Rumblings of a private-label RMBS revival have made the rounds for months now. Redwood Trust’s RMBS securitization last spring created some optimism that other issuers would follow.
However, without a bigger piece of the mortgage origination pie, potential private-label issuers are still scrambling to get the right assets for a securitization market revival.
One of the most important tasks facing policymakers as they tackle the enormous challenge of the U.S. housing finance system’s appropriate reformation is establishing a clear role for the private sector to work in conjunction with the public sector, said Tom Deutsch, executive director at the American Securitization Forum. The aim is to provide mortgage originators with efficient
funding sources to make loans to home buyers.
At the moment, the government is funding the vast majority of mortgage originations through Fannie Mae, Freddie Mac and Ginnie Mae. The government has essentially created its own affordability products by keeping interest rates low and (until the end of April) offering homebuyer tax credits, said Royal Bank of Scotland (RBS) analysts.
"The challenge is to manage the tension between generating volume and creating sustainable affordability alternatives," analysts said. "The current environment has made cheap credit available to high credit quality borrowers and drastically reduced mortgage credit to everyone else. As the 2012 elections get closer, the administration and congressional Democrats will have to exercise discipline to avoid creating a secondary housing bubble."
One path to private origination and the resulting expansion in housing demand is the redevelopment of the securitization market.
"The GSE reform's goal is to have a more robust private-label market, and we expect that by 2011 we will get some blueprint laid out by the Treasury, but it won't be implemented for many years," said Chris Flanagan, head of U.S. mortgage and structured finance research at Bank of America Merrill Lynch.
Legislative and regulatory initiatives have also added to the uncertainty about the future viability of private-label mortgage securitizations. Banks face a higher capital requirement under the new Basel II regulations, and mounting regulatory pressure on rating agencies to be conservative on credit enhancements means that costs have proven less attractive.
"Private lenders would benefit greatly from clarity, especially with respect to the dissonance created by government encouragement to increase lending along with legislative and regulatory developments that would appear to increase the overall cost of funding," RBS analysts said.
Louisiana State University (LSU) economist Joseph Mason believes that the market needs a fundamental change in the issuance paradigm similar to what happened in the credit card sector following the Russian crisis.
"Consider what the issuance trust did for credit cards," he said. "In that case, it was a liquidity problem and not a credit-linked problem. Spreads increased and deals became uneconomical. Banks became unable to fund themselves, and the securitization market came to a halt for nine months. MBIA stepped in to restart the market."
The question now is still the same. How can deals be better structured to avoid problems?
Mason said that the market could consider an issuance trust where the structure delinked the mezzanine piece from the rest of the deal, allowing it to be sold first into the market and thereby creating a buffer against hot money movements."In a way it's why the credit card sector has been the last man standing during this present crisis, because they had this buffer," he said.
So far the market has seen the Redwood Trust RMBS deal. In the spring, Redwood came to market with a $238 million Jumbo MBS, the first private-label deal in 18 months. The REIT does not fund mortgages directly and instead must rely on correspondent loan purchases from mortgage banking firms, including depositories.
Redwood said in its new quarterly review that it will likely come to market with a $300 million Jumbo MBS sometime in the fourth quarter. However, the publicly traded REIT noted that its ability to buy Jumbo mortgages in the secondary market is "constrained by headwinds," in particular what it calls the government's (Fannie Mae and Freddie Mac) "outsized role" in the mortgage market.
Redwood complained that the GSEs are snatching up "conforming Jumbos" (mortgages that are $417,000 to $725,750 in size) when instead these loans should be going to private sector buyers.
"Redwood Trust functions more like a private Freddie Mac looking to guarantee and securitize, but it's the only non-agency deal that we have seen," said Greg Reiter, managing director for agency residential security strategy at RBS. "There are more Redwood Trust-like originators who would like to come to market but most have had capital drained from them so it's unlikely that we will see many deals going forward. But you need the large banks to step in because they are the ones with the most stability and when they do, that will help restart the private mortgage market."
