The Securities and Exchange Commission is set to release a major new regulatory proposal on Wednesday aimed at reining in the $2.1 trillion asset-backed securities (ABS) market that played such a prominent part in sparking the financial crisis.
According to a knowledgeable source, the SEC will propose new restrictions on companies that issue these securities, the vast majority of which are backed by mortgages.
The SEC's action follows on the heels of the Federal Reserve pulling out of the mortgage-backed securities (MBS) market on April 1. Since December, 2008, the Fed had bought $1.25 trillion in subprime MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae in an effort to keep the MBS market going and help keep home-loan interest rates low.
ABS values are based on the values of the specific assets -- including mortgage loans, credit card payments and auto loans -- that back specific securities.
According to Asset-Backed Alert, major issuers of ABS in 2009, included Barclays PLC, with $95.8 billion; Royal Bank of Scotland Group, with $74.1 billion; JPMorgan Chase, with $62.8 billion; and Citigroup, with $41 billion.
Less Guessing About "What's in There"
The new rule proposal, expected to be some 600 pages long, will require ABS issuers to provide an an inventory for all of the underlying assets in the securities. That hasn't been previously required, and many of the mortgages held in the securities have proved to be poor investments because the mortgage holders were unable to keep up with payments on their loans.
Currently, companies only have to provide general information about the assets pooled in the securities. The new information "would be at the asset level, so you don't have to guess at what's in there," the source says.
The information would have to be provided in a standardized, "tagged" format so that analysts, credit raters and others researching the security could find the information easily. The new requirement likely won't be extended to credit-card-backed securities, which are held by some 40 million people.
Speed Bumps on the Path to Issuance
Tom Deutsch, executive director of the American Securitization Forum (ASF), says there "could be some strong positives to some of that additional disclosure." But the devil is in the details, he adds. Would the additional disclosure show such key information as whether loans were modified, the location of the real estate, the amount of equity in the home, or if there's a second lien? "The question is: What is most relevant to investors, and what is cost-effective?" Deutsch says.
As part of the overhaul, the SEC may propose some "speed bumps" in the "shelf registration" system for ABS. Currently, that system allows companies that are well known in the markets or that carry investment-grade ratings to take their securities to the market quickly when conditions are favorable, without having to get approval from the SEC for the prospectus and other required filings. Those filings are made periodically and can be pulled off the "shelf" when the company wants to market securities.
Many issuers of securities use shelf registrations because the SEC's traditional registration system takes much longer to get approval of prospectuses and other required disclosures.
Issuers Would Have to Retain Some Risk
In addition, to be allowed to use the SEC's shelf registration system, companies would have to keep some "skin in the game." Currently, they're allowed to sell the entire security to investors without holding any of it themselves. Financial regulation reform legislation approved by the Senate Banking Committee would require that companies that issue the securities hold 5% of the assets. The SEC is likely to propose something similar.
"We've been very opposed to an arbitrary percentage of risk retention, like 5%," Deutsch says. "It doesn't necessarily change the incentives of the issuer." The ASF supports prohibiting loan originators whose loans don't meet set standards from selling the loans, or requiring them to repurchase the loans for full price in the event of default. That would provide full coverage to investors, Deutsch says.
Also, for a security to be eligible for shelf registration, chief executive officers may be required to certify that the assets held in the security have demonstrated the capacity to produce enough in earnings to make the security's required payments to investors.
And instead of allowing immediate sales of ABS, the SEC may propose that issuers announce their intentions of going to market with a security a set time in advance of the security's sale.
Problems with credit ratings that led to poor investments in many of the securities are prompting the SEC to make these changes, many of which are similar to requirements that Europe has instituted. "Now we know AAA is not always AAA," says the source, referring to credit ratings that were extended to many ABS transactions.
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