RMBS Transparency

Summer goal: Consistent blog postings!

Having taken a bond analysis course this semester, I have been able to study the "technical" side of mortgage backed securities (MBS).

Residential MBS and Commercial MBS securities are inherently different loan types, as identified in their nonrecourse and recourse attributes, respectively. Residential loans in an RMBS pool share similar characteristics and metrics, such as consistent loan-to-value ratios and interest rates. However, commercial loans in a CMBS pool cannot be analyzed from an aggregated basis; instead, each loan's riskiness is based on its projected cash flows from an income producing property and subsequently discounted. In this situation, a loan-to-value ratio doesn't make much sense, so a case-by-case evaluation of each commercial loan based on geographical, industry, and seasonality factors help determine the loan's riskiness.

While there are many other differences between RMBS and CMBS, like the treatment of prepayments, the process in which underlying loans are analyzed remains an important distinction. So what's the problem here? Though CMBS are still relatively ambiguous instruments, RMBS are sometimes even less transparent. Investors only have credit ratings to follow to gauge a basic understanding of underlying collateral, sometimes without information regarding geographical dispersion of loans.

At the European Securitization Forum in Decemeber 2008, the group released a set of voluntary guidelines for RMBS issuers to follow. Inside the report (PDF) there is a list of several fields that the organization asks European investment banks to disclose at the security's pre and post issuance and on a regularly scheduled basis.

This specific loan-level information is vital and must be made accessible to individual and institutional investors of RMBS. For example, portfolio managers must be attentive to geographical loan characteristics due to potential differences in prepayment speeds -- a factor critical to RMBS performance. Therefore, the question arises: should investment banks (or credit rating agencies for that matter) post this information, in an organized, structured, and standardized fashion along side its ratings? Or is such a change negligible as the system possess much greater risks?