Elton Wells, director in MBS at SecondMarket, said that there has been interest from some hedge funds, but there isn't really any demand for newly issued non-agency paper at the moment. "We are still far away from the private-label market re-establishing itself in a big way," he said.
The fact is that, despite rumblings of more deals to come, the GSEs remain dominant. It's likely to be slow for the foreseeable future considering that the Federal Reserve Bank is showing no signs of pulling out of the market.
"They can't get out of the market; they are way too big and own too much, said Jesse Litvak, mortgage trader at Jefferies. "They literally are the 700-pound gorilla in the room...it's a tough situation."
Weaning Off the Govt.
Wells believes that the U.S. Treasury will eventually undergo a gradual weaning to help jump-start new issuance in the private-label ABS market.
From the securitization market perspective, the ASF had done its work to create an operational framework for RMBS deals. However, the government has to allow the market to happen.
"There is a slowdown in the origination of mortgages - the GSEs have become the subprime lender of the market and I don't think that will change anytime soon," Wells said. "You have a situation where the government has taken on so much responsibility and with the upcoming election it's less likely that they want to be seen as stepping out."
At the crux of the matter is figuring out how to get the private label sector jump-started while maintaining open avenues of lending for the less-than-prime borrowers through government-sponsored programs. This is required since any comeback of private label mortgage lending will be only for the most prime borrowers.
Reiter said that when reforms do happen, it is unlikely that the government will step out entirely.
In mortgages, subprime replaced the function of lending to first-time home buyers with low deposits or higher LTVs. Without this alternative, borrowers will turn to Ginnie Mae to provide mortgages to the lower end of the market.
Above-conforming Jumbo mortgages are likely to be the first products the government steps away from and would likely shift back into the private market. However, before that can happen, banks need to see the opportunity to create more capital and less risk. Reiter believes that only an interest rate hike would offer the solution to that equation.
"Until the banks can make money off of writing mortgages, it's likely that the GSEs will have to remain to service the market. For now, the housing market is, to an extent, addicted to the lower interest rate provided by the government. But it's clear that the GSEs are losing money and they are making loans that are unprofitable - on the one hand the government wants to keep people in house, but on the other the rates just don't make sense," Reiter said.
Whatever shape reforms take, government policy will be biased toward expanding programs that keep borrowers in their homes through modifications or short refinancings. For non-agency MBS, an increase in principal forgiveness modifications would have the effect of accelerating a portion of losses and extending the duration of cash principal receipts with generally positive valuation implications for bonds at the top of the capital structure and negative implications for mezzanine and IOs, RBS analysts said.
Short refinancings would accelerate losses and greatly increase voluntary prepayments, having a disproportionately positive impact on discount current and second-pay structures and a disproportionately negative impact on mezzanine and IOs. Both principal forgiveness modifications and short refinancings should help lower foreclosure rates, mitigate possible negative house price movement and reduce loss severities.
The Quest for Assets
Banks are also facing the problem of sourcing assets. The fact is that originators need to increase originations each year without the volume of private-label mortgage origination in the market that faces a supply constraint.
Mortgage origination volume, according to RBS, has declined dramatically over the past three years and house prices have fallen significantly, but the economics of the housing market are still somewhat complicated.
The origination pace of Jumbo loans, for instance, is likely to be half of what it was projected to be and half of that will be taken up by the GSEs; it reduces the assets that the private side has to work with.
Redwood in its company report stated that in 2009 there was $192 billion of residential mortgage originations over the $417,000 standard conforming limit. Of which, $100 billion (52%) went primarily to Fannie Mae and Freddie Mac instead of the private sector.
According to Reiter, since 2009 90% of all mortgages underwritten have been done through the GSEs, and the other 10% have been kept on originator balance sheets such as community banks and savings & loans. None were done through the non-agency MBS market.
"The private-label market is absolutely frozen and credit isn't flowing to that side of the market," he said. "So banks are unable to make economic profit, and most of these players are concerned with the changes ahead that will bring greater capital charges."
