Will FDIC’s “Clarification” of Safe Harbor Rules Make a Difference

Earlier this month, the FDIC provided the American Securitization Forum a formal response to the ASF’s  interpretive request from August 2011 in connection with the FDIC’s final “Securitization Rules” published in September 2011.

The lack of clarity for how securitizations issued by “Insured Deposit Institutions” will be treated in cases of FDIC conservatorship or receivership has been vexing the structured finance markets since the beginning of the credit crisis.

On February 7th, the FDIC provided clarification to several key provisions or standards in the Securitization Rules; Disclosure, Servicer Best Practices, Reserve Funds for Repurchases, Underwriting of Obligations, Six Credit Tranched Limitation and Limitations on Advancing.

The basic premise is that the FDIC will agree not to utilize its powers to seize assets that have been pledged to a securitization issued by an insured institution, if the issuer can demonstrate that they have met each of the standards in the Securitization Rules, including the six  mentioned above.

Prior to the credit  crisis, most investors took for granted that assets pledged to an off balance sheet financing would be treated separately by the FDIC in cases of receivership or conservatorship.  However over the last several years, in word and some cases in deed, this “conventional wisdom” was challenged by the FDIC.  New powers granted to the agency under Dodd-Frank and the general climate for more aggressive interpretation of existing powers created increasingly higher levels of uncertainty among investors about their abilities to exert a lien on collateral which they believed was theirs.  This uncertainty has had a significantly detremental effect on the recovery of several key securitization markets, most notably RMBS.

We hope that these clarifications have the desired effect and they help investors to return to the market but we are not sure we are there just yet.  While these clarifications seem to close some gaps, it seems to us that the rules still leave too much room for interpretation.  Something more along the lines of a “firm policy statement” from the FDIC as to their projected treatment of securitizations against which these individual rules could be applied would be a bigger step in the right direction.

Banks May Be Telegraphing Return to ABS Investing

Over the past ten days, there have been several articles indicating that leading banks are increasing their tolerance for risk and are returning to both asset-backed securities and high yield bonds in search of increased performance in their investment portfolios. 

We highlight the word tolerance mostly as a means of signaling that we do not mean tolerance for risk in the classic sense but rather in the context of tolerance for “headline risk”.  The movement to conservative investment principles, on so many different levels over the past several years, is almost unprecedented.  However, as with any downturn and contraction in risk taking that we have been through before, when the market does start to come out of it, the reason is usually groups of investors attempting to outperform their competition and the pressure to keep up with competitors tends to feed off itself.

Last week, the Financial Times ran a piece on the growing number of banks that are returning to investing in “bundled mortgage” products, mostly in the form of CMO’s backed by GSE securities.  While the trend is still small and the number of banks involved is similarly small, we would project that this trend will grow and will likely expand to “non-managed” bundled programs which include private mortgage securities.  We’re not so bold as to predict that the return of CDO’s is around the corner but we remain bullish on the return of at least a segment of the “managed” market over time.

This week has illuminated the return of the high yield bond markets with the announcement of three flagship transactions by Caesars Entertainment, Realology and Energy Future Holdings totaling nearly US$3B.  This could breathe new life into the high yield markets as banks may lead the way in the charge to improve overall portfolio performance.  If this recent activity does turn into a trend, as many expect it will, this will likely have a very positive impact on the CLO market.  We believe it will begin to loosen up what has, up until now, been a relatively small group of institutional investors that have shown a willingness to get back into high yield, either directly or via a CLO structure.

In both cases, the return of more investors to the market will increase the confidence of still other investors and so on and so on…….

Market signals like these are a long time coming for structured finance and there can be any number of false starts along the way.  Nevertheless, we’ll take this double dose of good news as a positive sign that the securitization markets are on the road to recovery.

Healthly Optimism Coming Out of ASF Conference

 This past week found 5,000 beleaguered industry professionals returning to Las Vegas for the first time since the credit crisis for their annual conference.  The decision by the American Securitization Forum to return to Las Vegas was, in its own right, a strong signal to both issuers and investors that the industry is ready to get back to work.

Clearly, there is still so much lack of clarity in the critical area of regulation both in the US and the EU markets but we walked away with the distinct impression that folks are tired of waiting for the regulators to figure things out and they are taking faith that the integrity of their structures and their investing decisions in these critical investment markets will ultimately stand the test of time and regulation.

