An industry in search of a silver bullet

The mood was sombre at the American Securitization Forum annual conference in Las Vegas last month as industry participants sought ways to restore confidence in the market

"What is to be done?" was the question to which speakers and delegates kept returning at the American Securitization Forum's annual conference in Las Vegas last month.

Six thousand market participants met for the event at which securitisation professionals pored over the failings that led to the liquidity crunch and how to put them right.

Immediate concern among delegates focused on the wave of adjustable-rate mortgages due to reset this year. Many fear these will cause a spike in foreclosures that will further undermine confidence and drag the housing market lower.

Proposals for reform over the longer term included tightening rules on predatory lending, addressing conflicts of interest at the rating agencies, and improving transparency and disclosure practices across the industry.

Opening the conference, US Federal Reserve governor Randall Kroszner outlined the Fed's thinking on how to restore confidence in the markets. "Protecting borrowers protects issuers and investors too," he told delegates. "Action against predatory lending will help to revive the market."

The Fed has proposed rules - out for consultation until April 8 - that would regulate the provision of high-risk mortgage products, explained Kroszner.

Risk layering

The Fed's analysis shows that the troubles in the mortgage market arise not from a single practice in isolation, but instead from the complex ways that risk factors and underwriting practices can affect each other, sometimes called 'risk layering', said Kroszner. "Therefore, we have proposed using a loan's annual percentage rate, or APR, to determine whether the loan is covered by stricter regulations," he told delegates.

So-called higher-priced mortgage loans would be singled out under the proposal. These loans comprise those with an annual percentage rate 3% or more above the yield of comparable Treasuries (or 5% for second-lien loans).

For these products, the proposals would require lenders to assess fully the borrower's ability to pay, verify the borrower's income and assets, and to escrow insurance and tax payments due on the mortgage for at least the first year.

The new rules would be enforceable both by regulators and by consumers, said Kroszner. The application of the rules to patterns of behaviour rather than individual cases will curb the threat of excessive litigation, he said. Thus lenders will not find themselves forced to increase interest charges to cover that risk.

The requirement that lenders verify a borrower's income reflects evidence that failing to verify income "invited fraud", said Kroszner. However, the rules would allow lenders to use credible non-traditional documents to corroborate a borrower's claims.

Robert Steel, US Treasury under secretary for domestic finance, used the second keynote address of the conference to detail government-backed initiatives to help homeowners facing mortgage resets. "Market participants must accept some degree of responsibility and commit to lessons learned," he told delegates.

Steel spoke of the work of the Treasury-backed initiative Hope Now, which has brought lenders together to help borrowers in default or likely to struggle with their mortgage.

Hope Now members have mailed 430,000 letters to delinquent borrowers who had not responded to previous contact attempts by servicers, said Steel, with around 77,000 responding. Most servicers now contact borrowers 120 days before the reset dates on their loans, he said.

Steel also made clear the expectation that lenders implement thoroughly the Treasury-backed loan modifications plan brokered by the ASF in December. "We want and expect the rate of modifications to increase," he told delegates. "It is up to the industry, including those of you here today, to put this plan into action."

Fast-track borrowers

The ASF loan modification plan aims to fast track targeted borrowers through a modification process whereby their interest rates would be frozen for up to five years. The aim is that by fast tracking some borrowers, servicers will free up time to help others.

Asked whether the ASF plan could undermine the contractual obligation of servicers to investors, Steel said there was appropriate flexibility in pooling and servicing agreements to allow servicers to modify loans. The Treasury does not want to approach a current problem in a way that has unintended consequences for the availability of credit going forward, he said.

Turning to the FHA Secure programme initiated by the US administration, Steel said around 75,000 families have refinanced through the programme and around 100,000 more loans are in the pipeline.

Despite Steel's enthusiasm about these programmes, however, speakers on subsequent panels were sceptical about the effectiveness of efforts to reduce delinquencies and foreclosures.

In a panel discussion on the loan modifications, Rod Dubitsky, head of ABS research at Credit Suisse in New York, said rates of loan modification had been pitiful prior to the ASF plan. Several speakers doubted whether servicers would have the manpower to modify loans in substantial numbers even with the fast-tracking guidelines in place.

Rate cuts

Rate cuts have lessened the potential impact of resets for borrowers and will continue to do so if the Fed cuts rates further as expected, said Dubitsky. But borrowers' equity has been substantially reduced by house-price falls and that could prove to be a greater problem even than rate resets, he said (see also, News focus, page 7).

Elsewhere at the conference, the role of rating agencies in the recent difficulties and the need for improved transparency and surveillance on securitisation deals dominated discussion.

During a session on rating methodology, sections of the audience applauded one investor as he told representatives from the rating agencies: "You should be ashamed of yourselves."

Raters responded by saying the current environment is unusually stressful and one in which some securities initially rated up to single-A might reasonably be expected to default. Regarding transparency, several panels identified the need to make available more data on the performance of individual deals, including loan level data, as essential to the recovery of confidence in the market.

A survey of delegates carried out by the ASF ahead of the conference identified transparency as the second most important issue that must be improved to bring investors back to the securitisation market.

Forty-six per cent of delegates polled ahead of the conference said disclosure and transparency must improve. The most important issue identified by delegates was the restoration of confidence in the processes and outputs of the rating agencies.

Rob Mannix.

PAULSON LAUNCHES LIFELINE

US Treasury-backed efforts to prevent a wave of foreclosures continued in February with secretary Henry Paulson announcing a further initiative to help troubled homeowners.

Six of the largest servicers, accounting for half the mortgage market, together launched Project Lifeline - an effort to contact homeowners already 90 days or more delinquent with the offer of a possible pause in the foreclosure process. The initiative will apply to all borrowers, not just subprime.

Announcing the plan, Paulson said: "None of these efforts are a silver bullet that will undo the excesses of the past years, nor are they designed to bail out real estate speculators or those who committed fraud during the mortgage process. These efforts are to help American families who both want to and can, through a loan modification or refinancing, stay in their homes." He urged all servicers to adopt Project Lifeline and the ASF's loan modification framework.

He also called for those who have joined the Hope Now alliance to report progress monthly on loan modifications under these initiatives. "We have a lot of work ahead of us; these efforts can succeed only if they are pursued industry wide," he said.