By Mark P. Dangelo
Lenders want to lend. Consumers want to buy. Investors want to invest. Governments want tax revenue and GDP growth. Politicians and their appointees, let’s face it, want politics.
Generically, it sounds very familiar, pro-consumption, and mainstream capitalistic. Historically, when put into practice across the financial services supply chain, it has been the growth formula for developed countries since the end of World War II. That is at least until March 2008, when “financial engineering” designed to mitigate risks exposed systemic, seismic regulatory shocks that erased over $20 trillion in global wealth, while simultaneously increasing sovereign debts.
Now, with financial reform passed, many assume that the vast uncertainties surrounding markets, assets, and corporations should close a chaotic chapter in our historical timelines. But what about pending updates to existing regulations? Weren’t they “closed out” as well?
As the summer brings reflection, let us examine the backdrop for the proposed Regulation AB (REG AB) revisions, the rationale for REG AB, and a brief review of the extensive changes out for comment. Oh, by the way, the short answer is no, there are many more regulatory “adjustments” still in the works.
The Stage for REG AB Revisions
It is quite possible, if not highly probable, that the U.S. economic outlook will languish for at least another two years. With high unemployment stoking a steady stream of public and private loss mitigation actions, published and stealth home inventories will rise, as real household incomes will potentially stagnate and potentially drop for over 90% of the population. At the risk of upsetting the optimists and those longing for a return to the good-old days, the freewheeling, frivolous consumer of old is dead.
The once stoic trophy of household debt funded by rising real estate prices is now replaced with disillusionment and reduction. The lemming investments of “me-too,” which created the largest loss of capital in history, have been replaced with a government of business as usual — all underpinned by securitized assets “guaranteed” by entities in receivership.
True, the markets and the consumer are improving – but that improvement is hardly robust and not assured. The Fed is once-again nervous, the markets are manic-depressive, and the consumers and homeowners are still seeking hope. The omnipotent economy has improved from its worst – but will it last or is it even architected for sustainability? What a difference an economic quarter makes.
It was early in the second quarter of 2010, against the prospect of a more promising future, the SEC released, “… significant revisions to Regulation AB and other rules regarding the offering process, disclosure and reporting for asset-backed securities.” Spanning 667 pages, the implications of these proposed changes are far reaching and their compliance using new information captured within a repurposed EDGAR will have a pronounced impact on operating processes and business models for years to come.
REG AB Rationale
Come August 2, 2010, the comment period surrounding the proposed revisions to numerous 17 CFR (code of federal regulations) parts and sections will end. It is anticipated on that by the end of 2010, some form of these new revisions and demands for private securitization (i.e., ABS, asset backed securities) will be made law.
Pushing aside politics and headlines, without the creation of new ABS issues and markets comprised of transparent and liquid asset-backed private securitizations, mortgage banking and real estate will potentially languish for another decade. Without faith in quality, non-government guaranteed ABS instruments, investors will continue to refocus their investment monies elsewhere.
But will these regulatory revisions succeed? What will be the net burden and ROI? Has the SEC with the REG AB changes articulated a critical set of enablers needed to entice investors to open their strategies to more than government-backed assets?
For those who remember, REG AB was first approved back in January 2005. Now with the lingering crisis two years old, the SEC in their REG AB revisions states, “These proposals are designed to improve investor protection and promote more efficient asset-backed markets.”
Let’s take a cursory examination of the 667 pages of disclosures, new rules, eligibility, obligations, reports, and officer certifications.
Parts, Sections, and Paragraphs
What stands out in the revisions first and foremost are the data fields proposed for RMBS’s and the new use of EDGAR for source code submission of cash waterfall projections.
Regarding RMBS, the revisions declares, “We are proposing 137 data points for ABS backed by residential mortgages. The staff has surveyed the data and definitions provided by the organizations … to require additional data fields … on information already typically provided by sellers to Fannie Mae and Freddie Mac or likely to be collected by participants in Project RESTART.” With additional mentions of the OCC, OTS, MERS, and MISMO, the data field specifics are described in detail starting in Table 2 and running for 30 pages.
Regarding the use of EDGAR, two statements within the SEC revisions stand out. First, “Because we believe that asset-level data should be provided to investors and all market participants in a form that facilitates data analysis, we are also proposing to require that asset-level data be filed on EDGAR in XML format.”
This statement goes beyond the initial filing and may include the need for updated information to ensure timeliness of information within mandatory periodic reports. Or as stated in the SEC revision document, “We are proposing 151 data points for periodic reports for ABS backed by residential mortgages.”
Secondly, EDGAR of the future may be importing waterfall cash projections for RMBS issues in Python. “Under the proposed requirement, the filed source code, when downloaded and run by an investor, must provide the user with the ability to programmatically input the user’s own assumptions regarding the future performance and cash flows from the pool assets, including but not limited to assumptions about future interest rates, default rates, prepayment speeds, loss-given-default rates, and any other necessary assumptions … The waterfall computer program must also allow the use of the proposed asset-level data file that will be filed at the time of the offering and on a periodic basis thereafter.”
The complexities and implications of the revisions are numerous, and it is more than likely an organization will require specialized legal guidance to navigate the regulation in its final form. However, what is apparent already is that an entire new class of technologies, analytics, and value-added services will spring from these revisions – at the same time taking current proprietary information solutions and offerings into the public domain.
As stated several years ago in this column, the reverse financial supply chain is now gaining increased efficacy — when contrasted to the historical forward approach. Profitable survivability for private ABS issuers and those supplying mortgage assets appears to be dependent on the ability to navigate from the investor requirements back into the consumer.
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Yes, it is true. None of us like regulations or the compliance mandates that follow them into practice. But, out of all the market concerns and anxieties that the government has gone awry, will anyone be willing to tackle the disposition of the GSE’s absent a private and functioning ABS marketplace?
Are we just hoping that any GSE remediation’s post midterms won’t bring the lending markets to a complete standstill once again? Without new, private ABS issues, especially in CMBS and RMBS, where will the liquidity come from for lending to consumer and corporate customers?
So, if we don’t like the proposed revisions, our window of response to the SEC’s comment period is rapidly closing. In their defense, this regulator is asking for feedback on a lot of questions and potential market concerns.
In the end, it appears, our organizations’ need to be prepared for new process, technology, analytical, and procedural requirements before 2011 arrives — as some form of an updated REG AB will be likely issued.