Some of that confidence seems to be spawned from  the steady trickle of good or better news from US and EU governing and regulatory bodies about how Dodd Frank and other key “crisis era” legislation may be tweaked to restore investor confidence and reasonable economics for issuers.  In other cases, it is clear that investors are looking for better yield opportunities than they can find in other markets and there is growing sentiment that securitization may represent the best opportunities for yield while managing risk.  This last part may sound counterintuitive to casual followers of the industry over the past few years but we view it as a fact that many within the industry have always known.

We observed that many bankers and advisors are scratching away at the edges of the industry trying to revive structures in more of the emerging asset classes, where they have to work harder and longer but the level of commitment is admirable and confidence levels are growing.

Excellent move by Tom Deutsch and his colleagues at ASF to return to Las Vegas; perhaps just the tonic the industry needed after 5 years on the ropes.

EU May Allow Banks to Count ABS Towards Liquidity Rules

Potentially important news out of Denmark this past week as a draft of a new law which  would allow European Banks to utilize ABS holdings to meet new liquidity rules will be considered by the European Union in the coming weeks.

The draft which was apparently first released on January 9th by Denmark, which currently holds the EU Presidency, would require the European Banking Authority to allow member banks to count “asset-backed securities of  high credit quality and liquidity” against the “liquidity coverage ratio” as prescribed by Basel III.  Asset-backed securities are currently not eligible under the Basel III rules.

No matter how you slice it, this has the potential to be a very significant development; one that could have a significant impact on the return of  European banks as investors in Euro-originated ABS as well as US and Asian originated ABS. 

While the end result may only open the door to very safe and perhaps very “plain vanilla” structures, nevertheless,  in a yield hungry investor community, the opening of the door to ABS for European bank balance sheets has many, many positive implications.  

In order for the proposal to become law it will have to be approved by each of the governments in the 27 nation European Union and the European Parliament.  The sooner, the better.

MERS Scores Big Victory from Courts

Score one for “sanity” this week as the 10th Circuit Court of Appeals upheld rulings from three lower courts that MERS, the beleaguered electronic mortgage registry, does in fact have the right to foreclose on properties assigned through the securitization process.

Over the past several years, any number of consumer advocates, including elected officials and other public watchdogs, have painted MERS as a master of evil, contrived by unscrupulous bankers, all for the purpose of stealing homes from underneath poor and innocent consumers. 

We have noted at several times along the way that most of these advocates of course took advantage of the electronic media to reach their constituents and other fans as efficiently as possible while ignoring the fact that the purpose of MERS was essentially to do the same thing for the historically arcane world of mortgage origination, filing and recording by placing these “securities” into a highly efficient and cost-effective data repository.

The arguments against MERS were wrong-headed then and they continue to be in many corners of the court of public opinion.  Nevertheless, as more time elapses from the hysteria associated with the sub-prime mortgage mess, slowly but surely, sounder heads seem to be prevailing.

Good for MERS and good for all those borrowers and their advocates who never understood a good thing when they saw it!  Banks and other lenders cannot generate more mortgages unless they have an efficient market for selling a portion of their loans to secondary investors.  MERS is a key ingredient to that process and one that cannot be restored to the public confidence soon enough in our opinion.

Swiss Re and Credit Agricole Launch First Canadian Life Insurance Backed Securitization

This week brought the announcement that Aurigen Capital Limited, a Toronto-based reinsurer had launched the first ever securitization structured around the embedded value of Canadian life insurance polices.

Credit Agricole Securities and Swiss Re Capital Markets co-managed the placement of the CAD120mm six year notes which were sold under Rule 144-A to a limited number of holders.  Standard & Poor’s rated the notes BBB+.

Despite the broad brushing of the life insurance securitization by several global regulators as an asset class that investors should stay away from, apparently there is a creeping demand for the stuff.  Aurigen Reinsurance issued the notes through a Bermuda special purpose entity named Vecta I Ltd.

Garrett Bill to Aid Private MBS Moves Ahead

Good news yesterday for the private MBS market as Representative Scott Garrett’s Private Mortgage Market Investment Act was passed by the House Financial Services Subcommittee on Capital Markets Insurance, and Government Sponsored Enterprises.

