What will happen to the rating agencies?

A major section of the Todd-Frank legislation is dedicated to the reform of the credit rating agencies.  Much of the momentum behind the drive to highlight this action as one of the major fixes to the US securities markets came from the obvious failures of Standard & Poor’s, Moody’s and Fitch Ratings in their ratings and surveillance of structured debt over the past decade.

The Todd-Frank bill provides for several areas of reform most of which are probably good ideas whose time had come. 

However, there is one section of the bill which has many industry experts very concerned.  That would be the section that eliminates statutory requirements for credit ratings in determining the eligibility of a security for certain investors.  These statutes may have applied to public pension funds and other similarly regulated investors.  Many felt that these statutes created a virtual oligopoly for the credit rating agencies or NRSRO’s, as they are known in the trade, essentially forcing issuers into securing a rating for their securities programs and generating fees for the rating agencies.

The hope of the new legislation is that issuers will now be less inclined to seek ratings for all their programs, as investors are “encouraged” to complete their own analysis of their investments both before they buy and while they own a security.  Some market analysts are predicting severe consequences for certain markets, particularly for securitization.

We don’t see it that way.

What we suspect will actually occur over the next several years is that the rating agencies will slowly rebuild their reputations and investors, possessing neither the time nor the resources, will once again lean heavily on credit ratings when making investment decisions.  They will recognize that the rating agencies are, in fact, experts in this area and are far better equipped to conduct the analysis across a broad array of security types, asset classes and individual issuers than any single investor might hope to be on its own.

This “investor demand”  for credit ratings will drive issuers to return to the credit rating agencies for all but the most exceptional cases.  While it may take some time, we believe the end result is inevitable.

Academics won’t heal securitization

The FDIC and the Federal Reserve are hosting a little symposium in Arlington these past two days to discuss the future of the housing finance industry in the US.  If you were lucky enough to catch the remarks of Sheila Bair, Chairman of the FDIC, you pretty much got the gist of the general tone at the event.

The panels for the various topics are stocked with academics and government officials, each with a list of mostly vague views of what caused the mortgage crisis and how to fix it.  It is noteworthy to us that such a public examination of potential fixes for the markets did not include any signficant representation from either the mortgage industry or the securitization industry (bankers, issuers or investors) yet each panel felt very comfortable voicing opinions about what these industries need to do to fix their problems.  Maybe it’s us but the lack of participation by these industries in an event like this seems rather telling.

Let’s pick one recurring theme in yesterday’s discussions.  Several panelists indicated that the return of  mortage-backed securitization  will be central to the return to health of the mortgage industry.  Nevertheless, several indicated that the securitization market could not continue to exist in its pre-existing form (i.e. its puts too much risk on the American taxpayer).  There was talk about the need to shore up taxpayer liability, about how issuers would have to undertake a whole series of remedies from enhanced disclosure to assuming more vertical risk.  Investors will have to live without government guarantees and understand safe harbor rules.  Once again maybe it’s us but this “new securitization world” that these experts have dreamt up doesn’t sound like it will be very appealing to either issuers or investors. 

Do these folks get it?  If you tell people that they need to scale a 20 foot wall to buy oranges and once they get over that wall there’s no guarantee that those oranges (that they bought) will be theirs to keep, then I think any logical person might say, people will stop buying oranges; except one at a time and only if that’s all that is available to eat.

To make matters worse, Chairman Bair, in her remarks, offered no comfort to investors that the resolution of investor rights for existing rmbs product will be resolved any time soon.  Can these folks not see the connection between a weak or non-resolution to existing market issues and the debilitating effect on the reemergence of a market for new securitization product?

The best these experts can say is that they are continuing to “discuss” and to “analyze” .  All fine and good.  Just don’t hold your breath waiting for investor enthusiasm to return until some real and “transparent” resolutions for investor rights are in place.

Investors Revolt!

Maybe too strong a statement to call it a revolt but it was refreshing to see the results of the recent Keefe, Bruyette and Woods survey of the large institutional investor community about their view of the Financial Accounting Standards Board’s (FASB) Fair Value Accounting rules.

For those of us that have been following the conga line of “improvements” to balance sheet accounting and securitization, the news that fully two-thirds of those surveyed are either strongly or very opposed to the FASB recommendation is a breath of fresh air.  You heard that right; 66% opposed!

So what do we have here?  Is this a case of the poor investors simply not understanding what’s best for them? 

We don’t think so; not by a mile.

What we do have is a perfect example of one the primary faults of arm-chair quarterbacking.  Unless you’ve played the game, it can be hard to understand what the players want.  In this case, the tower that FASB sits in is clearly far removed from where their constituents toil and, on face, it would appear that the Board never really considered just how pervasive objections to these new rules are in the investor community.  Certainly, the FASB cannot deny that these objections were and have been raised at many points in time throughout the discussion of the need to revise the valuation rules.

