When asked about the still-struggling nonagency market might return, some market participants in New York for the Mortgage Bankers Association’s National Secondary Market Conference even took on the controversial question of whether a subprime credit secondary market should come back some day.

The group, brought together by this publication to represent a broad range of market participants and data providers familiar with both the origination and loan performance issues in the market, debated the topic in the following excerpt from that discussion.

Opinions were mixed, with the interest in yield driving arguments for the cautious and eventual return of subprime in a new form. Others argued that discussion of this puts the cart before the horse, given the continuing struggle for a return of investor trust and the need to re-establish lower-risk nonagency parameters first as well as to better see how evolving government policy will shape these.

Stephen M. Calk, chairman and chief executive officer of Chicago Bancorp and The Federal Savings Bank; Jon Daurio, former chairman/CEO, Kondaur Capital Corp.; Martin Goodman, president, LoanMLS; and Avi Naider, CEO, ACES Risk Management Corp., participated in the discussion organized by National Mortgage News managing editor Bonnie Sinnock and moderated by myself.

FOGARTY: I guess what everybody’s been talking about at the conference is when will there be a viable secondary market that’s not Fannie, Freddie or Ginnie? So what do you guys think about that?

DAURIO: We’re seeing the beginnings of securitization come back on jumbo loans and we also securitize some nonperforming loans and the ability to continue to securitize nonperforming loans and jumbo loans appears to be getting more robust, I’ll use that terminology.

We think that that is what will eventually lead to whether it’s through securitizations or we’re seeing an influx in people coming to market forming REITs with potentially an idea that a REIT will be the place to raise money to purchase and hold these loans. When? That’s the unknown but at least there’s movement in that direction. But I would say it’s like a journey of 1,000 miles and we’ve only made the first few steps.

FOGARTY: Why would a REIT structure be helpful?

DAURIO: From what we understand that just with the whole financial meltdown being tied to the securitizations and the ability to securitize poorly underwritten product I think just that it’s just that it’s something new and different, that that’s what allows the REITs to be able to purchase it. Also the REIT structure already has in place retained risk in the sense that the way the REITs are you have to distribute 95% of the income but retain 5% of the income so it’s a lot easier or it’s more acceptable, I’ll put it that way, to have a REIT structure where now they are trying to figure out how to mandate originators or the entities that are securitizing the loans to maintain more risk than just owning residuals.

FOGARTY: Anyone else have an opinion about when we are going to see a robust nonconforming secondary?

Naider: Within the next couple years you are going to see entry of private buyers into the market and it’s going to be primarily driven by quality perceptions.

The analogy I like to use is in the auto industry, when a car company has a big problem and their brakes fail on cars and consumers shy away for a little while because nobody wants to buy a car where you think your brakes might fail. Well, when consumers were buying loans and securities that had good yields relative to safe investments but actually poor yields relative to risky investments, there’s a risk perception or perception of high risk, you’re just not going to see that high participation in the market.

But driven by a lot of the loan quality initiatives, we’re now seeing a much greater focus on prefunding, verifications of assets, of income, post-closing QC. What’s ultimately going to happen is that understanding of what’s going on within the industry starts getting out there and they understand that the loans that are getting generated right now have a much higher quality than those of several years ago and the constraints are much tighter, you’re going to start see investors who want those higher yields where they perceive that the investment grade is pretty safe, they’re going to be returning to the market.

DAURIO: One of the things though that may hinder this is the free markets are not so free. What I’m saying is that the incredible influx of stated predatory lending laws are preventing lenders from being able to charge what is a reasonable rate or points commensurate with the risk...

GOODMAN: …We’ve all felt a betrayal of trust. We trusted that a securitization is what it says we trusted the loans were what they said and the truth of the matter was most of them were not. And technology, in particular, is allowing us to peer down and drill down much easier than it was even five years ago to see what’s in this pool?

Let’s…understand a little bit more. The other thing that’s interesting is we’re seeing a new type of subprime borrower. We have lots of people that have excellent jobs with verifiable income but they had a slew of rental properties…It’s going to be a very long time before any of us go back to the type of subprime lending standards that existed.

We would never do that but there is a whole new class of subprime borrower out there and there’s a ton of private money going after that. Technology is going to let us marry the buyers and sellers. In many cases we’re finding originators are going outside the traditional channels of building up in a warehouse and then securing it, going after microsecuritizations…

DAURIO: If you go to the history of securitization, that’s how it was in the beginning with the securitizations, at least I know the ones that I worked on…

CALK: Back to your original question regarding a robust secondary market I think before we can get into the esoterics of subprime lending or getting technology platforms for that, I’m inclined to agree with most of what Jon said, however, we really need to address a couple key topics.

One, what is QRM going to look like? And although there might be some jumbo or other for lack of a better word alt-A or esoteric products out there, until we understand what the core product market is going to be and what that’s going to look like we won’t know whether there is going to be a robust market because we won’t know really what those yields are…the second area that’s going to affect this…is what are MSRs going to look like in the next year or two?

You can’t begin to estimate really what the securitization market’s going to look like until you understand where people are going to park that cash, you see community banks and other banks build portfolios, specifically of higher-yielding, near-miss jumbo loans where they can get a decent…spread over their cost of funds...We’re already seeing REITs, we’re being approached by hedge funds, by REITs with unique and different ways. At the end of the day addressing what the underwriting standards are and to ensure that they have a debt-to-income ratio that they can stand behind…and then explaining that method of calculation to their regulator.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.