If the Bank of England wants this information, how can this court deem it irrelevant? NOTE: BOE defines investors as note-holders.
information on the remaining life, balance and prepayments on a loan; data on the current valuation and loan-to-value ratios on underlying property and collateral; and interest rate details, like the current rate and reset levels. In addition, the central bank said it wants to see loan performance information like the number and value of payments in arrears and details on bankruptcy, default or foreclosure actions.Editor’s Note: As Gretchen Morgenstern points out in her NY Times article below, the Bank of England is paving the way to transparent disclosures in mortgage backed securities. This in turn is a guide to discovery in American litigation. It is also a guide for questions in a Qualified Written Request and the content of a forensic analysis.What we are all dealing with here is asymmetry of information, which is another way of saying that one side has information and the other side doesn’t. The use of the phrase is generally confined to situations where the unequal access to information is intentional in order to force the party with less information to rely upon the party with greater information. The party with greater information is always the seller. The party with less information is the buyer. The phrase is most often used much like “moral hazard” is used as a substitute for lying and cheating.
Quoting from the Bank of England’s “consultative paper”: ” [NOTE THAT THE BANK OF ENGLAND ASSUMES ASYMMETRY OF INFORMATION AND, SEE BELOW, THAT THE INVESTORS ARE CONSIDERED "NOTE-HOLDERS" WITHOUT ANY CAVEATS.] THE BANK IS SEEKING TO ENFORCE RULES THAT WOULD REQUIRE DISCLOSURE OFborrower details (unique loan identifiers); nominal loan amounts; accrued interest; loan maturity dates; loan interest rates; and other reporting line items that are relevant to the underlying loan portfolio (ie borrower location, loan to value ratios, payment rates, industry code). The initial loan portfolio information reporting requirements would be consistent with the ABS loan-level reporting requirements detailed in paragraph 42 in this consultative document. Data would need to be regularly updated, it is suggested on a weekly basis, given the possibility of unexpected loan repayments.42 The Bank has considered the loan-level data fields which
it considers would be most relevant for residential mortgage- backed securities (RMBS) and covered bonds and sets out a high-level indication of some of those fields in the list below:
• Portfolio, subportfolio, loan and borrower unique identifiers.
• Loan information (remaining life, balance, prepayments).
• Property and collateral (current valuation, loan to value ratio
and type of valuation). Interest rate information (current reference rate, current rate/margin, reset interval).
• Performance information (performing/delinquent, number and value of payments in arrears, arrangement, litigation or
bankruptcy in process, default or foreclosure, date of default,
sale price, profit/loss on sale, total recoveries).
• Credit bureau score information (bankruptcy or IVA flags,
bureau scores and dates, other relevant indicators (eg in respect of fraudulent activity)).
The Bank is also considering making it an eligibility requirement that each issuer provides a summary of the key features of the transaction structure in a standardised format.
This summary would include:
• Clear diagrams of the deal structure.
• Description of which classes of notes hold the voting rights and what proportion of noteholders are required to pass a resolution.
• Description of all the triggers in the transaction and the consequences of them being breached.
• What defines an event of default.
• Diagramatic cash-flow waterfalls, making clear the priority
of payments of principal and interest, including how these
can change in consequence to any trigger breaches.
52 The Bank is also considering making it an eligibility
requirement that cash-flow models be made available that
accurately reflect the legal structure of an asset-backed security.
The Bank believes that for each transaction a cash-flow model
verified by the issuer/arranger should be available publicly.
Currently, it can be unclear as to how a transaction would
behave in different scenarios, including events of default or
other trigger events. The availability of cash-flow models, that
accurately reflect the underlying legal structure of the
transaction, would enable accurate modelling and stress
testing of securities under various assumptions.
Pools That Need Some Sun
LAST week, the Federal Home Loan Bank of San Francisco sued a throng of Wall Street companies that sold the agency $5.4 billion in residential mortgage-backed securities during the height of the mortgage melee. The suit, filed March 15 in state court in California, seeks the return of the $5.4 billion as well as broader financial damages.
The case also provides interesting details on what the Federal Home Loan Bank said were misrepresentations made by those companies about the loans underlying the securities it bought.
It is not surprising, given the complexity of the instruments at the heart of this credit crisis, that it will require court battles for us to learn how so many of these loans could have gone so bad. The recent examiner’s report on the Lehman Brothers failure is a fine example of the in-depth investigation required to get to the bottom of this debacle.