This bill would authorize the Federal Housing Finance Agency to develop standards for mortgage products, repeals the Dodd-Frank Act’s risk retention rule, increases the quality of loan level information and disclosures for investors, removes conflicts of interest between servicers and investors, and prevents regulators from unilaterally forcing investors to reduce the principal of loans in which they have invested.

The closeness of the vote by the subcommittee (18-15) may hide the fact that apparently many legislators on both sides of the aisle agreed on many of the proposed elements.  The biggest bone of contention seems to have been the repeal of the risk retention or so-called skin-in-the-game provision legislated by the Dodd-Frank law.  This publication is already on the record for taking a stand against this arbitrary and totally unnecessary provision and how it probably hurts more than it helps the securitization market for residential mortgages, as well as other asset classes.

The next step for the Garrett bill is the full House Financial Services Committee although, as of today,  no hearing dates have been scheduled.

This is a great leap forward for the restoration of some sanity to the securitization markets.  Hopefully, momentum will continue to build.

Can the “TBA” Market Save MBS Trading?

Much discussion in recent weeks about the importance of the “TBA Market” to a healthy secondary market for mortgage-backed securities.

The TBA (“to be announced”) market, essentially, allows buyers and sellers to set pricing, maturity, coupon, principal, etc without actually specifying the individual securities that will be delivered to a buyer on the settlement date.  It provides a tremendous level of liquidity to this historically very active marketplace.

With the possible demise of the GSE’s on the horizon, the cultivation of a healthy TBA market for the non-agency or private mortgage-backed bond markets will likely be essential.

Earlier this month, the National Housing Conference, a gathering of  the US mortgage industry’s most important movers and shakers was convened in Washington, D.C. and the TBA market was a hot topic.  There seems to be a near complete consensus among bankers, investors and even government officials that the TBA market needs to be protected.

Similarly, it would appear that TBA will be a central topic at the American Securitization Forum’s Annual Conference Las Vegas next January. 

We would prefer that the long-term US strategy include the GSE’s in their historic (if more closely regulated) position as the “lead market-maker” for the US mortgage markets.  However, we also acknowledge that the political winds remain strongly in the face of such a development.  The TBA market may represent more than just a hedge to ensure that the US mortgage market returns to a more historically attractive level of liquidity.  Without it, any hope for a sustainable long-term recovery of the structured finance markets is probably dim.

US Congress Takes Another Run at Covered Bond Legislation

A bipartisan group of US Senators yesterday submitted legislation which is aimed at finally getting a U.S. Covered Bond market off the ground.

Senators Kay Hagan (D-N.C.), Bob Corker (R-Tenn.), Chuck Schumer (D-N.Y.) and Mike Crapo (R-Idaho) introduced the United States Covered Bond Act of 2011 which contains many of the same provisions included in a House bill which was sponsored by Representatives Scott Garrett (R-N.J.) and Carolyn Maloney (D-N.Y.).

While we have stressed in the past that the establishment of a clear framework for a U.S. Covered Bond market is important, it should not be viewed as a panacea.  Under the best of circumstances, we would view a vibrant Covered Bond market to be simply one complimentary component to a healthy structured finance marketplace.

Certainly, banks and other originators of mortgages and other related assets will appreciate the additional and potentially more efficient funding option that covered bonds could represent for their funding strategies.  However, the fact that these assets will remain on the balance sheet and therefore will need to remain “capitalized” on the balance sheet, most  likely makes the option signficantly less attractive than a pure securitization structure.

Nevertheless, we view this as another positive, if small, step in the right direction to resurrecting a structured finance market in the U.S.

Assuming that the Senate and the House come together to pass a bill, keep in mind that there will still be one very significant hurdle to be overcome.  The FDIC continues to drag its feet on clarifying their position related to investors rights under an issuer insolvency scenario.  So long as they refuse to make it crystal clear that they will not violate the “safe harbor” expectations of covered bond investors, this market will not gain much traction in the US, regardless of whether the proposed legislation is passed by Congress.

MSR Market is Building: Signs of Basel III Impact Have Begun

It looks like we may have been right on the money about the “motivations” of traditional mortgage originators to sell mortgage servicing rights (“MSR’s”) in the “Basel III” regulatory environment.

