Can We Please Finally Separate Securitization from Robosigning?

The steady, thumping headache that just won’t seem to go away for the structured finance markets is the seemingly never-ending connection between mortgage servicing abuse and the securitization industry.

This week’s installment features the negotiations between Bank of America (as the owner of the former Countrywide Mortgage), The Bank of New York Mellon (as the bond trustee for holders of Countrywide mortgage-backed securities) and 49 State Attorneys General (less New York’s AG who was booted from the team).  To add some spice, a side-show story once again tries to tie in the electronic mortgage registration system (“MERS“) into the plot.

Article after article for more than 3 years running has tried to connect the failures of the mortgage servicing industry into some twisted plot hatched by Wall Street bankers.  When this nonsense will ever end is what we would like to know.

What we would like to do is to separate these two very different topics, hopefully forever, although we have no reason to believe that we can.

First let’s think for a minute why and how the mortgage servicing industry could have gotten so screwed up with the paperwork (servicing) of  residential mortgages.  Let’s think about the explosion in home ownership and the resulting financing of those properties over the past 10-15 years.  At every turn, new volumes records were being hit quarter after quarter by private mortgage issuers including banks of all size and color across the US, independent mortgage companies (like Countrywide), mortgage brokers (who could easily find banks and non-bank lenders eager to get into the US real estate market) and of course, the “big kahunas”, the Government lenders (GNMA, FNMA and FHLMC). 

The competition for new borrowers became fierce, with every new entrant to the market trying to get in on the action.  This forced lenders to offer increasingly more competitive “pricing” which put pressure on their earnings in their mortgage businesses.  This in turn forced lenders to look for more ways to “streamline” their operations which of course meant their mortgage servicing operations.  What should be very apparent but somehow gets lost in the zeal to create a conspiracy theory is that the folks that actually run the servicing operations at these lending institutions have very little to do with what happens to the mortgages after they are underwritten.  Most were just told to either service them or package them up for a buyer (we’ll come back to the second scenario in a minute).  All these servicers were interested in doing was trying to keep up with an increasingly smaller spread (earnings) in their business.  No doubt the decision made at some point, after things got tight, to introduce a strategy such as robosigning to their procedures was a bonehead decision but how in the world someone decided a few years back to connect this “mistake” to some grand strategy germinated on Wall Street just doesn’t make any sense. 

What did the banker who put the mortgage-backed bonds together have to do with decisions about how the mortgages were serviced after the deal was in the market, including the decision to foreclose and how to do it?  The investors, on the other hand, had every incentive to push the servicer to speed up the foreclosure process, in order to retain as much value in their portfolio as possible.  While we acknowledge that some of these same banks wore both the hat of the investment banker and the investor, they were typically one of many investors and we would suggest that it was pressure from the investor side , which includes all types of institutional investors, from hedge funds to public pension plans, that “birthed robosigning”.  In fact, it is much more likely that it was the “distressed investor community” which applied most of the pressure on servicers to foreclose quickly because as a “late arriving investor” their bet was on their ability to recover any margin above the steep discount price that they paid for the securities.

We can tell you with a very high degree of certainty that many mortgage-backed investment bankers have never stepped onto the floor of a mortgage servicing operation and most of those that have, never left the conference room.  No one said one day, “Hey let’s just forge some signatures on this mortgage file so we can get this deal done.  No one will ever know.”  Sorry, while it makes for good Hollywood, that simply did not happen.  The deals were already done before robosigning came into vogue.

Servicers made bad decisions about policies, not to further the securitization of their mortgages but to better profits in their operations.  In the case of robosigning they did so under pressure from their investors.  The theory that the investment banks were somehow able to apply pressure so that they too weren’t sued for losses because they so poorly underwrote these deals, again while simply fascinating, doesn’t hold up.  This was not some huge “pump and dump” operation with some zen master pulling all the levers.  There were simply too many moving parts to try to tie what the servicers were doing into what the original intentions of the investment bankers were and what they may have become, once it all hit the fan. 

