By Katie Prideaux, analytics product specialist
There is consensus that unfair and predatory lending behaviors were a driving force behind the 2008 subprime mortgage crisis. And when these irresponsible lending practices came to light, so too did the importance of governance for securitized assets such as mortgage-backed securities (MBS). However, with the subprime crisis now 12 years behind us, governance around lending and servicing practices can still fall short, and irresponsible behaviors persist.
At Yield Book, we are developing an ESG taxonomy for securitized assets, focusing first on crucial areas within governance, namely responsible lending and servicing behaviors. This taxonomy enables quantitative measurement of lending practice responsibility, such that investors can fully understand the risks associated with securitized assets—and engage lenders and servicers to improve their governance.
The subprime crisis and the importance of governance
Governance is an important consideration when selecting MBS investments, and we’d be hard pressed to find a better illustrative example of this than the subprime crisis. The crisis left a staggering economic toll in its wake—$3.3 trillion was lost in home equity, and $6.9 trillion in shareholder wealth was effectively erased. And when the world looked to trace the crisis to its root causes, irresponsible lending and servicing practices were key among them.
Of course, predatory lending behaviors can only become widespread if the proper guardrails aren’t in place to prevent them. This was indeed the case in 2008, when the prevalence of irresponsible lending and servicing practices was exacerbated by lack of adequate regulation and governance.
Mortgages are a complicated product for the average borrower – and legislation to protect them allows many cases to fall through the cracks
The US has developed some regulations to prevent predatory lending since the crisis, but they’ve lacked the specificity to be entirely effective. To date, only 25 US states have since implemented anti-predatory lending laws—and some of these laws are limited in their efficacy, as they vary in strength.
In the absence of sufficient regulation to address them, irresponsible lending and servicing practices persist. This underscores the importance of understanding the related risks in MBS investments. But to begin to address MBS governance in Agency and non-Agency RMBS markets, we must first know how to measure it.
Yield Book’s securitized asset ESG taxonomy is designed to quantitatively assess lenders and servicers—and how fair and responsible they are in their practices. As shown below, we’ve identified several key metrics to gauge the extent of responsible lending and responsible servicing.
These metrics—described in more detail in our recent paper—are normalized and aggregated into both scores and rankings for pools, lenders, and servicers across Agency and non-Agency RMS. These figures enable investors to identify where to mitigate risk or engage lenders and servicers to promote better practices.
Still more lessons to be learned
The subprime crisis unfolded 12 years ago, but it’s clear that legislation and governance still hasn’t come far enough to adequately protect borrowers from predatory lending. This could become an even greater concern amid the current COVID-19 crisis, as once forbearance schemes are withdrawn, borrowers could become targets for predatory lending and servicing practices.
As such, it’s of heightened importance that investors are able to detect irresponsible lending and servicing behaviors. This is key to understanding the full dynamics of the securitized asset market, mitigating the associated risks, and identifying opportunities to promote more responsible practices through engagement.
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