Hiring Strengthens in US Securitization Market

If the first month of 2011 is any indication of prevailing sentiment, then we should see many firms re-stocking their stalled securitization units over the next several months.  Seemingly attempting to get ahead of the curve for a resurgence in new issuance activity, several US banks and law firms have been making strategic hires.

Some of the action for this past month includes:

* Key Bank has restarted their CMBS program with several new hires planned over the coming weeks, including Randy Martin who joined the Chicago office last month from Charlotte-based Grandbridge Real Estate Capital.  Martin reports to Dan Baker, who heads up the CMBS group for Key.

* Chapman & Cutler hired James Croke and Peter Manbeck away from Orrick Herrington to bolster the firm’s New York-based securitization practice group; a sign that the firm may expect a revival of the asset-backed commercial paper market.

* Cadwalader, Wickersham & Taft added CLO specialist Joseph Beach to their Charlotte securitization team from Dechert, in an apparent attempt to tap into the revival of the syndicated loan market and the positive impact this activity is expected to have for new CLO issuance.

* Sidley Austin added Kevin Blauch as a partner to its New York based securitization practice group, where he will bring a substantial background in CMBS to the Sidley team.

Perhaps this activity bodes well for the many securitization professionals who will be gathering in Orlando next week for the American Securitization Forum’s annual conference; many, no doubt, with CV in hand.


FASB Rolling Back Fair Value Accounting

Good news this week that the Financial Accounting Standards Board (“FASB”) has finally acknowledged what so many in the industry have been saying for years.  The relatively recent rule that forced banks and other financial institutions to account for “all” assets at Fair Market Value or to “Mark-to-Market”, as it commonly called, just doesn’t make sense.

At the Board’s meeting on January 25th, one of the central topics of conversation was the accumulating evidence that both the companies holding these assets AND the very investors that the rule was supposed to “protect” both think that forcing these companies to assign a current market price is not consistent with their  business model, does little to help investors understand the value of these companies and very likely was a major contributor to the financial crisis.

For months and months, the banks held onto loan positions, despite the draconian write-down rules that the Fair Value standards placed on them, simply because everything they had been taught and everything they had learned over the years told them that these assets were actually much more valuable than market prices in 2007, 2008 and 2009. As it turns out, the banks were right, as market values did ultimately recover.  Many of these banks have been rewarded for holding out.   However, this was not before way too much “unnecessary pain” was inflicted on these companies and their shareholders.  Tough lesson, no doubt. 

The decision to consider the business model for the entity carrying the asset (e.g. bank vs. broker dealer) as an important component of the overall analysis is a significant step backwards from FASB’s previous “one size fits all” position.  Good for FASB and good for the market! 

From the FASB news release…… “The Board decided that a business activity approach should be used and that financial assets that an entity manages for the collection of contractual cash flows through a lending or customer financing activity should be measured at amortized cost.”

We’ll wait to see exactly how expansive the definition for “lending and customer financing activity” becomes.  We, for one, would hope that for assets held and managed away from the trading floor, the banks be given as wide a berth as possible, in this area.

New SEC Rule 193 Adds Muscle to Issuer Disclosure Process

Another important ruling by the SEC this past week should significantly tighten up issuer disclosure related to the review of asset pools pledged to new securitizations.

A particularly sticky wicket in the unraveling of what might have gone wrong along the path to placing so many “toxic” assets in sub-prime mortgage and other asset-backed structures has been the inability to pin the responsibility for shoddy due diligence or portfolio reviews on any particular party in the “issuance chain” including, the issuers, underwriters, rating agencies, accountants and law firms.

Over the past few years, it has been clear to even the casual industry observer that while the industry (in the form of the same parties mentioned above) had for years been saying one thing (i.e. the collateral pools had been put through rigorous review and testing), in too many cases, it had been doing quite another (i.e. totally inadequate due diligence).

Once again, we think that SEC has gotten it right with the issuance of new Rule 193 of the Securities Act of 1933.  The rule does two important things:

1) It begins to set some standards for the level of review that an issuer should undertake in connection with a new securitization.  While leaving ample room for interpretation to exactly how detailed a review should be completed on an asset by asset class basis (e.g. perhaps a 100% review for a CMBS securitization and something more like a sample in the case of a credit card transaction), the Rule makes it clear that the collateral review should “provide reasonable assurance that the disclosure in the prospectus regarding the assets is accurate in all material respects”.

2) Rule 193 makes it much clearer that the issuer or a third-party that might have been relied upon to perform the collateral review shall be accountable for the quality of the review.  In fact, the Rule will require an issuer that has relied on a third-party firm to conduct the review to disclose the name of that firm in the registration statement, thereby exposing that third-party firm to liability as an “expert” under the Securities Act of 1933.

