Securitization and its players have started to emerge from the black hole the market was in at last year's gathering. In 2008, the attendees at this event were worried about the possible end of securitization. Everyone was so downtrodden that it almost seemed like there would never be another ABS East conference.
But this year proved that wrong. Last week's gathering was markedly different, and investors at the event seemed more optimistic about getting back into the game. "I think the reason everyone has been so positive this year is because the world as we know it didn't collapse," said John Devaney, CEO of United Capital Markets.
The opening general session echoed the optimism, and economists speaking on the panel confirmed that the recession appears to be ending. Higher stock prices have helped consumer confidence, and economists said that if this continues to improve, it's likely to drive some of that pent-up demand back into the market.
"A year ago there was so much anger with securitization, but now there is definitely an understanding that it has to be here," said Paul Colonna, president and chief investment officer of fixed income at GE Asset Management. "It's important to remember that securitization didn't blow up - a lot of it worked as it should."
However, Colonna said that the products created solely for securitizations are less likely to survive and are less likely to ever stage a return.
Securitization also helped distribute risk that arguably lessened the overall blow banks felt. As a financing tool, it has not been a problem and it is not to blame for the loan defaults. The difficulty, panelists said, lies in the collateral backing these structures.
"It wasn't just mortgage loans in securitization that didn't do well; it was also the loans on the banks' balance sheets," said Alex Wei, senior vice president and head of structured credit investments at Delaware Investments. "Imagine if those assets had all been sitting on balance sheet; there would have been no cushion, and securitization helped provide that. It's actually helped stabilize the financial markets."
David Jacob, executive managing director at Standard & Poor's, who moderated a general session at the event, said that without a securitization, the country would have to be prepared to see banks offer less credit - a reality no one is prepared to face. "Securitization has lowered costs to consumers," he said.
Glenn Boyd, head of U.S. ABS and CMBS strategy at Barclays Capital, predicted that next year will be a pivotal point for ABS and it could turn virtuous, although he added that if it does stage a comeback, it will be on a much smaller scale.
Boyd also said that, eventually, banks will have to consider extending credit beyond only the best candidates, which means some kind of a return to subprime lending, if the economy were to successfully stage a robust recovery.
"Real estate is one of the cornerstones of the economy, and a non-agency RMBS market is critical," Colonna said. "There was a subprime market before the crisis and there will be again, but probably not the same size."
The TALF Equation
The Term ABS Loan Facility (TALF) emerged as a clear winner among attendees and with it a clear understanding that the program has gone a long way to stabilize pricing in the consumer ABS area.
"It brought in new investors, and the market began to recognize that we were through the worst point of the economy," said Richard Johns, head of securitization at Capital One. "Today that market doesn't necessarily need TALF, but there is an understanding that we wouldn't be in this situation, where spreads came in dramatically inside TALF, without TALF in the first place. It's the program that helped us get there."
In general, both the buy-side and sell -side remain bullish on pricing over the next three to six months. There is a feeling that TALF may have run the course it needed, at least in the ABS space, although Johns said that extending the program beyond the June 30, 2010 deadline (for newly issued CMBS) and March 31, 2010 (for newly issued ABS and legacy CMBS).
Reed Auerbach, a partner at Bingham McCutchen, said that although TALF does not permit RMBS, its role in the recovery for ABS structures has created an ideal environment for subordinate bonds to catch up.
TALF has already boosted the bond values for CMBS, said panelists, who also revealed that Deutsche Bank and JPMorgan are currently looking at a new-issue CMBS deal.
"We have to have patience because these markets are curing separately," said Brian Lancaster, head of MBS, CMBS and ABS strategies at Royal Bank of Scotland's global banking and markets business. "TALF is working, the bank market is curing, the corporate bond market is curing and the CMBS market is curing."
However, Lancaster warned that commercial real estate faces a big problem if the CMBS market remains shut down for much longer because there is no takeout finance.
Lancaster estimated that delinquencies are now reaching 1993 levels. "It's the low interest rates that keep the wheels on the bus," he said. "It will be interesting to see what impact a rate increase will have, and it is likely to put more pressure on those balance sheet portfolios."
Colonna agreed and added that on the commercial real estate side, the fundamentals continue to be very weak for some time.
