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

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.


 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.

TARP Postscript: FDIC’s Little Secret

There was an interesting story making the rounds last week which drew comparisons between US Banks with more than $1Billion in assets (a.k.a. those dastardly Wall Street Banks) and smaller regional and community banks.

It has been many months since the TARP program has been in the news on a daily basis but make no mistake, the program is alive and well, particularly at your friendly neighborhood bank.   You see, it turns out that while 23 of the 25 large banks have paid off their TARP loans in full, less than half of the 682 smaller banks that received TARP funds have paid them back.

At the time these loans were made, there was much talk in the media about bankers fearing that taking these loans would appear to be a sign of weakness and how, behind the scenes, the US Treasury was strong-arming these banks into taking the loans (“for their own good”).  The Feds’ theory was that if they provided these banks with more liquidity they would lend more.  Turns out that this theory was wishful thinking as all banks, both big and small, grew increasingly conservative about lending, more than offsetting any benefits that came from the fresh capital.

We all remember how many/most of the large banks couldn’t wait to get their TARP loans paid off.  The increased scrutiny and oversight that TARP brought along with it was more than enough incentive to find the exit as soon as possible.  You would think that such motivation would apply to all banks, both large and small.  That doesn’t seem to have been the case with the smaller banks and we are left to wonder why that is.

Could it be that these banks are generally in worse shape than the large banks?  Could it be that these smaller banks, as a group, were actually operating more risky business strategies than their big bank counterparts?  How could that happen?

A closer look at the residential and commercial mortgage businesses at many of these smaller banks, complete with cozy relationships with local developers and fast and loose mortgage brokers is probably a good place to start the analysis.

Throughout the recent credit crisis, the FDIC worked overtime to build up its reputation as the superior regulator, the one with the most experience overseeing and resolving problems at troubled banks in the US system.  Some of us found it more than a reach when the FDIC suggested that it was they who should be given supreme command over all bank regulatory enforcement.  Many of us felt that, while the FDIC might be able to make an argument for their experience with smaller institutions, it would be difficult for them to get their arms around the more complex large institutions (a.k.a. the dastardly Wall Street Banks).

With this new information about TARP paybacks, we believe that we now have some hard evidence to question whether the FDIC can even handle the small guys.  With decidedly simpler business models at your typical run-of-the-mill community bank, how is it that the FDIC which had been regulating these institutions for many, many years, missed some of the early (and some not so early) warning signs that lending and other banking practices were getting more and more risky?

The answer is that the FDIC was in over its head.  It turns out that the smaller community banks were actually in much worse shape (granted on a relative basis) than their Wall Street counterparts.  We can’t help thinking that if Sheila Bair was the head of the SEC, US Treasury or the Federal Reserve at this point in time, she would surely be utilizing these new facts to support her arguments for those organizations becoming the super regulator.  Probably good for all of us that she wasn’t in charge of those organizations because it seems clearer every day that the FDIC, perhaps more than any other regulator, missed the boat.

Credit Suisse Retrenches

Word out this week that Credit Suisse may be giving up on waiting for the securitization markets to bounce back. 

Once one of the highest flyers in the business of underwriting and trading securitized debt programs, Credit Suisse has grown weary of the string of lackluster quarters that their fixed-income banking units have posted and decided now is the time cut some of their losses.

More than a year ago, CS began to move away from the asset-backed commercial paper markets, as the benefits to the bank and its clients continued to deteriorate in the post-credit crisis era.  Now comes news this week that Credit Suisse will be exiting the commercial mortgage-backed market and downsizing several of its asset-backed banking units.

We see this as a natural result of the continued uncertain regulatory environment in the securitization markets.  Whether it be the lack of clarity surrounding the implementation of Dodd-Frank or a similar level of uncertainty for the specific implementation of Basel III guidelines, who can blame these banks for throwing their hands up.  We are fairly certain that bank management must have considered the fact that if and when the air clears, they can always get back in with a few key hires. We would find that logic hard to argue against.

Nevertheless, we would hope that this does not become a trend.  While it might be wishful thinking, perhaps some of the regulators are paying attention and this possibility will inspire them to act more decisively in drafting and approving final regulations. 

Likewise, those regulators who have begun to come around to the benefits and even the “necessity” of the return of a robust securitization marketplace are paying attention.  If they wait too long, there may be no one left to invite to the party.