The defendants in the Federal Home Loan Bank case were among the biggest sellers of mortgage-backed securities back in the day; among those named are Deutsche Bank; Bear Stearns; Countrywide Securities, a division of Countrywide Financial; Credit Suisse Securities; and Merrill Lynch. The securities at the heart of the lawsuit were sold from mid-2004 into 2008 — a period that certainly encompasses those giddy, anything-goes years in the home loan business.
None of the banks would comment on the litigation.
In the complaint, the Federal Home Loan Bank recites a list of what it calls untrue or misleading statements about the mortgages in 33 securitization trusts it bought. The alleged inaccuracies involve disclosures of the mortgages’ loan-to-value ratios (a measure of a loan’s size compared with the underlying property’s value), as well as the occupancy status of the properties securing the loans. Mortgages are considered less risky if they are written against primary residences; loans on second homes or investment properties are deemed to be more of a gamble.
Finally, the complaint said, the sellers of the securities made inaccurate claims about how closely the loan originators adhered to their underwriting guidelines. For example, the Federal Home Loan Bank asserts that the companies selling these securities failed to disclose that the originators made frequent exceptions to their own lending standards.
DAVID J. GRAIS, a partner at Grais & Ellsworth, represents the plaintiff. He said the Federal Home Loan Bank is not alleging that the firms intended to mislead investors. Rather, the case is trying to determine if the firms conformed to state laws requiring accurate disclosure to investors.
“Did they or did they not correspond with the real world at the time of the sale of these securities? That is the question,” Mr. Grais said.
Time will tell which side will prevail in this suit. But in the meantime, the accusations illustrate a significant unsolved problem with securitization: a lack of transparency regarding the loans that are bundled into mortgage securities. Until sunlight shines on these loan pools, the securitization market, a hugely important financing mechanism that augments bank lending, will remain frozen and unworkable.
It goes without saying that after swallowing billions in losses in such securities, investors no longer trust what sellers say is inside them. Investors need detailed information about these loans, and that data needs to be publicly available and updated regularly.
“The goose that lays the golden eggs for Wall Street is in the information gaps created by financial innovation,” said Richard Field, managing director at TYI, which develops transparency, trading and risk management information systems. “Naturally, Wall Street opposes closing these gaps.”
But the elimination of such information gaps is necessary, Mr. Field said, if investors are to return to the securitization market and if global regulators can be expected to prevent future crises.
While United States policy makers have done little to resolve this problem, the Bank of England, Britain’s central bank, is forging ahead on it. In a “consultative paper” this month, the central bank argued for significantly increased disclosure in asset-backed securities, including mortgage pools.
The central bank is interested in this debate because it accepts such securities in exchange for providing liquidity to the banking system.
“It is the bank’s view that more comprehensive and consistent information, in a format which is easier to use, is required to allow the effective risk management of securities,” the report stated. One recommendation is to include far more data than available now.
Among the data on its wish list: information on the remaining life, balance and prepayments on a loan; data on the current valuation and loan-to-value ratios on underlying property and collateral; and interest rate details, like the current rate and reset levels. In addition, the central bank said it wants to see loan performance information like the number and value of payments in arrears and details on bankruptcy, default or foreclosure actions.
The Bank of England recommended that investor reports be provided on “at least a monthly basis” and said it was considering making such reports an eligibility requirement for securities it accepts in its transactions.
The American Securitization Forum, the advocacy group for the securitization industry, has been working for two years on disclosure recommendations it sees as necessary to restart this market. But its ideas do not go as far as the Bank of England’s.
A group of United States mortgage investors is also agitating for increased disclosures. In a soon-to-be-published working paper, the Association of Mortgage Investors outlined ways to increase transparency in these instruments.
Among its suggestions: reduce the reliance on credit rating agencies by providing detailed data on loans well before a deal is brought to market, perhaps two weeks in advance. That would allow investors to analyze the loans thoroughly, then decide whether they want to buy in.
THE investors are also urging that loan-level data offered by issuers, underwriters or loan servicers be “accompanied by an auditor attestation” verifying it has been properly aggregated and calculated. In other words, trust but verify.
Confidence in the securitization market has been crushed by the credit mess. Only greater transparency will lure investors back into these securities pools. The sooner that happens, the better.
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