Risk Retention Should Result In Lower MBS Loss Rates, Fed Research Shows

Posted by Orb Staff on December 14, 2010 No Comments
Categories : Residential Mortgage

New research from the Federal Reserve Bank of San Francisco indicates that the 5% risk-retention provision included in this year's financial reform legislation will have a significant impact on loss rates for mortgage-backed securities (MBS).

Title IX of the Dodd-Frank Act requires securitizers to retain at least 5% of the credit risk associated with securitized mortgages. The so-called ‘skin in the game’ requirement is meant to eliminate problems attributed to the originate-to-distribute model of lending.

In an economic letter published Monday, Christopher M. James, a visiting scholar at the San Francisco Fed and a professor of finance at the Warrington College of Business at the University of Florida, studied the differences in loss rates for different MBS deal structures. He compared rates for affiliated deals (where a single originator acts as the MBS sponsor and servicer) with rates for mixed deals (where the sponsor is affiliated with one of multiple originators) and unaffiliated deals (where the sponsor is not an originator).

Citing data from a University of Florida working paper he co-wrote with Cem Demiroglu in 2009, James wrote that loss rates are lower for affiliated deals and higher for mixed or unaffiliated deals. The performance differences were evident before the collapse of the housing market, he adds, explaining that the loss rate on affiliated deals was 0.28% in mid-2006, compared to 0.75% for unaffiliated deals.

‘In short, 'skin in the game' matters for performance,’ James wrote. ‘More important, because in this study the residual interest retained by the sponsor is three percent or less of the total value of the securitization, these findings suggest that a five percent loss exposure requirement is likely to have a significant impact on loss rates.’

SOURCE: Federal Reserve Bank of San Francisco

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