SEC Requires Issuers of Asset Backed Securities to Disclose Repurchases. This is a good thing.

January 21, 2011

On January 20, 2011, the SEC finalized a rule that requires issuers of asset-backed securities to disclose repurchases.  What the heck does that mean?   Well, asset-backed securities are securities made up of pooled together mortgages, car loans, etc.  For instance, once you give a mortgage to your house, it is packaged with other mortgages into “securitizations” and then those securitizations are split up and sold as securities.  Part of the deal is that the issuer (or some other party to the deal)  has to buyback non-performing mortgages (depending on the deal, usually mortgages that haven’t been paid in 90-120 days).  Issuers (and other parties) weren’t doing that, and now they have to disclose whether or not they are repurchasing those loans.

It is more complicated than that, but the SEC does a good job of explaining it:

[I]in the underlying transaction agreements for an asset securitization, sponsors or originators typically make representations and warranties relating to the pool assets and their origination, including about the quality of the pool assets. For instance, in the case of residential mortgage-backed securities, one typical representation and warranty is that each of the loans has complied with applicable federal, state and local laws, including truth-in-lending, consumer credit protection, predatory and abusive laws and disclosure laws. Another representation that may be included is that no fraud has taken place in connection with the origination of the assets on the part of the originator or any party involved in the origination of the assets. Upon discovery that a pool asset does not comply with the representation or warranty, under transaction covenants, an obligated party, typically the sponsor, must repurchase the asset or substitute a different asset that complies with the representations and warranties for the non-compliant asset. The effectiveness of the contractual provisions related to representations and warranties has been questioned and lack of responsiveness by sponsors to potential breaches of the representations and warranties relating to the pool assets has been the subject of investor complaint.

Why we had the whole subprime debacle is that banks were filling these securitizations with mortgages that weren’t, and were never going to perform, i.e., people were not going to be able to pay their mortgages, and the mortgages that made up the securitization ended up being worthless, making the securities significantly decrease in value.   It is a small but valuable step for investors.  Assuming you read the disclosures.

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