Miss-selling

09 Oct 2015 | Richard Kemmish


I am called literally at least twice a day by people trying to persuade me to sue my bank for miss-selling payment protection insurance. The fact that I have never bought payment protection insurance seems to be a minor detail that they can easily overlook. Annoying though they are, these people’s persistence is indicative of just how much money banks have had to provide for their retail product selling practices.

In a similar development, many government particular in central and eastern Europe are finally resolving the problem of the Swiss franc mortgages that many people took out. Usually in a way that is very expensive for the banks who happen to own them.

For covered bond holders this is not so much of a problem. Of course it is a negative that the issuer takes big losses, potentially it could even trigger a downgrade. But it seems implausible that it will actually trigger a default – no government, no matter how un-friendly to the banking system, would take action that could be seen to cause a major bank to default. Political suicide.
 
More importantly, that wonderful principle of a revolving asset pool means that as soon as losses are realised in association with an asset it must be replaced, or topped up by new assets for as long as the issuer remains solvent.

In short, the problem remains that of the bank accused of the miss-selling. Not the bondholders.

But what of securitisations?  Generally in the mortgage sale agreement between the bank and the securitisation SPV, the bank makes various representations about the mortgages sold. Including, either explicitly or implicitly that there was no miss-selling going on. Obviously at the time of sale the bank will have signed that agreement in good faith. What happens if a flaw is subsequently discovered? Or if subsequently occurs – for example due to the passing of a retroactive law?

I would genuinely like to know which of the two possible scenarios applies in the event of a miss-sold asset in the pool. Either, the SPV is due compensation from the bank under the mortgage sale agreement, or they aren’t.

In the former case, the bank may have transferred the credit and market risk associated with the mortgage but they have not transferred the risk associated with any future potential liability. As Commission focuses increasingly on consumer protection legislation, this becomes an ever more significant part of the risk inherent in the mortgage underwriting business. What is worse, it is systemic, not idiosyncratic. PPI and Swiss franc mortgages both demonstrate that we are looking at huge potential changes in the risk profile of an asset pool, not just one mortgage going bad.

In the latter case, of course the bank is fine. They have genuinely transferred this risk to the bond holders. But do rating agencies or bond holders ever attempt to quantify this risk? If not, why not? I don’t believe for a moment that Swiss francs and PPI are the last of these cases.


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