Treasury Secretary Timothy Geithner’s proposal to “fix” securitization was released last week, and it is a mixed bag for CMBS.
On the positive side, he stated the SEC should promote increased transparency for both the deals and the rating agency methodology used to rate the deals. The best line was “Investors and credit rating agencies should have access to the information necessary to assess the credit quality of the assets underlying a securitization transaction at inception and over the life of the transaction.”
The bad news for CMBS lies in two other proposals:
1. The issuer (or sponsor) of a securitization be forced to retain a 5 percent interest in a pool that cannot be hedged or sold.
2. Issuers cannot achieve a “gain on sale” accounting treatment until the underlying loans are paid off.
The whole point of securitization is to transfer risk. Taking both accounting and credit incentives away is troublesome and unproductive, making securitization harder, not easier. Instead, we should focus on freeing the data so investors and rating agencies know the value of the collateral. This way, we will re-establish the credibility of our asset class.
Investors are not dumb
Of course if you cannot transfer the risk because you cannot find a buyer, then you are stuck. And the only investors today are value investors who will only buy CMBS at reasonable spreads if we share our data and prove our value.
While aligning economic interest is absolutely a good idea, I would suggest this point is so fundamental it should be assumed as mandatory. If the issuer and the investor do not have aligned interests (i.e. we issue and securitize loans that aren’t actually going to pay back), we should not even consider bringing back CMBS.
W T F with 5%?
Why did Geithner come up with 5%? Why not 10%, 20%, 50%? How much equity is needed to keep all players’ interests aligned? The fact is the answer does not matter because the amount changes depending on the market. Today, you need 100% equity (or close to it). In 2007, you needed 0% (or close to it).
Standards and Transparency
While coming up with an equity/skin-in-the-game component is a fairly simple “tweak,” it does not represent the permanent reforms that are required. The keys are standards and transparency with all parties using common underwriting models.
I rant about this in one of my first blog postings which was a response to Ethan Penner’s article on this issue: Transparency vs. Skin.
The Proposal and the CMSA Response
Click here to download the Obama regulatory reform proposal.
Click here to download CMSA President Par Sargent’s response to the proposal.
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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.