This week’s renewed attempts to drag MERS into this grand conspiracy just doesn’t wash either.  If today’s average mortgage industry neophyte with a blog were to actually study the development of the US mortgage industry over the past 20 years, they would have known that the origins of MERS lies in an attempt to create an industry standard for the “immobilization” of the paperwork behind US residential mortgages, similar to what DTCC has created for the securities markets (bonds, equities, etc).  By establishing an industry accepted “repository” for mortgages, the industry was hoping to create a more efficient method for banks to buy and sell mortgages.  Why do banks want to sell mortgages?  The easiest answer is that they want to be able to diversify their portfolio and to mange that process on an ongoing, if not daily, basis.  Buyers and sellers of residential mortgages may or may not decide to securitize their portfolios.  Many do, others do not and still others hold some and securitize others.  In our neck of the woods, we call that a market!  That’s why MERS was formed and once again, not under some grand scheme cooked up on Wall Street to create bogus MBS structures.

These “facts” do not absolve the issuer like Countrywide and the investment banks, law firms, accounting firms and rating agencies (nor the investors that bought the paper) from having constructed, reviewed, opined, sold or bought so many bad mortgage-backed bonds or, subsequently, so many bad CDO’s from bad underlying mortgages.  It is, without a doubt, very clear that often several participants in too many transactions either turned a blind eye or worse, knowingly tried to turn “hamburger into steak” by packaging loans with bad underwriting and poor due diligence.   However, we’re not going to try to blame the bankers for what the servicers were doing or did and we’re not going to blame the servicers for the parties that were involved in the creation, selling and buying of these poorly underwritten securities.

These are, quite simply, two unrelated stories and we wish that the folks would start to recognize that “fact”.

Is China Gearing Up for Mainstreaming Securitisation?

It was only a short and mostly generic sounding release from the China Banking Regulatory Commission but, as is often the case with regulatory pronouncements from the Chinese authorities, what they say can often be less important than why and when they say it.

Close China market watchers are reading between the lines of the Commission’s recent release of “guiding principles” for the securitisation of commercial receivables by banks in China.  Is this a case of the domestic banks approaching a tipping point in their desires to utilize structured finance techniques to better manage their growing balance sheets or is the government attempting to reassure the outside world (global investors) that they are watching the developing securitisation market with great intent, therefore providing some comfort that the market will not spin out of control before it even takes off?

Given the events in the structured finance markets over the past several years, this looks to be a sound step for the Banking Commission to be taking.  Certainly a market with an increasingly strong and more predictable pool of consumer assets available for structured programs can only be a good sign for investors looking for new investment opportunities.  If this market does begin to heat up and the regulators can help make it a smooth launch, it can only be good for the markets throughout the region.

Here the China Banking Regulatory Commission’s release from earlier this month:

Notice of China Banking Regulatory Commission on Further Improving the Management of Credit Assets Securitisation Business


Since the pilot program of credit assets securitization was launched in 2005, some banks have successively commenced this business and witnessed the business scale gradually expanded. In order to safeguard the healthy development of this securitisation business and improve related risk supervision, all banking institutions are required to make following efforts.


I.                  Paying attention to assets quality and steadily promoting securitisation activities in line with business strategy and management capacity. Given the current market situation and investors’ risk appetite and endurance, banks are expected to have their good assets securitized. Where non-performing assets are included, banks should take effective measures to diversify credit risk and default risk associated with the business and fully disclose the information.


II.              Ensuring “veracious sales” and controlling credit risk. The initiating bank should sell the securitized assets in real sense so as to make these assets off balance sheet and mitigate credit risk. In addition, the initiating bank should precisely distinguish and appraise the risk shifted away by transactions and the risk still remained, of which the later one must be effectively monitored and controlled.


III.           Accurately judging the risk transfer and strictly abiding by capital requirement. Banks revolving in securitisation activities should, based on the veracious risk transfer, set aside provisions for risk exposures arising from securities issuance, credit enhancement, investment activity and loan service, etc. in order to ensure capital adequacy and prudential operation.


IV.            Strengthening risk management and internal control thus to ward off operational risk. Upon the initiation of asset-backed securities, the initiating bank should establish particular internal risk management system for the business, covering operational procedures and administration, selection process of basic assets, relevant accounting methods, etc. And this particular system should be incorporated into the bank’s overall risk management systems. When going through loan service function, the lending banks should clarify business procedures and internal policies for offering information and transferring funds, put in place a rigid internal supervision and examination mechanism with a view to improving completeness and steadiness of the whole system functions.


