Counselor to the Secretary for Housing Finance Policy Speaks on Treasury’s RMBS Initiative (with Schwartz Comment)

In his remarks before the Fitch Ratings 2015 House View Conference, Counselor to the Secretary of the Treasury for Housing Policy Dr. Michael A. Stegman focused on the RMBS market initiative announced in 2014 by U.S. Treasury Department Secretary Lew. The purpose of the initiative was to help revitalize the private label RMBS market through the development of a benchmark securitization transaction.

Dr. Stegman noted that improved post-crisis loan quality and adequate geographical pool diversification would appear to allow for enough reasonable subordination levels to achieve the desired ratings in private label transactions. However, he also observed that a significant lack of investor confidence in the private label RMBS market remains. It stems, he said, from the "structural deficiencies" of pre-crisis transactions, which resulted in relatively weak representations and warranties, coupled with inadequate mechanisms to identify breaches and enforce remedies for breach. Notwithstanding relatively low subordination levels based on the credit risk of the collateral, investors are now demanding considerable risk premiums for purchasing private label RMBSs, the high cost of which largely renders issuance economically senseless.

According to Dr. Stegman, discussions between the U.S. Treasury Department ("Treasury") and institutional investors on how best to address their concerns have coalesced around the creation of a new independent transaction party referred to as a "Deal Agent," who, subject to the same fiduciary duties of care and loyalty as a corporate director, would be responsible generally for protecting the interests of investors. Significantly, the Deal Agent's responsibilities would involve not only investigating and enforcing breaches of representations and warranties upon the occurrence of objective triggers or otherwise in its judgment (similar to the activity performed by independent reviewers or controlling holders in post-crisis transactions) but also the oversight of servicing, vendor management and cash flow reconciliation. This would include the ability to address servicer underperformance and recommend servicer termination. While Dr. Stegman noted that many details, including the selection and compensation of the Deal Agent, "still have to be worked out," he indicated that the Deal Agent's role and duties should improve the governance of private label RMBS transactions significantly, contribute to the alignment of incentives among transaction participants, and help to eliminate the current risk premium assigned by investors to private label RMBSs based on their experience with legacy transactions.

Jordan Schwartz Comment: Treasury's efforts to jump-start the private label RMBS market by addressing core investor issues are to be applauded. Caution is warranted, however, about the proposed role of a Deal Agent as outlined in Dr. Stegman's remarks. While an independent third party is needed to assess compliance by the securitizer with its representations and warranties (as contemplated by the new shelf eligibility requirements of the SEC's "Regulation AB 2") the greatly expanded powers of the Deal Agent will require emergent institutions with sufficient depth in mortgage origination and servicing, and securitization cash flow structures, to be able to perform the role competently, particularly when girded by fiduciary responsibility. This is so, even if such institutions are protected by something akin to the business judgment rule that protects corporate directors. It is also important to note that such expertise, coupled with potential liability, will not come cheaply. Whether and when it will come, only time will tell.

See: Dr. Stegman's Remarks.