Wednesday, July 21, 2010

FINRA Press Release: Subprime Securitizations

FINRA Fines Deutsche Bank Securities $7.5 Million for Negligent Misrepresentations Related to Subprime Securitizations

The Financial Industry Regulatory Authority (FINRA) issued a press release today announcing that 
it has fined Deutsche Bank Securities Inc. $7.5 million for negligently misrepresenting delinquency data in connection with the issuance of subprime securities.
The settlement is detailed in the FINRA AWC No. 20080128087. According to FINRA, Deutsche Bank Securities underreported the percentage of mortgage delinquencies of 6 subprime residential mortgage backed securities in 2006. It also failed to correct such similar underreporting by a third party vendor in relation to 16 subprime residential mortgage backed securities in 2007. Further, it failed to provide proper supervision over how mortgage delinquencies are reported.

A mortgage backed security (MBS) is a debt security whose cash flows come from, and are backed by, the principal and interest payments of borrowers on the mortgage loans. The pooling of mortgages into a debt security is called securitization and is performed by a trust. Mortgages are originated by public and private agencies, they are then securitized into MBS by a trust, and then the MBS is issued to public investors by the trust. MBS carry a variety of risks for investors, such as interest rate and prepayment risk (when the borrowers refinance to a new mortgage) and credit risk (of the borrower). When mortgage delinquencies increase the credit risk of the MBS obviously increases, this explains why brokerages that sell MBS have an incentive to cover up delinquencies.

SLCG has written a paper describing the market and history of CMOs (a type of MBS) in the wake of the collapse of Brookstreet Securities and two Bear Stearns hedge funds which held CMOs and suffered huge losses. Investors can use our dedicated website for other papers and notes.

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