The Keefe study (co-sponsored by Greenwich Associates) focused on investors in the bank loan market.  Their primary objections to the new standards lie in a lack of faith in mark-to-market valuations and the impact on both their own investment activities and the cyclical impact on values due to fluctuations in bank earnings and the US economy.

So, here you have the exact constituents for whom the new rules are written, saying that they don’t want the new rules, that it won’t help them and, in fact, it may hurt them.

We can only hope that, this time, maybe someone is listening.

Is Student Loan ABS really making a comeback?

Total Securitization ran an article last week citing some renewed optimism from several bankers, traders and issuers in the student loan abs market.  The remarks were gathered at the recent ABS East Conference held in Miami and those interviewed noted a year-over-year improvement in issuance levels with the prospect of nearly $50 billion in the issuance pipeline.

Does anyone really believe this?  Only $15 Billion has been issued through the conference dates in October.  Let’s allow for some optimism and suggest that the market might reach $25 Billion in new issuance by year-end.  Our analysis is no more scientific than the $50 Billion projected in the article; perhaps just a bit more realistic with less than 3 months to go in 2010.

The optimism and enthusiasm expressed by these industry participants probably does more harm than good.  One industry source in the article did key in on the “handicap” the industry has faced over the last several years, dating back even before the 2007 meltdown from the aggressive “regulatorization” of the private market, that shows no signs of letting up.

What these rosy commentaries do create, however, is a perception among regulators and law makers that the remedies and restrictions they have prescribed are “just the right amount”.  We are guessing that most abs bankers, issuers and investors, when asked to be totally honest, would not project anything less than a minimal recovery in the markets for the next several years.

While we understand that it may be easier on the ego to sound optimistic, we are left wondering if a little more honesty wouldn’t speed up a realistic assessment of the new rules and regulations in search of a more reasonable environment for the private student loan market and the return of securitization in this asset class as an attractive method for joining issuers and investors.

National Credit Union Administration EASILY launches $3.85B Securitization; more to come

With a little bit a fanfare, the National Credit Union Administration, together with Barclays Capital, yesterday announced the pending sale of a nearly US$4 Billion securitization of mortgage loans, which are part of nearly US$50 Billion in loans and securities that the agency has assumed since April of this year, in connection with its rescue of failed US credit unions.

The issue represents just the first of 8-10 issues the NCUA plans to launch over the next several months as it disposes of what it now projects to be 98% of the problem assets formerly held by credit unions under its jurisdiction.

So you might say, great but what’s the news here?

We just wanted to point out that even though these are distressed loans, the speed with which this structure has been placed (a matter of weeks) is pretty remarkable.  The backing of the “full faith and credit of the US Gov’t” is undoubtedly a significant factor in the expectation that these notes will be gobbled up by investors.  However, let’s keep in mind that the structure is a “securitization” and the structuring features are none other than those tried and tested methods that have been used to great success for more than 20 years.  No real innovation here!

In fact, that’s just our point!  Investors will easily understand what to expect from these securities, including what happens if something goes wrong.  Wouldn’t it be novel if issuers and investors in the private asset-backed and mortgage-backed markets had as much “faith” for their respective obligations and rights in their “non-government” market!

Of course, government officials at the NCUA, FDIC and other agencies are too busy patting themselves on the back to notice that they are using the same structuring technologies that they are essentially shutting off in the private markets by instilling little to no confidence in either issuers or investors that the quagmire of new laws and regulations they have mandated to “fix” securitization will #1 work and #2 not continue to shift under their feet.

Does Sheila Really Understand?

It is hard to fathom how Sheila Bair, the chairman of the FDIC, can continue to misunderstand how the securitization markets have worked for the past 30 years.

The latest example involves some of her comments this week related to the newest industry snafu in connection with the processing (or shall we say “mis-processing”) of mortgage foreclosures for residential properties in the US market.  Clearly, if it turns out that there was rampant levels of “corner cutting” going on by either the lenders themselves (through their mortgage servicing arms) or by hired sub-contractors, then we will have yet another black eye for the industry to overcome on this bumpy road to recovery.

What amazes us is that Sheila appears to blame the actions of  mortgage servicers (i.e. the motivation to pursue foreclosures at the expense of loan modifications) on securitization and the motivation to take care of the bond investors first.  What she doesn’t seem to understand is that it is not the bondholders that the issuer/servicer is looking to protect; it is the “funding source” or “capital source” that the issuer is trying to protect.  If the mortgage lender does not protect its access to additional funding/capital it will not be able to sell more loans.  If it can’t sell more loans, it will have to find alternative sources of funding or face going out of business.  The reason that financing companies (both independents and subsidiaries of financial services companies like banks and insurance co’s) have utilized the capital markets through securitization and securitization structures is that it has represented the most economical feasible method for raising capital and, thereby, growing their businesses.  Take this source away and firms will have to look to more expensive funding sources.  In the case of independent companies, such other sources may not exist.