V.                Working out a proper assessment mechanism of loan service performance thus to ward off moral hazard. The lending banking should have in place sound internal policies and standards for securitized assets management with clear post description and proper assessment mechanism. Due diligence of the management should be covered by the assessment in order to guard against moral hazard. Where the borrower defaults on the payments after the loans are securitized, the bank should intensify efforts of collection and resolution so as to reduce operational risk and reputation risk.


VI.            Standardizing procedures of transferring creditors’ rights thus to ward off legal risk. Firstly, the initiating bank should employ professional and experienced law firms, underwriters, accounting consultants, rating agencies, etc. for the purpose of regulating activities of every business link. Secondly, the initiating bank should adequately communicate with relevant judiciary and supervisory authorities in a bid to ensure trade structure designing and practical operation are in compliance with law and regulations. Thirdly, the initiating bank should well inform debtors of the business and keep them from misunderstanding the activities, thus to facilitate the development of securitisation business and ward off legal risk.


VII.         Disclosing information and protecting investors’ legitimate interests. Banks involving in securitization business should fully disclose information concerning basic assets pool and urge the sub-prime securities investors to keep clients’ data in confidentiality when introducing basic assets to these investors.


VIII.     Reinforcing financial education on investors. Banks revolving in securitization business are expected to well educate the public, particularly the medium and small investors, on credit assets-backed products and related risks.

FDIC is Unable to Skip Out on WAMU

Earlier this week, a Federal judge ruled that she would not dismiss a case brought by Deutsche Bank over the FDIC’s responsibility for billions of dollars in bad residential mortgages originated or purchased by Washington Mutual Bank in 2008 or earlier and later packaged into mortgage-backed securities.

In 2009, Deutsche Bank National Trust Company filed a lawsuit against the FDIC charging it with liability for losses from these bad mortgages up to US$10Billion.  The FDIC attempted to have the suit dismissed arguing that the plaintiff should be pursuing JP Morgan Chase & Co. which had acquired WAMU from the FDICThe FDIC had been appointed receiver for Washington Mutual in 2008, when the bank collapsed under the weight of the failure or its US mortgage business).  Not surprising that JPM argued that it had not assumed WAMU’s liabilities for these mortgages or the MBS structures.

Apparently, the judge seems to have agreed with JPM and the case against the FDIC will proceed in U.S. District Court.  This could turn out to be a very significant ruling and there are a couple of very interesting potential repercussions that come to mind.

1)  If we can take the judge’s ruling at face value then the FDIC’s liability will likely hinge on precisely what liabilities it agreed to retain in connection with the sale of WAMU to JPM.  We would suggest that it would not be unusual, particularly in the context of an asset sale (as this may have been structured), for the buyer and seller to agree upon some extensive “carve outs” for “pre-existing liabilities”.  How the the mortgage collateral was farmed and how these MBS securities were structured are good examples of the types of liabilities that a sharp buyer would be interested in avoiding.  If JPM is correct then it would seem that the FDIC is “left holding the bag”.

2)  Assuming that the FDIC is responsible and assuming that the plaintiff in the Deutsche Bank case prevails, we see the next milestone to be the determination by the FDIC of whether it will actually pay-up or not.  It may believe that it can fall back on Dodd-Frank or other pre-exiting laws and regulations  that would allow it to avoid liability for these bad loans.  We’re not yet exactly sure what their strategy might include but such a position seems logical, given their first reaction to point Deutsche Bank to JPM.  We believe that this strategy expose a long-held belief at the Agency that, while the FDIC can step in at anytime and take over an institution it oversees, it never takes on any liabilities for those actions, at least not to third-party mortgage-backed  investors.

If the FDIC is found to have assumed those liabilities then the good news for investors in securitization structures could be that the “liability chain” was not broken with the onset of FDIC receivership. 

Going further, if the plaintiffs in the WAMU case are able to recover all or a substantial percentage of their losses, might that not signal to the FDIC and the investor community that these structures must, in fact, be treated as off-balance sheet and, in effect, restore the concept of “perfection of security interest to where the vast majority of issuers and investors in securitized debt thought it was prior to 2008 and Dodd-Frank.

Wouldn’t that be something!!

CLO Manager Consolidation Not Slowing Down

As we reported earlier this year, the landscape for firms specializing in managing Collateralized Loan Obligations (“CLO”) and related institutional credit portfolios continues to rapidly consolidate. 