We believe that these measures are both necessary and appropriate.  We can so no reason why an issuer should be opposed to fulfilling the requirement of providing “reasonable assurance” to their investors that the particulars of the collateral pool are consistent with the representations described in the registration statement.

As you might imagine the requirement for third-party reviewers to “step up and be counted” has not been met with cheers by some in  the industry, most notably the firms that provide third-party due diligence and surveillance services.  It is certainly easy to appreciate that these companies would be very concerned about the costs associated with the liability that goes along with being labeled an “expert”, even if it is just the cost of additional insurance that they may have to carry.

We find these grievances to be just a bit hollow.  Hasn’t it been these same firms that for many years have touted their “expertise” and “experience” in this field; offering issuers a “better solution” for due diligence and surveillance, particularly in high volume asset classes (e.g. RMBS)?  We find the cry of additional cost to be a little bit too much to take, particularly when it might appear to some that these firms were paid for many years to deliver a level of quality that they clearly did not come close to achieving.   Even today, one can simply view some of the websites for these third-party providers and see words like “expertise” and “experience” thrown around quite liberally.  Seems to us that these firms should be willing to live up to their advertising. 

Some in the industry have also indicated that the costs associated with this additional liability may drive some of these third-party providers out of business.  We would again argue that this doesn’t hold water because, without changes like this (where issuers and their agents are willing to step up and be counted), there will be no resurgence in the securitization markets.  So on that basis, if they won’t step up, they need not worry, since there won’t be a market anyway.

We are also hearing that many third-party providers will be unwilling to have their names disclosed in a registration statement.  Cleary, the issuer will have to decide if they intend to rely on a third-party review or not.  If a third-party firm refuses to have their name disclosed, then it will be up to the issuer to take responsibility for the review.  Of course, we would hope that under such circumstances, issuers would receive the benefits of those third-party services at  pricing levels which are commensurate with the level of responsibility that their vendor is willing to assume.  Somehow, we imagine that market dynamics will kick-in along the way and one or more third-party providers will see the advantages associated with doing their job correctly and in demonstrating a willingness to stand behind it.

We also think that third-party providers who think they won’t have liability for their work under the new standard, if their name is not disclosed in the registration statement, are probably kidding themselves.  We would expect that any issuer with proper legal representation will require the third-party firm to stand behind their review in their contract, thereby giving the issuer the necessary level of comfort to make the required representations about such collateral review in the registration statement.  Either way, we see these third-party firms being on the hook.

It is our view that the SEC continues to make great strides in providing pragmatic revisions to securitization market practices.  Taken with the recent rulings related to disclosure of Repurchase History, we believe that Rule 193 will have a lasting positive effect on the resurrection of the securitization markets.

SEC Ruling on ABS Disclosure on the Mark

Late this week, the SEC published its Final Rule for disclosure for asset-backed securities, as required by Section 943 of the Dodd-Frank Act.

While there are any number of agencies considering changes to policies and regulations resulting from Dodd-Frank or simply as a result of the failure of past policies to adequately foresee or to cope with the wholesale collapse of the credit markets 3 years ago, we believe that the SEC’s rule may be the best of bunch.

Not only does the rule attempt to get right at the heart of the “toxic asset” issue, it really attempts to hold issuers of securitized debt to the basic principles that credible issuers have stood behind since the early days of this market.

Requiring issuers to disclose 3 years of Repurchase History should not be either cumbersome or an impediment to issuance for credible issuers of securitized debt. 

We have often spoken about the impractical expectation of investors performing granular level due diligence and surveillance on ABS, MBS, CDO’s, etc.  Sure, this all may have sounded good when most wanted to blame the rating agencies for not doing their jobs but we could never make the connection for how the average sophisticated investor could find the time or the means to perform that level of examination on their own.

What we like best about the new disclosure rule is that it will give investors a “practical metric” off which they can evaluate the suitability (“credibility”) of the due diligence process that a typical issuer utilizes in connection with their program.  Clearly those issuers with less repurchase activity would look more attractive (at least on that basis) to other alternatives in the market.

We are still studying the rule but bravo to the SEC for coming up with a measure that can be easily understood, can be reasonably easy to implement and will be of “real” use to investors.

We predict that this rule may have much more lasting impact on the resurgence of  “investor trust” than any other rule being considered including, the ever popular 5% Skin-in-the-Game rule.

Did the FDIC Just Float a Band-Aid on Safe Harbor?

There are a few articles circulating this week that refer to a letter that the FDIC has apparently delivered to the American Securitization Forum which describes a proposed extension of the interim policy to not exercise the Agency’s liquidation rights, as it relates to assets pledged to securitizations.

For the better part of 3 years, the FDIC had been rattling its saber about going after mortgages and other assets pledged to securitizations in connection with failing banks and non-bank issuers.  Dodd-Frank further institutionalized this position with its “Orderly Liquidation Authority” provision.