It may sound cruel but the motivation for survival of the company and its sources of capital far outweigh the motivation to help a single borrower or even a thousand borrowers through a loan modification process.

We also  find it strikingly incoherent that Ms Bair seems to believe that the obligation for a servicer to make advances on late p&i payments to bondholders demonstrates why the economics of securitization and the role of the servicer need to be revised.  She cites the ability of servicers to recover foreclosure related expenses and the obligation to make “servicer advances” on late paying loans as a negative incentive to seeking loan modifications.  Does she not understand that:

1- Even under the most extreme conditions the servicer’s obligation to make advances is not open-ended.  The servicer must exercise commercially reasonable judgment and, under the currently extreme market conditions, this might involve many months of advances.  However, in almost all structures, servicer advances are “first in line”  for recovery from the collateral pool.  Even in cases where the collateral loses half its value, the cushion is substantial  for a pool of assets with a 10-20 year cash flow.  So, we don’t buy it, even for second, that the servicer advance mechanism is a dominating motivation to foreclose.

2- No entity should know more about the value and potential for the underlying assets than the issuer/servicer.  In many or most cases, the servicer also originated the loan and if not has, at minimum, been servicing the property for sometime and should be familiar with the property, activity and market values in the local market and something about the financial condition of the borrower.  That is why the servicer is in the best position to “smooth out” cash flow streams that might be due to bondholders and that is precisely why the servicer advance function was developed.  In other words, in a well-functioning market, servicers are more than willing to finance these advances (for an above market return) because they have maximum knowledge and comfort with the underlying assets.  This in turn allows them to attract more investors or “sources of capital” to their financing activities.  Servicers were not “saddled” with this obligation.  They were/are happy to take it on.  One cannot use the “perfect storm” conditions of the past 3 years as an argument for bad economics leading to  mis-aligned motivations for servicers and the securitization structures that they have utilized to finance their activities.  Her logic just doesn’t work. 

In fact, we would argue just the opposite.  If the underlying value for a given asset/property has dropped so precipitously that the servicer no longer has confidence in that asset to produce enough value to cover its advances within a commercially reasonable period of time then that loan property should be foreclosed.  The motivation for a servicer to do so is EXACTLY the same as any lender should have.  In the case of an unsecuritzed loan, the lender would be protecting the interests of its shareholders and depositors.  In the case of a securitized loan the lender/servicer would be protecting the interests of its creditors (bondholders).  In both cases, sound business judgement should apply; not political wisdom.

TARP needs a publicity agent

If the US Treasury is even close to their projections that, at the end of the day, the TARP bailout will cost US taxpayers no more than $50 Billion and actually might turn a profit, how can we view this program as anything less than a resounding success?

TARP’s paramount objective was to stabilize the US financial services industry and by extension, the global markets.  Yes, there were many other items on the wish list of objectives for the program but stabilizing the markets was by far the 800 pound gorilla of the program’s objectives.  Even the severest critics of the program have to admit that this objective was met and perhaps, even exceeded (i.e. saved some companies that might not have needed saving).

Yet despite all this positive vibe coming out of the program and the results tallied by the Treasury this week, the general consensus in the media and academic circles is that TARP was/is a failure. 

Certainly, one can understand the general public’s conjugation of the word TARP to include solving everything from job creation to healthcare, as the word TARP has come to symbolize the failure of government to address these more “localized” symptoms of the Great Recession.  However, for folks who should perhaps know better, the easy path has been to simply avoid making a distinction between TARP and other policies and programs.

The fact of the matter is that the long debated healthcare legislation and the recently passed Todd-Frank financial services reform legislation have much more to do with the affairs and the relative improvement of the lot of the average US citizen, as we recover from this mess of historical proportion.

Makes one think that, if TARP were an actual person (let’s call him Tom TARP), and he was looking for some advice, I might suggest that he spend some of that profit the program might generate to hire a good public relations firm and get the “real story” out there.

If it wasn’t such a serious topic it might be humorous to reflect on the “Mother of All Bailouts”, the Resolution Trust Corporation,  and how that, purportedly, very successful bailout of the US Savings and Loan Industry cost US taxpayers approximately $160 Billion.  Compare that ‘conventional wisdom” against the current TARP cost estimates of no more than $50 Billion (and possibly a profit) and the relative size and scale of the two events and TARP is a clear winner; a first round knockout!

Maybe Mr. Giethner should convene a séance to call back the ghost of Bill Seidman to serve as his chief spokesman.  Now there was a guy who could sell a bailout program!   While he’s at it, maybe Bill could help “Steve Securitization” with his image too!