The U.S. Treasury Department (the “Treasury”) views a healthy private label residential mortgage-backed securities (“PLS”) market as “an important component of a reformed, safe, and sustainable housing finance system that will complement the enactment of comprehensive housing finance reform legislation.”1 Fifteen years ago, the PLS market saw approximately US$240.6 billion in new issuance; by 2006, the market reached a peak of approximately US$1.01 trillion in new issuance.2 However, in the eight years since the height of the financial crisis the PLS market has experienced modest activity, with just US$13.7 billion of new issuance activity in 2015,3 while securitization products like commercial mortgage-backed securities, auto loan securitizations and other esoteric asset classes have enjoyed more robust recoveries.4 In the interest of spurring further growth in the PLS market, the Treasury formed the “PLS Initiative,” a forum comprised of institutional investors, issuers, servicers, ratings agencies, due diligence firms and other key stakeholders, to discuss current issues in the PLS market and ideas for responsible growth.5
For over eighteen months, the PLS Initiative worked on developing proposals to achieve its goals.6 One proposal receiving renewed attention is the addition of a “Deal Agent” to new issue PLS. The Deal Agent is an independent deal party with fiduciary duties to the securitization trust and certain oversight responsibilities.7 Some investors believe that the presence of a Deal Agent would address certain structural problems in legacy PLS deals and could help jump start the PLS market.8 Moody’s Investor Services recently weighed in, writing that “[t]he inclusion of an independent and competent deal agent in future residential mortgage-backed securities (RMBS) transactions would strengthen transaction governance, increase transparency and reduce the likelihood of certain tail risks.”9 Moody’s notes that a Deal Agent is likely to have a more significant positive impact on PLS deals backed by weaker collateral due to the increased importance of servicing oversight and loss mitigation on these transactions.10 This article discusses the proposed Deal Agent framework.
History of the Deal Agent Concept
In an effort to understand why the PLS market was not recovering at the same rate as other parts of the securitization market, in June 2014, the Treasury published a Request for Information in the Federal Register seeking public input on the challenges facing PLS.11 This request ultimately resulted in the PLS Initiative. Treasury was motivated, in part, by how important PLS deals have been to housing finance.12 The 2008 financial crisis exposed collateral and underwriting issues and design deficiencies in many PLS deals and the Treasury expressed the belief that the PLS market may only fully recover with the benefit of specific market-led innovations addressing these deficiencies.13 The meetings of the PLS Initiative focused on a number of potential structural problems impacting legacy PLS deals, including conflicts of interest, lax enforcement of representations and warranties, lack of transparency and minimal servicer oversight.14 The Deal Agent concept arose out of these meetings, as one initiative that proponents believe will help mitigate each of these problems.15
The Deal Agent Role
The main sources of information about the intended role of the Deal Agent are a Green Paper16 published as a result of the PLS Initiative and two short explanatory pieces released by members of the Deal Agent Subcommittee.17 In general, the Deal Agent would function like a board of directors over the securitization, subject to fiduciary duties of care and loyalty with broad discretion to take action over the trust, to ensure that parties are fulfilling their obligations and to report its findings to certificateholders.18
The most important aspect of the Deal Agent as proposed is that it would exercise certain control rights over a PLS transaction in accordance with a heightened duty of care and duty of loyalty to the certificateholders as a whole.19 The proposals suggest that the Deal Agent would have an obligation “not to place the interests of any class of certificates above those of any other class of certificates.”20 Deal documents would require that the Deal Agent act with “the care an ordinarily prudent person in a like position would exercise under similar circumstances to maximize the value of the Loans and any other Trust assets and to otherwise protect the interests of the Trust, as if it were acting on its own behalf.”21 Furthermore, the Deal Agent would be required “to act solely on behalf of the Trust without regard to its own self-interest, to exercise its judgment and discretion in a manner it reasonably believes to be in the best interests of the Trust and to avoid conflicts of interest and/or self-dealing.”22 Proponents believe that this fiduciary duty of care and loyalty imposed on the Deal Agent could eliminate certain conflicts of interests that have affected pre-crisis PLS deals.23 For example, in certain legacy PLS deals the parties responsible for identifying and enforcing representation and warranty breaches were often affiliated with the originator.24 Even if such conflicts do not result in improprieties, their mere existence may thwart investor interest in a PLS transaction.
