Risk retention no solution for ABS

The Senate and House bill requirements for securitisers to retain 5% of the credit risk from pools of securities along with the SEC's proposal in April to have firms hold 5% of each class of ABS is still causing debate among industry participants, according to panellists at an IQPC ABS Summit in New York.

The 5% retention requirement made its way through Congress intact, Faten Sabry, svp at NERA Economic Consulting said. The inability to hedge that 5% risk retention is an important condition, she noted.

If risk retention has to be done, it should be catered to be deal-specific, Sabry added. "We as economists do not think there is a one-size-fits-all for structured products when it comes to risk retention."

Recent legislation from the Dodd/Frank bill, however, exempts some high quality mortgages from the risk retention requirements.

The three sets of parties that exist currently in the securitisation markets - such as banks, originators and brokers, investors and finally trustees and servicers - have competing and not necessarily aligned incentives, Sabry continued. "We need to find a way to align these incentives."

The SEC regulations have another 30 days for comments to be accepted regarding shelf-eligibility requirements. "The SEC said the arranger of the deal has to provide loan level data to make available to everyone. You have to provide a programme to help investors calculate the waterfall of these deals and give investors more time between issuance and think through the deal," she explained.

"The question is: is this an appropriate response?" Sabry asked. She further commented: "Is 5% retention risk without hedging and hiring a third party to verify the quality of the deal every quarter or every six months going to help?"

"Risk retention can mitigate the incentive of an issuer to sell poorly underwritten loans, but cannot remedy broad errors in risk management by market participants," noted Adam Ashcraft, vp and head of structured credit at the Federal Reserve Bank of New York. "In a sound securitisation market, investors have adequate time, information and incentives to do serious credit work on transactions."

Investors themselves are also not completely in favour of the risk retention requirement for banks. Some believe the banks will just figure out a way to get their profit first, one panellist suggested.

"Risk retention doesn't solve everything. Risks need to be aligned with the incentives of investors," he said.

Europe has similar 'skin in the game' proposals, noted another panellist at the conference, but key differences exist. In the US, most of the proposals are issuer-focused, whereas in Europe the compliance part of the European proposals is more focused on the buyer side of ABS, he explained.

Europe initially started out with a higher risk retention than 5% and eventually went back to a very flexible system that takes into account different assets, he added. If the US reform legislation is indeed signed in this week, he suggested that there will be "extra innings", referring to the heavy amount of uncertainty that still exists over the legislation.

"In the end, maybe retention won't be such a big deal if it's done properly," the panellist said. He noted that a whole new securitisation market is being built to fix one little piece of it.

The economic backdrop in the US is also not helping appease the risk retention debate either. Despite the various US government relief programmes, delinquencies for prime and subprime loans are at all time highs, NERA's Sabry pointed out. "The same is true with foreclosures," she noted.

KFH