Some of our readers may recall that back in February of 2011, we wrote a piece related to the negative impact of Basel III regulations on the value of holding MSR’s by large US banks, particularly those engaged in the RMBS markets (both through the GSE’s and for their own private conduits).  No longer would these banks be able to utilize the value of these MSR’s as an offset to their regulatory capital requirements, a distinct benefit under the existing rules.

First, here is a reprint of our earlier article.

Feeling the Impact of Basel III on Private Securitization Activity

February 4, 2011 by markferraris

It’s been a few months since the final Basel III Framework was endorsed by the G-20, complete with its revised “phase-in schedule” of changes to new capital ratios for both Common Equity Capital and Tier 1 Capital for banks. 

Many securitization industry followers may recall that back in July and August of 2010, there was much discussion about the provision in Basel III which would signficantly reduce the “credit” that banks would receive when applying Mortgage Servicing Rights (“MSR’s”) towards their Tier 1 Capital requirements.

Banks have traditionally been able to apply 100% of the value of MSR’s to their Tier 1 ratios.  Under Basel III, banks may only be able to apply a portion of their MSR’s to their Tier 1 requirements.  Under the new rules, MSR’s and other related classes of assets may only make up 15% of a bank’s Tier 1 capital requirement.  This has led many industry professionals to predict a significant contraction in the size of the private mortgage-backed business, even after the recovery of the markets from the recent credit crisis.

Most of the logic lies in the fact that many banks, both large and small, that have run active mortgage businesses and especially those that have run private RMBS programs, will now view the overall economics of the mortgage business in a very different light.  The Tier 1 credit that MSR’s have traditionally generated for these institutions has been one more ancillary benefit to those organizations; certainly one that “doing without” may discourage banks from being as committed to the mortgage business.

Some have gone further and stated that the reduced MSR benefit may drive pricing up for borrowers, as there will be fewer banks competing for these loans.  We’re not prepared to jump on that wagon, just yet, but it does sound like the argument may have some merit.

It will be interesting to see how the banks react to these new requirements, this year and next.  Basel III does provide the banks with a “phased-in” approach to this reduction in benefits for MSR’s, beginning with a 20% reduction in 2014, 40% in 2015, 60% in 2016, 80% in 2017 and, finally the full reduction to a 15% credit towards Tier 1 in 2018. 

If some of these predictions are correct, then we would believe that the banks would already be starting to make  some adjustments in their mortgage businesses.  Certainly, from a reporting perspective, 2013 will be here faster than you think.

There is another school of thought that suggests that private market securitization activity will not be reduced, as a result of the Basel III MSR rule.  Rather, it has been suggested that the there will be a significant expansion of the REIT industry and the buying and selling of MSR’s in the private market, as banks calibrate and re-calibrate their balance sheets each quarter.  In other words, perhaps the banks will get comfortable with the notion that they may not be able to retain all the benefits that “retained servicing” has provided over the years but that they can keep a significant slice of it in the form attractive re-sale values in a more fluid secondary market.

Next week, the securitization industry will be gathering in Orlando, FL for the American Securitization Forum’s Annual Conference.  The agenda is stockpiled with panels discussing a variety of new regulatory changes and polices.  Perhaps the impact of Basel III on the private mortgage-backed industry will get some air time.

END

 Back in February, we predicted that the big mortgage lenders would begin to develop strategies aimed at offloading at least a percentage of their MSR’s as a result of this reduced benefit to their Tier 1 capital ratios.  Little did we know that the biggest cow in the yard would get started so soon and in such a big way.

 

Last week, there was news in the markets that Bank of America was close to completing the sale of $50Billion in Freddie Mac MSR’s to an undisclosed buyer.  This is on top of another $70Billion that BoA sold in a hush-hush trade apparently completed in August 2011.

 

Now, granted both trades apparently involve legacy Countrywide Mortgage portfolios and who wouldn’t want to create as much space between your company and the old Countrywide, if you were current BoA management.  Nevertheless, just 3 or 4 years ago, these MSR’s would likely have been touted as a windfall benefit for BoA in the Countrywide transaction.

 

BoA is almost universally viewed as in an “asset sale mode” and clearly, if they can get a good price for their MSR’s this is a good way to raise capital to address a portion of their short-term needs.  However, over the longer term, we do not see this as a positive trend and if we are correct, the loss of the “regulatory capital benefit” associated with MSR’s cannot  be good news for the recovery of the RMBS markets in the US.