Momentum Builds for Inclusion of MBS for Basel III Liquidity Rules

Basel Committee members met last week and Reuters reports that committee members may be coming around to the idea of broadening the types of assets that can be counted towards the new Basel III short-term liquidity rules.  Scheduled to go into full effect in 2015, the original rules severely restrict the types of assets that can be utilized by global financial institutions to meet the new guidelines.  As we have reported in the past, banks are not waiting to make adjustments in how they manage their balance sheet and the negative effects are already apparent.

Most notably, banks would no longer be able to utilize mortgage-backed securities, a long time staple in their portfolios, to meet the new test.  A derivative of this restriction is the elimination of the utilization of mortgage servicing rights (“MSRs”) as an eligible asset for meeting the liquidity guidelines.

It now seems very likely that the original definition of asset types that might be utilized to meet the new Basel rules will be altered and it seems a cinch to many that covered bonds and highly rated corporate bonds will find their way into a revised definition.  There is growing momentum to add mortgage-backed securities as well.  The European Central Bank, apparently feeling some pressure from it smaller member countries, seems to be lobbying for the addition of mortgage-backs to that list of eligible assets.  We completely agree with those that contend that such a move would provide a big boost to the securitization markets.

Allowing the banks to resume their position as a key group of  “net-buyers” of mortgage-backed securities and other ABS will restore a vital “source of demand” for new issuance.  The sooner the better!

Moody’s Critical of Some New ABS Structures

Last week, Moody’s published a report which seems to be openly critical of its brethren NRSRO’s (Nationally Recognized Statistical Rating Organizations) for some of their more recent work in asset-backed securities.  Moody’s concerns look to be aimed at some of the “fringier” asset class structures that have hit the market over the past several months.  Asset classes such as sub-prime auto seem to be in their crosshairs.  The stated concerns include issues such as the ability of smaller and thinly capitalized issuers to meet each of the representations and warranties promised to holders in the related bond offerings.

We have no doubt that Moody’s has ample data and basis for their warning to ABS investors about the loosening of credit standards.  However, it really does remind you of the days before the crisis when each of the major rating agencies took turns beating up the criteria of the others in an attempt to either curry the favor of investors or, unfortunately, to bully issuers into seeking a rating from the squeaky wheel.   Is this report a breath of fresh air and a signal of a sustainable “behavioral change” for the rating agencies or is it a signal of a return to “competitive driven behavior” which seemed all too commonplace prior to the credit crisis?

Time will tell.

The Buzz Continues for Mortgage Servicing Rights

As we noted a few months ago, the secondary market for Mortgage Servicing Rights or “MSRs” continues to be hot.

Sellers, usually banks, are not waiting for new regulatory capital rules to kick in.  Several have already drawn up plans for when and why they may sell rights in their mortgage businesses and buyers are lining up strategies to take advantage of what many perceive to be a buyer’s market; assuming of course you know what you are getting into.

Over the past several days, two large and somewhat unique trades took place.  The first involved a “re-trade” of MSRs by Ocwen Financial to a newly formed Cayman entity called Home Loan Servicing Solutions.  According to the company’s filings, Home Loan was formed for the purpose of acquiring MSRs.  The transaction represents a sale of MSRs which were originally acquired by Ocwen in connection with its purchase of a servicing business from Barclays Bank in September 2011.  One has to wonder if the portfolio will trade yet again somewhere down the road.

The other transaction involves the sale of a huge MSR portfolio by Aurora Bank, the former Lehman affiliate to Nationstar Mortgage, in  conjunction with New York-based Newcastle Investment.  The group acquired more than US$60Billion in MSRs from Aurora for a disclosed price of approximately US$480MM.

We do not doubt that the valuation process for these transactions can be tricky and the market track record remains scant.  Nevertheless, some smart folks are thinking they see some real opportunity to buy these portfolios at a sharp discount as sellers look to adjust to a new regulatory capital regimen.  Ocwen’s management made it clear that the sale is meant to free up valuable room on their balance sheet.  With the coming changes to regulatory capital rules, banks that historically been able to utilize MSRs to help meet capital ratios are now finding that MSRs just like other assets are simply just another  commodity and where there are commodities, a market is sure to follow.

Expect more, not less, of these trades as we move ahead.