One of the most widely discussed ideas at ABS Vegas for boosting issuance of private-label residential mortgage securitization involves hiring a third party to monitor the quality of the collateral.
Redwood Trust, one of the most frequent issuers, has been talking up this kind of role for over a year. In written testimony submitted to the Senate’s Housing, Banking and Urban Affairs Committee in October 2013, Redwood recommended requiring that securitization trusts create the position of a “credit risk manager” to manage representation and warranty claims and monitor servicer performance.
The role is one of a number of best practice recommendations for RMBS 3.0 being discussed by a committee of the Structured Finance Industry Group.
The idea is that an independent third party could act as a referee in the event the senior investors and the party that owns the first loss security disagree on whether or not to pursue a claim, according to Redwood’s Senate testimony. It would also remedy the fact that there is currently no independent review of quality control of the servicer’s decisions.
So far Redwood hasn’t found it necessary to use a credit risk manager, at least not for plain-vanilla transactions backed by loans to borrowers with pristine credit and plenty of equity in their homes. But future deals could include more loans that don’t qualify for a legal safe harbor under new ability-to-repay rules. A credit risk manager could help broaden the investor base for such deals.
Alessandro Pagani, portfolio manager and director of securitized research at Loomis Sayles, sees some merit in the idea. Speaking at an RMBS panel Tuesday afternoon, he said that an entity in this role could “act as a thinking entity that has the power to protect all investors in RMBS transactions.”
In addition to the two responsibilities outlined by Redwood in its testimony, Pagani said that a credit risk manager could also guaranty loan-level transparency to investors through the life of the transaction.
Vincent Fiorillo, global sales manager at Doubleline Group, and another panelist, agrees. “Redwood decided to create great bonds backed by great collateral — great but not good for investors who are a credit buyer,” Fioirillo said. He said that investors don’t have time pour over pages and pages of documentation; they need a more efficient way to analyze credit quality. “Investors want better representation, better access to loan level information and the ability to do something if things go wrong,” he said.
Other investors are more skeptical.
James Grady, managing director and head of the structured finance sector team at Deutsche Asset Management and another panelist, is concerned that a credit risk manager may end up being just “cosmetic.” Grady also questioned whether bigger RMBS issuers will be on board. “Trustees should have assumed some of these duties but we all know what happened there,” he said.
Investors are also concerned about the potential cost of hiring a credit risk manager. Allan Berliant, portfolio manager at Grantham Mayo Van Otterloo, believes that neither the investor nor the securitization sponsor should be on the hook for the cost. Instead, Berliant proposed that the borrowers pay for third-party monitoring of transactions. Borrowers who take out nonconforming loans “bring the element of risk,” he said. “If they want to get a nonconforming loan they’ll have to pay more.”