Moody’s also views the Deal Agent’s continual fiduciary duties as a positive feature.25 The Deal Agent’s broad role and higher standard of care “could minimize certain transaction governance risks and put the deal agent in the position of a loyal, proactive advocate of the trust with some ‘skin in the game.” Moody’s points out that other deal parties, like servicers and trustees, act in a more limited capacity, meaning that their interests do not necessarily align with certificateholders.26 The standard of care for servicers typically requires that they operate in accordance with practices of other prudent servicers; servicers are usually not required to be free of conflicts of interest and are generally not responsible for the best interests of the trust as a whole.27 While trustees have limited duties to the securitization trust, PLS deals have not generally required trustees to proactively manage PLS deals or provide oversight of other transaction parties.28 In contrast, proponents note that the Deal Agent’s fiduciary standards “would mitigate risks owing to affiliations, self-dealing, and passivity.”29
Oversight and Enforcement
The proposals suggest that the Deal Agent would have certain specific oversight functions, the most important ones being reviewing compliance with asset-level representations and warranties and servicer oversight.30 Defined trigger events would obligate the Deal Agent to determine whether a review of compliance with loan-level representations and warranties is warranted.31 If breaches of representations and warranties are uncovered, the Deal Agent would be empowered to pursue remedies under the transaction documents. The Deal Agent would also be required to review servicer performance on a platform level basis.32 This review would focus on evaluating compliance by the servicer with the transaction documents rather than specific outcomes.33 If a servicer is found to have violated its obligations, the Deal Agent would be empowered to pursue a claim against the servicer or terminate the servicer altogether.34 Since the Deal Agent is intended to function in a manner similar to that of a board of directors, the Deal Agent would have great flexibility in exercising its oversight and enforcement functions to further the best interests of the trust.35
Ability to Deal with Unforeseen Consequences Efficiently
The Green Paper suggests that the Deal Agent could negotiate on behalf of all investors in case of unforeseen circumstances.36 Moody’s points out that this ability could mitigate some credit risk posed by new legislation or developments in the market.37 Existing PLS deals require the consent of a significant number of investors in order to execute amendments to trust documents.38 In practice, coordinating among the large number of parties required to give consent is often impractical. Proponents believe a single Deal Agent entrusted to act on behalf of the trust would be able overcome this obstacle while simultaneously looking out for the best interests of investors. The Green Paper indicates that the Deal Agent would have additional responsibilities with regard to defaulted loans, such as mitigating losses, modifying the waterfall, effecting charge-offs, final dispositions and loan sales, and managing REO properties.39 Moody’s believes that these capacities would likely be underutilized on transactions with pristine collateral.40 On transactions with weak collateral, however, such granular responsibilities could add value due in part to the heightened standard of care applicable to the Deal Agent.41
The Deal Agent would be required to report the results of its collateral and servicer reviews to certificateholders on a monthly basis.42 In addition, the Deal Agent could be required to account for any servicing decisions pertaining to loss mitigation, recoverability and advance reimbursement.43 The Deal Agent would also be empowered to review investor inquiries and perform appropriate analysis to address them.44 While a master servicer typically performs servicer oversight, it is not generally obligated to report its findings to investors. Proponents, therefore, believe the new level of reporting by a Deal Agent could significantly improve transparency.
Indemnification and Liability
A Deal Agent would be protected from liability, either through indemnification by the securitization trust or through an alternative means agreed to by the parties, so long as it acted in accordance with its duties of care and loyalty.45 Certificateholders would be able to sue and remove the Deal Agent if it failed to act in accordance with its duties of care and loyalty.46 The Deal Agent would be liable for gross negligence or willful misconduct, and would be expected to comply with all privacy laws relating to non-public personal consumer information.47 The Deal Agent framework would be enforced through arbitration whenever possible to reduce legal costs to the securitization trusts and the Deal Agent.48
As proposed by the PLS Initiative, the Deal Agent would be a comprehensive role with significant responsibilities to investors in PLS transactions. The recent thumbs up from Moody’s adds credibility to the proposal. However, only time will tell whether, or how, the Deal Agent is implemented into new deals and whether the Deal Agent is the catalyst needed to promote the growth of the PLS market.