Friday, November 20, 2009

FDIC May Tie Asset-Backed Performance to Rater Pay

Posted on Bloomberg by Jody Shenn:

The Federal Deposit Insurance Corp. may force underwriters and credit raters of asset-backed debt to tie their compensation to the performance of the securities, as it seeks to create better lending practices.

The requirement may be part of new rules for bank securitizations to be proposed by FDIC staff at an agency board meeting next month, Michael Krimminger, special adviser for policy to FDIC Chairman Sheila Bair, said in an interview yesterday. The FDIC will host a meeting today on the topic with other regulatory bodies, said people familiar with the matter who declined to be identified because the talks will be private.

The FDIC, whose power to influence practices probably would be limited to deals sponsored by banks and not the securities arms of their parents, is working on a package of new policies for securitizations after the business helped create a “crisis that rocked the foundations of our financial system,” Krimminger said. The meltdown, fueled by demand for “unsound” mortgages, offers lessons in what needs to change, he said.

“The underwriters get all their cash upfront, the ratings agencies get all their cash upfront, and nobody really has a strong incentive to make sure the loan performs in the long term,” Krimminger said.

Lender Compensation

Lenders should have their compensation tied to how well they meet the contractual promises they make over the quality of loans that back bonds, Krimminger said in an e-mail. Such representations and warranties can require originators to repurchase ineligible debt.

FDIC proposals will likely include requirements for greater disclosure on assets backing securities, limits to how much of the underlying debt lenders can buy from others to put deals together and a demand that issuers retain a certain amount of the credit risk from the underlying loans, Krimminger said in the interview.

Asset-backed bonds are securities derived from receivables such as mortgage interest, auto-loan payments, credit-card payments and royalties. They are typically sliced into classes, or tranches, with varying ratings and risk. The bonds contributed to about $1.7 trillion in write downs and losses at the world’s biggest financial institutions since the start of 2007, according to data compiled by Bloomberg.

The FDIC may seek to limit the number of classes allowed in a securitization, strengthen rules directing the firms that service the debt to act in the best interest of all tranches and prevent the bonds from being turned into even more securities unless issuers offer information on all underlying loans, Krimminger said.

Safe Harbor

The FDIC wants the conditions as part of any extension of a so-called safe harbor that prevents assets in securitizations from being available to the agency when it winds down failed institutions, Bair said last week.

Barbara Hagenbaugh, a spokeswoman for the Federal Reserve Board, William Ruberry, a spokesman for the U.S. Office of Thrift Supervision, and Kevin Mukri, a spokesman for the Office of the Comptroller of the Currency, declined to comment.

Ed Sweeney, a spokesman for Standard & Poor’s, and Sandro Scenga, a spokesman for Fitch Ratings, declined to immediately comment. Thomas Lemmon, a spokesman for Moody’s Investors Service, didn’t return a message.

Regulators should establish minimum underwriting standards for all mortgages made in their countries, Comptroller of the Currency John C. Dugan, who oversees U.S. commercial banks, said in a Nov. 18 speech in Tokyo.

‘Widespread Damage’

“Sometimes, when underwriting standards get so out of balance that they cause widespread damage to borrowers and lenders alike, it becomes necessary for regulators to act more prescriptively,” he said, according to a copy of his remarks on the agency’s Web site. “If ever there was a demonstrated need for such intervention, the searing U.S. mortgage market experience of the last several years fits the bill.”

Chris Flanagan, an analyst covering asset-backed securities in New York at JPMorgan Chase & Co., said in a Nov. 13 report that part of the reason for the drop in prices of securitized debt this month is “regulatory overshoot concerns.”

Financial-overhaul bills unveiled over the past month by Senate Banking Committee Chairman Christopher Dodd and House Financial Services Committee Chairman Barney Frank would force asset-backed issuers or loan originators to retain 10 percent of the credit risk of debt and offer greater disclosures.

Accounting Rules

Last week, the FDIC acted to extend its “safe harbor” for securitized debt through March after new accounting rules sparked concern it would be able to tap the pools underlying credit-card securities to protect its deposit insurance fund after banks fail.

The Financial Accounting Standards Board rules take effect for fiscal years starting after Nov. 15, and require issuers to include assets and liabilities of securitized debt on their balance sheets.

Attaching conditions on practices to a longer-lasting FDIC safe harbor won’t make credit harder to get or more expensive for consumers and companies, as the rules will help revive the market, Krimminger said.

“I view this as not putting in conditions that will impair in any way securitization, but actually creating the kind of transparency” and other protections that “the investor community wants to have,” he said.

No comments: