Location Location Location — Is Reg AB II Irrelevant

Privacy may no longer be realistic for mortgage borrowers.  This being the case, the new SEC rule-making with respect to Reg AB II, designed to balance considerations of transparency for RMBS investors with considerations of privacy for borrowers, may be a case of the generals fighting the last war.

Why do we say this?  The SEC took into consideration a variety of potential disclosure rules to mitigate the risk of “re-identification.” That is, the SEC wanted to make it difficult for anybody viewing the pool data in RMBS to reverse engineer (“re-identify”) who the exact borrower was in a pool. This could be possible by looking at loan amounts, borrow dates, geographic locations, credit scores, and other data points helpful to investors analyzing the pool. If re-identification is possible, then every home-owner runs the risk of having personal finances exposed to the public. We could, for example, figure out exactly who owns Frank Lloyd Wright’s iconic Fallingwater (pictured), how big a mortgage is on it, when the loan was taken, what the borrowers credit scores were, etc, and apply all of that information to our projected performance of the deal and its waterfall.

Different disclosure approaches were judged to have different “re-identification” risks associated with them. For example, using just location, sales price, and origination date with respect to MBSData, LLC databases, the SEC felt it would be possible to identify 76% of borrowers if a 5 digit zip code were disclosed. Using only 2 digits of the zip code would reduce the “uniqueness” of a particular borrower (and his identity disclosure risk) to just 20% of the pool. Using only origination date and sales price (with no location) would reduce the identified borrowers to just 2% of the pool. So, location, location, location.

Reg AB II went with a truncated 2-digit zip code. But technology may be making this all yesterday’s news. Some DealVector clients already believe they can reverse engineer pools to identify exact borrowers at an 85% rate, even before the Reg AB disclosures are made available. (Call us if you would like to speak with these wizards.) So it will be interesting to see if Reg AB II has any practical impact at all among elite practitioners in the RMBS space analyzing these pools.