This past week brought two significant announcements; first with Los Angeles-based Ares Management LLC announcing that they had acquired Indicus Advisors and with it more than US$2Billion in CLO’s and other credit programs.   This is the third acquisition by Ares in 2011.   In April they had agreed to buy about $2.5 billion in loans from Nomura Holdings Inc. and in March it said it would buy a European CLO from Octagon Credit Investors LLC.

The Ares announcement was followed by news later in the week that Carlyle Group had acquired a $500mm CLO from Well Fargo Bank’s Foothill Group affiliate.  This is a transaction that had been rumored to be under negotiation for several months and is just the latest in a string of consolidation plays in the CDO and CLO markets by Carlyle over the past two years.

According to Barclay’s Plc, more than US$30 billion of CLO management contracts have been transferred since the start of 2010.  Most argue that this continued shakeout is being driven by a combination of market forces including, pressure on the performance of existing programs, strong competition for new loan product in a tight credit market and the resulting failure of some of CLO managers to be able to reach “critical mass”.  These programs can be both highly sophisticated and expensive to manage.  Managers with anything less than US$3-4Billion under management will likely continue to consider their options.

From an investor perspective, we view this consolidation as a positive trend, as it will force out managers with anything less than a high level of commitment to superior results.

Don’t Blame the Messenger (S&P)

This column is normally dedicated to a discussion of the recent regulatory and industry news affecting the securitization industry and we have usually tried to stick to the script.  However, we feel that the announcement by Standard & Poor’s on Friday August 5th that they would take their rating of US debt down from AAA to AA+ is worth noting. 

The fact that S&P, in their initial report and in the strong defense of their decision during a conference call over the past weekend, pointed out the obvious that the primary rationale behind their decision to downgrade was not whether the US has the means to meet its obligations but whether the “political risk” associated with the never-ending logjam in Washington, D.C., makes the downgrade both appropriate and necessary.  What S&P is saying is that for the first time in modern history, holders of US debt should envision a number of scenarios where the US “might” not honor its obligations.

We found the reactions to the downgrade in both the Administration and Congress to be laughable.  You have to ask yourself, “what show they have been watching for the last year”; it certainly hasn’t been the Potomac Circus that the rest of us have been watching.  Clearly this is a great example of those howlers being much to close to the “action” to be anything close to objective.  Let’s face it, Washington politics are now the mostly highly rated Reality TV Show in the US.  All S&P is telling them is that we have been watching and with every side-show event that goes by, the Washington pols continue to sap the market’s confidence in both their grasp of how the markets work and their abilities to make good policy.

The downgrade should not be overstated in that it is really only a bucket of cold water on the US Government.  Certainly no sane investor is going to continue to believe that US Treasuries are anything but the safest bet around.  Nevertheless, particularly the obviously unenlightened members of Congress (both House and Senate) need to understand that there is nothing etched in stone that says that US debt will always retain the same status we have enjoyed and benefitted from since before many of these folks were born.

We imagine that many of you who have been following the bond markets for years can’t help but chuckle about how similar the reactions by Treasury officials, members of Congress and the Administration sound to all those grumblings by corporate  CEO’s and CFO’s, over the years, immediately following their meetings with the rating agencies in a last-minute attempt to avoid downgrade.  This, by the way, sounds exactly like what must have been going on late last week at the Treasury Department, as they attempted to avoid the inevitable.

We don’t think it is stretch to tie this back into the overall mismanagement of the legislative and regulatory reactions to the 2007 Financial Crisis and, in particular, the securitization markets.  The failure of the politicians to grasp even some of the most basic market fundamentals in first prescribing and then implementing changes to the system is brightly illuminated by the “Doesn’t S&P understand that we just solved the problem” reactions, across the board, in Washington.  The securitization markets have been equally “unimpressed” by the content quality and the speed of implementation to changes in their markets as S&P (and the rest of us) are about how Washington solves fiscal policy problems.

What the US economy needs is more “Balance Sheet Capacity”.  We can think of no better solution then fully restoring the abilities of banks and other originators of assets to leverage their balance sheets through securitization.  This does not mean a return to the excesses of the early 2000’s because we continue to believe that, if the regulators had effectively utilized the regulations that were already in place at that time, much (maybe all) of that excess would have been avoided.  Instead, the cure has been to return banks to management strategies which resemble the 1950’s.

Perhaps this S&P “wake-up call” will reverberate across all the legislative and regulatory bodies that have been so overly focused on “elementary school economics” and “change simply for the sake of change”.