Another key question for the mortgage market is what next steps the government will plan with respect to quantitative easing. Flanagan said that the obvious question that could affect the market would be if the government opted to exit its MBS portfolio. "It's a main objective because it's difficult to manage that portfolio and implement monetary policy," he said. "The path forward may be in the non-agency space where this agency paper will eventually end up for refinancing and eventually could end up as securitizations."
For the non-agency space, whatever the next steps might be in regards to quantitative easing, it's a win-win scenario for banks. "On the one hand, if the market does not require quantitative easing, that means credit performance will be OK; on the other hand, if it turns out that the market needs more stimulus, then the non-agency space will get the benefits of a lower yield environment," Flanagan said.
However, Wells believes that even if the GSEs sell off the MBS on the books, they may not be put back into the market as private-label securitizations. It's also unlikely to offer any valuable support to primary issuance volumes in the sector, or to really kick-start the market in any sustainable way.
The dearth of reinvestment in MBS may also impact valuations because of higher levels of mortgage originations needed to sustain the market. The void is due to the federal government holding nearly 40% of the MBS market through the Federal Reserve, the Treasury Department, Fannie Mae and Freddie Mac, asset-management firm Smith Breeden Associates said in its bi-monthly commentary.
To find innovation in the industry issuers will need to realize where they decide value continues in liquidity funding over the last few basis points they can get out of the deal by further structuring. Investors also need to want to start picking up the issues, and the only way that is going to happen is if the government begins to wean the buyside off of the GSEs.
Tom Millon, chief executive and founder of Capital Markets Cooperative (CMC), said there has been more rumbling of future private label RMBS deals.
CMC in September announced that private equity firm WL Ross would invest "significant capital" in its business. The added equity facilitates the sale of loans made by smaller lenders to big secondary market buyers such as Wells Fargo.
He said that the equity injection positions CMC to participate in the revival of the private-label RMBS market. "We have seen more activity in the last six months," Dillon said. "Banks want the loans, but the fact is that the origination just isn't there."
At the moment, CMC does the majority of its business in the agency space. However, Millon said the company is looking toward expanding its non-agency side and could use the loans as collateral in a private-label deal.
According to LSU's Mason, more PMI providers are also writing coverage for new loans, and these providers have expanded coverage to step in where the GSEs step out. Much of the market has long awaited the opportunity to take over the prime sectors historically dominated by the GSEs.
Although talk of PMIs stepping in to pick up some of the slack where the GSEs leave off may be encouraging, Wells said that the monoline debacle is still fresh on the mind of buy-siders who might question how valid the backstop provided by these companies will be when it comes time to pay up.
"Are they going to be able to make all the payments? When compared to the government, will the appeal make sense because you don't consider that the government will have difficulties making good with its assurances?" he said.
Secondary Market Improving
On the secondary front, more progress has been made in terms of pricing the hundreds of thousands of RMBS bonds outstanding. JPMorgan Securities said that in the non-agency space market, at press time, pricing reached levels close to its two-year highs
According to Kyle Beauchamp, a director in the structured finance group at Markit, bonds are trading at improved pricing, and liquidity has improved. Where bonds price has also become less surprising, and the number of players in the market who are no longer forced sellers of RMBS mean less volatility from one trade to the next.
"As the equity market rallies and the corporate loan market rallies, investors have looked at non-agency RMBS as an asset type with attractive expected returns with limited downside," he said. "We have seen some real money and hedge fund investors look to place money in the space, but the fact is that there hasn't been any new issuance." ASR
Rumblings of a private-label RMBS revival have made the rounds for months now.
Redwood Trust's RMBS securitization last spring created some optimism that other issuers would follow. However, without a bigger piece of the mortgage origination pie, potential private-label issuers are still scrambling to get the right assets for a securitization market revival.
One of the most important tasks facing policymakers as they tackle the enormous challenge of the U.S. housing finance system's appropriate reformation is establishing a clear role for the private sector to work in conjunction with the public sector, said Tom Deutsch, executive director at the American Securitization Forum. The aim is to provide mortgage originators with efficient funding sources to make loans to home buyers.