The regulatory overhaul of the housing market has taken center stage in most discussions regarding securitizations.
As regulators and legislators discuss the macro-issues behind housing finance reform, ABS players said it is actually the micro-topics that could have a more immediate impact on housing.
The Dodd-Frank Act does not address one of the fundamental underlying problems with which the RMBS market must still contend with - the issue of supply overhang. Securitization players seem well aware of the growing threat that foreclosures and the shadow inventory pose to supply pressures, said industry players at the recent American Securitization Forum's (ASF) 2011 Annual Meeting held in Washington, D.C. on June 21 and 22.
The Obama administration has used several housing policy tools that prevent and delay foreclosures including lower monthly mortgage payments, ignoring negative equity and backend DTI ratios. These methods all rest on the hope that an economic recovery will lift housing. These efforts might have been good for homeowners but not for the overall housing market.
"The market sees through the strategy, it's a kick-the-can approach," said Ralph Daloisio, managing director at Natixis and ASF chairman. "Housing needs to find an economic bottom. The politics of housing are impeding natural economic and market behavior."
Daloisio said that the largest impediment to RMBS recovery is the overhang of legacy assets. There is no economic incentive for the private market to generate new paper when secondary trading is yielding 6% to 8% for '06 and '07 subprime paper, according to Daloisio.
However, getting to the bottom of housing depends less on macro-issues like regulatory policy and more on micro-issues such as servicing advances and reps and warranties.
"The crisis brought on a lot of consolidation activity in a hurry and many are dealing with the exposures they inherited," said speaker Howard Kaplan, a partner at Deloitte & Touche . "It's a very significant exposure to manage."
Investors are also feeling very motivated to defend their rights and companies are concerned that this might set a precedent for future performance issues on legacy assets.
On the servicing front, Kaplan said that the foreclosure moratorium issued earlier this year has created a back up in liquidation as well as creating a huge issue for industry players. He estimated that on average it now takes well over two years to foreclose on a property. This timeframe will only lengthen as housing policy issues delay the right to foreclose on properties.
"During that period most people think that the servicer advance is for principal and interest payments to the investor but it must also cover property tax and insurance on the vacant properties as well as maintenance fees - it can be very expensive for the servicer," Kaplan said. "The longer it takes the less profit that is made and servicers are thinking they should not advance for P&I."
Kaplan said that a mortgage industry that saw servicer advances disappear would completely shift the mechanics of the mortgage market. Part of the analysis looks at whether servicers believe they can recover their advances out of the proceeds from the sale of the property.
"If it takes three years to recover and property values continue to go down, you are going to recover less and your entire analysis changes," Kaplan said. He noted that a halt in P&I payments would cause an "uproar" in the markets.
However, servicers are shelling out billions and billions of dollars of advances while the days to foreclose and liquidate continue to rise. "It is consuming resources and capital and, in many cases, the patience of large financial institutions as they work through this," Kaplan said.
Peter Sack, managing director at Credit Suisse, said that mortgage servicing rights (MSRs) and servicer advances will create some opportunity for new-isssue volume in the securitization market. Sack said that at least $100 billion exists on banks books of MSRs that will be subject to restrictive capital requirements.
"When you look for something that is in need of securitization, the servicer advances and the MSRs are in that category," he said.