Renewed Securitization Momentum: Brazil and China

Some interesting and possibly very positive securitization related news out of two large BRIC markets last week.  Both Brazil and China market leaders are recognizing the need to restore or expand the use of structured finance to meet the needs of their local capital markets.

In China last week, local news agencies were reporting that a joint notice issued late last month by the People’s Bank of China, Ministry of Finance and China Banking Regulatory Commission calls for the restoration of Credit Asset Securitization Pilot Programs which will once again allow banks to issue asset-backed securities.  Originally authorized by the central authorities in the middle of the last decade, the authorities suspended the program in 2008, during the height of the credit crisis.  Now, it appears that authorities are recognizing the need to add another valuable tool for banks to utilize when managing their balance sheets.  This program is expected to allow the banks to create a better balance between their short and long-term liabilities by transferring some of the risk to other parties.  Another important feature of the program will be allowing non-banking institutions to invest in these securities, thereby transferring some of the risk to parties outside the banking sector.

On the Brazilian front, Fitch Ratings issued a report describing the rapidly declining abilities of the Brazilian banking sector to support the borrowing needs of the rapidly growing residential mortgage market.  They predict that mortgage lending (demand) could outstrip banking deposits (supply) by as soon as 2013.  If that is accurate, one would think that there must be a strong and rapid response by the securitization markets to fill the expected gap between supply and demand.  The securitization of residential mortgages is not new to the Brazilian market.  Authorizing legislation dates back as far as 1997.  It would seem that Fitch is expecting the market to dust off some of this framework and will be putting it to work very shortly.

The overriding observation, not to be missed in both of these cases, is the micro-economic example that both economies provide for observers in the most historically developed securitization markets; the US and Europe.  A healthy global securitization market is essential to a sustainable global market recovery.

QRM 20% Standard Could be Lowered

There seems to be some momentum building among US regulators to revise the “20% Down Payment Rule” that Dodd-Frank requires for residential mortgages to qualify for exclusion from the 5% “skin-in-the-game” rule, which was another key restriction on the securitization of residential mortgages coming from the landmark legislation.

None other that Barney Frank is tipping the market that the final rule will likely see a lower threshold than the 20% originally proposed.

This could be a very important development for the mortgage industry and the revival of something which resembles a healthy RMBS market in the US.  We’re on the record for taking this argument a step further and have suggested that the entire notion of the 5% skin-in-the-game rule is, in itself, arbitrary and unnecessary.  We believe that the 5% rule simply adds unnecessary cost to capital for issuers of securitized debt who already have a ton of skin-in-the-game in their mortgage businesses in the form of servicing risk, alternative cost of capital structures, future access to the capital markets, etc, etc.  In our opinion, trying to regulate underwriting standards by penalizing the processes by which firms raise capital is a clear case of attacking a problem from the wrong end.

Short of scrapping the entire section of the law related to QRM’s or “Qualified Residential Mortgages” (mortgages which would be exempted from the skin-in-the-game rule) and “skin-in-the-game”, any signficant reduction in the 20% hurdle for qualification should have a desirable effect on the cost of capital for RMBS issuers.  Perhaps the silver lining is to view this as a first step back towards some rationality.