"It will be interesting to see new deals being issued just as the old ones move out," he said. "These new deals will be more conservatively underwritten. The marginal investors have been squeezed out and what we have left are the real investors, the guys who want to go through all of the deals. These are the real estate experts."
Post-TALF, it is likely that some asset classes will do better than others; namely credit cards and auto loans. For the more off-the-run asset classes included in the program, like private student loans, it is not yet known how they will perform in a post-TALF world.
"What is clear is that the future of securitization is not dependent on TALF being around," Johns said. "Issuers will want to issue, but with accounting regulations in fluctuation it is not clear what the remaining incentives will be for banks."
Investors Still Not Getting Loan Mods
An issue that is causing plenty of concern is the loan modification programs that investors can't factor into yields. Barclays' Boyd said that the market will learn a lot about modifications and their effect on forbearance.
A survey conducted by the Mortgage Investors Coalition (MIC) found that of the four largest servicing companies, including Bank of America Home Loans, Wells Fargo, CitiMortgage and JPMorgan Chase, only one has stated that they will honor the Treasury's guidance on how to mete out losses when forbearing principal for homeowners.
The Treasury's guidance states that forborne principal should be treated as a realized loss "unless otherwise directed by the applicable [Pooling and Servicing Agreement] PSA." This requires the servicer to turn to the PSA to determine if principal forbearance can be treated as a realized loss. And principal forbearance is not enumerated as a realized loss in the PSA, as it was not contemplated as a loss mitigation technique at the time the PSA was written.
The reluctance of some servicers to readily adapt the guideline set by the Treasury highlights the inherent conflicts of interest between different classes in a securitization.
If losses on the forborne principal are not realized until the payment comes due, the junior tranches are not written down and will receive cash flow if there are sufficient funds. Alternatively, if the forborne principal is taken as a realized loss when the loan is modified, the junior tranches are written down more quickly.
A Question of Timing
The panelists agree that it's likely to be a jumbo RMBS deal to bring back the market. "RMBS has to come back first, and there is clearly a way to get it done in the non-agency space," Wei said. "TALF as a tool on the ABS space worked, but it is no longer needed. The hope is that it moves into RMBS and it could have the effect of budging pricing."
Boyd agreed, but he added that the Federal Reserve doesn't yet have the option on the radar.
Wei also believes that loans have to be of better quality over the long term and that there should be a minimal standard for LTV limits. He suggested setting the bar at the 80% mark so that the borrower also has some incentives to stay with the mortgage.
As a result, other segments of the securitization market are likely to drag as well. Colonna said that, for example, there is no appetite for CDOs and the market is not likely to return anytime soon. Lancaster added that transparency remains an issue for this asset class.
All Not Said and Done
Economists speaking at the event said that there still remain headwinds. One factor that could potentially have a negative impact on a full recovery is an expected peak in the unemployment rates across the U.S. consumers' worry about losing their jobs also stops them from spending.
"The financial markets are just beginning to stabilize, [but] what if a collapse happens again?" said Beth Ann Bovino, senior U.S. economist at S&P. "Before the Lehman Brothers collapse, there was also indication that the economy was beginning to stabilize, and Lehman blew it out of the water."
Panelists said that the housing market is expected to bottom out at some point mid next year, but the glut of shadow inventory homes is likely to keep prices trudging at the bottom for a longer period. This "U-shaped" recovery means that it will take some time yet before the fundamental return to the housing market.
"What really matters is that people need homes," said Anatoly Burman, senior managing director at Aladdin Capital Management, who spoke in the general session panel that looked at the lessons learned from the crisis. "When the market bottoms out, you still need a way to finance purchases, but before credit is extended the fundamentals must return and before that happens securitization has to come back because the last time I checked neither banks nor insurance companies are looking to hold unrated and sub-investment-grade assets on their balance sheets."
United Capital's Devaney, who also spoke on the panel, said that the unlimited ability to borrow caused the housing bubble and saw many banks become overleveraged. Banks should be prepared to use less leverage and be happy with earning less.
"There are tons of opportunities in distressed bonds to buy cash flows, but the banking system will have to use much less leverage, and legislation is going to prevent the unlimited borrowing we saw in the past," he said.
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