What we may be winessing is that the regulator may be starting to really understand just how important a sound safe harbor standard and the sanctity of concepts like “true sale” and “bankruptcy remote” are to a healthy securitization and, let’s go even further,  a healthy capital market.

The “liquidation topic” was on the agenda for the FDIC’s board meeting this week.  Interestingly, while other topics were discussed and the results of those discussions were posted by the Agency on its  website, last we checked, the “letter” to the ASF was not posted.  We are left thinking that the intention was to “float” the concept past the securitization industry, somewhat quietly first, to test the waters.

What we understand is that the proposal is to simply postpone the implementation of the liquidation rule for another three months (through June 2011).  However, we would like to think that this is a good signal that there is some real second thoughts about the long-term debilitating effect that the threat of the FDIC utilizing this authority is having and will continue to have on the revival of the securitization markets.

Aussie RMBS Issuance Poised for Recovery?

In the past, we have looked to the Australian securitisation market for signs of recovery (or further deterioration) from the great credit crisis.

In late November, Guy Debelle Assistant Governor for Financial Markets of the Reserve Bank of Australia made a speech to update the markets on the state of the bellweather Australian residential mortgage-backed marketplace.  The overall conclusion was that while the market still has some way to go on the road to health, there are many “relatively” positive signs coming from the Australian RMBS market.

We have always liked to utilize the Australian market as a measuring stick for how the market, in general, is performing because:

* It is relatively small and therefore easier to understand (certainly easier than the US market)

* The market has been among the most progressive in the world, as it relates to accommodating the development of securitisation as an important component for capital formation among financial institutions

* The market has always been accommodating to offshore participants, whether they be issuers, arrangers or investors.  The result has been the development of highly consistent and predictable “Aussie Product” which is widely accepted in other markets.

Mr. Debelle’s speech contained a number of useful graphs, two of which we show here.

This first graph shows the historical importance of offshore funding for the Australian RMBS markets.  No matter what steps the Australian Government takes to stimulate a re-birth in the securitisation market, it is clear that the point that they must keep one eye on the offshore investor has not been lost on Government officials (a good sign and perhaps a lesson for their US counterparts).

We also like this next graph which provides comparative statistics for non-performing mortgages in each of the major global markets.   Based on this chart, one could conclude that if there is a market ripe for leading the recovery of new RMBS issuance, it may very well be Australia. 

A stable, government friendly market with a strong track record for ‘global investor participation’ would seem to be as ripe a place to start the mortgage-backed recovery as any.

Battle Over Skin-in-the-Game Rules Heats Up

There are a couple of good articles circulating this week detailing the punches being exchanged between various market participants and with regulators over setting some final rules around Risk Retention guidelines for residential mortgage lenders and servicers.

Broadly speaking, Dodd-Frank set forth a rule requiring issuers of securitized mortgage debt to retain 5% of the risk (loan) in connection with a securitized portfolio.  The legislation also provided Government regulators with the flexibility to define (or refine) the definition for what types of loans would be covered by this 5% rule. 

As you might expect, the ‘interpretive discretion’ afforded the FDIC and other regulators has spawned a tidal wave of lobbying by a number of financial institutions that will be affected (either positively or negatively) by these rules.

We have been saying for many months that, while this seemingly straightforward attempt to rein in unnecessary risk taking by mortgage lenders (i.e. quickly transferring mortgage risk to unsuspecting investors in mortgage-backed securities) seemed logical to many at the time, we believe that the only thing this requirement will do is raise the cost of a securitization. 

It is likely that this increased cost will manifest itself in a couple of  ways:

1- It will reduce the size of the securitization market as issuers absorb the increased “cost of funding” and look to other (suddenly more competitive) alternatives for capital formation.  Net-net, business models for lenders will suffer.

2- Some or most of these costs will be transferred to other parties, whether that be equity investors (reduced returns/dividends) or borrowers (higher interest rates).

Interestingly, several  market constituents are fully engaged in trying to influence the final regulations to benefit their own business models and, perhaps, give themselves a competitive advantage.  One example could be Wells Fargo, who is now on record recommending that only residential mortgages that involve a 30% down payment should be exempted from the 5% retention rule.  Since a large portion of Wells Fargo loans fit this criteria, that would seem to give them a competitive advantage in the securitization market going forward.

Of course, the notion of returning the US Mortgage Market to the ‘old days’ of high down payment mortgages does not sit so well with many consumer advocates, the mortgage insurance industry and lenders with businesses built around a low down payment model.

It would appear that the old adage of  “if you push on one side, something is bound to come out on the other” would seem to apply to this debate.  Maybe the seemingly straightforward concept of skin-in-the-game isn’t quite as simple as many first thought.