued that they were not responsible for problems that were caused by the housing crisis.
The Treasury Department asserts its commitment to seeing reform and resurgence in the PLS market, which it hopes will broaden access to mortgage credit for many qualified borrowers. To achieve its stated goal of addressing these issues, the Treasury has undertaken an initiative to introduce structural reforms into the private-label RMBS market.
Treasury has identified three main areas that could be addressed in order to invigorate the market for RMBS issued by private financial institutions:
  • Adding a deal agent to the transaction structure.
  • Servicing reforms.
  • Addressing weaknesses in representations and warranties.

Adding a Deal Agent to the Transaction Structure

The main suggestion that came from the comments and discussions conducted by Treasury was for an independent firm to act as a deal agent to oversee the other parties in each transaction and ensure that the home loans that are bundled into mortgage bonds are identical to the version that was advertised in the prospectus accompanying the issuance of those securities.
Public commenters and participants in the Treasury discussions asserted that the inclusion of a deal agent into the RMBS structure would help to make smarter decisions by allowing a “thinking” entity to make decisions in both routine circumstances, and importantly, in response to unforeseen events.
Commenters and participants in the discussions believe that the deal agent should act as a fiduciary and be subject to duties of care and loyalty to ensure that an entity act in the best interest of the securitization trust instead of placing the interest of a certain class of bondholders over another. Suggested responsibilities of the deal agent would include:
  • Review of representations and warranties.
  • Enforcement of breaches of representations and warranties.
  • Servicer oversight.
  • Reconciliation of cash flows going into and out of the securitization trust.
  • Bondholder communication.
On February 25, 2016, the Association of Institutional Investors published Proposed Deal Agent Agreement: Key Principles. Although these key principles have not been universally accepted they symbolize the continued progress resulting from the conversations among market participants. Most participants and commenters agreed that the inclusion of a deal agent would provide additional transparency, oversight and enforcement to the transaction, although some participants expressed concern that the extra value does not justify the increased fees and expenses that a deal agent would add to the trust.

Servicing Reform

Commenters and participants in the Treasury discussion also advocated the creation of a framework in which servicing errors could be caught early and fixed quickly, with an emphasis on compliance with all applicable laws and regulations. Examples of these changes would include:
  • Strengthening minimum servicing standards by requiring servicers to maximize the value of collateral to the trust as a whole.
  • Improving the alignment of interests between servicers and the trust (and thereby investors).
  • Alternative compensation structures.
  • An oversight mechanism based on defined measures, or key performance indicators, with servicer termination and transfer in the event of nonperformance or underperformance.
  • Potential ways to improve alignment of interests such as:
    • trust ownership of mortgage servicing rights;
    • restrictions on including loans with second liens in the securitization pool;
    • checks and balances pertaining to affiliates; and
    • automatic stop-advance triggers for principal and interest.
  • Increased standardization and transparency for net present value (NPV) models and decisions pertaining to loss mitigation, recoverability, and reimbursement of advances.
  • Improving the processes related to cash flow reconciliation between primary and master servicers.
  • Representation of investors in bank and servicer settlement negotiations.
  • Prohibition on the use of trust modifications to fulfill settlements.

Representations and Warranties

Many commenters and participants in the Treasury discussion felt that ensuring the enforcement of contractual terms for all transaction parties would help to enhance investor confidence and further bolster the market. Participants focused on ways to improve the disclosure and repurchase enforcement mechanism.