Securitization

Banks and insurance companies that issue trust preferred securities are now highly sensitive to financial institution risk and have acquired a distaste for the CDO structure, which has pooled these securities.

Last week started off promisingly enough. The Federal Reserve gifted the credit markets with a 75-basis-point rate cut and provided more liquidity in the form of the $200 billion term securities lending facility. Also, the industry absorbed news of JPMorgan Chase's bargain basement buyout of Bear Stearns, rescuing the investment bank from total failure.

The Federal Reserve-orchestrated fire sale of Bear Stearns to JPMorgan Chase has forced the market to come face to face with the prospect of massive government bank bailouts, and of what it could mean to taxpayers.

With Bear Stearns' fate far from determined, the future of the bank's Latin American structured finance business is likewise uncertain.

Morgan Stanley and Royal Bank of Scotland are working on Bishopsgate Asset Finance Series 4, a corporate bond repack for Thames Water Utilities. The underlying collateral is expected to have a triple-B- plus rating, and the deal will be denominated in sterling. The transaction is expected to be launched in the near term, depending on market conditions.

Northern Rock said last week that it plans to become a smaller, more focused mortgage and savings bank. However, it still intends to continue with its securitization business.

Two major investment banks, Lehman Brothers and Goldman Sachs, reported first-quarter earnings last week. While the two banks may have beaten analysts' estimates for the period's performance, both acknowledged significant RMBS losses and credited client activity with buoying their fortunes.

Earlier this year, during an industry conference, representatives of Wilshire Credit Corp. were said to be scouting for capital partners willing to purchase whole loans, while giving it the servicing rights.

When Standard & Poor's an-nounced that write-downs related to subprime losses might be nearing an end, it should have caused at least a brief rally in the market simply because good news has been so rare over the past months.

XL Capital Assurance's (XLCA) parent company Security Capital Assurance (SCA) responded to a lawsuit filed yesterday in New York by Merrill Lynch, accusing XLCA of refusing to cover losses on $3.1 billion in seven CDOs that the company had written swaps on. SCA said that it had terminated XLCA's contracts with Merrill Lynch due to a breach of contract in the obligations by promising control rights in the investment to various parties. "Merrill had repudiated its contractual obligations to XLCA by committing to provide one or more third parties with the same CDO control rights that it had previously promised to XLCA." As a result, SCA said that is in not obligated to make these payments. Quinn Emanuel Urquhart Oliver & Hedges will represent SCA in court.

Advisory firm Westwood Capital has launched a hedge fund which will patronize a segment of the mortgage market that most investors are avoiding. The New York City-advisory firm created the fund in a partnership with ARC Global Partners, also of New York, and has begun bidding on loans. The targeted assets: first-lien, owner-occupied, nonperforming loans in the 60-day-plus delinquency bucket, according to sources familiar with the situation. At its bare essentials, Westwood's strategy is to pick up the loans at a discount and use its servicer, which was not named, to get the loans to reperform. To spearhead the initiative, Westwood appointed three industry veterans. Morton Dear, former vice chairman of The Money Store, is chairman of the new fund; Evan Mitnick joined as president. Mitnick joined Westwood Capital in June 2007 after leaving New Century Financial, where he was a senior vice president. Mitnick was also a director at Citigroup Global Markets.

The Office of Federal Housing Enterprise Oversight, Fannie Mae and Freddie Mac have made a major initiative to increase liquidity and support the U.S. mortgage market. The move is expected to offer up to $200 billion of immediate liquidity to the MBS market. OFHEO projects that two GSEs' existing capabilities along with this new initiative and the release of the portfolio caps announced in February, should allow the GSEs to buy or guarantee about $2 trillion in mortgages this year. This capacity will permit them to do more in the jumbo temporary conforming market, subprime refinancing and loan modifications areas. OFHEO announced that it would now permit a considerable portion of the GSEs' 30% OFHEO-directed capital surplus to be invested in mortgages and MBS. As part of this move, both companies announced that they will start raising significant capital. The agencies also said they would maintain overall capital levels well in excess of requirements while the mortgage market recovers. OFHEO will also immediately reduce the existing 30% OFHEO-directed capital requirement to 20%, and will consider further reductions in the future. This move by the OFEO will free up $2 to $3 billion in excess capital and will result in the GSEs having a significant capital cushion over the new 20% regulatory requirement, which eventually should drop to 0%, according to Morgan Stanley equity analysts. With excess capital, Fannie Mae and Freddie Mac might be able to buy as much as $100 billion or more in MBS. However, Morgan Stanley expects spreads to compress on the announcement of this deal, thus actual purchases by the GSEs would likely be lower. Morgan Stanley analysts viewed this announcement as a positive in terms of allowing faster growth in retained portfolios and net interest income for Fannie Mae and Freddie Mac. It also reduces the probability for the need to raise dilutive common equity if credit losses trend upward. Another positive is that it is a philosophical victory "that reaffirms the mission-purpose of the retained portfolios, which government officials and politicians had called into question in recent years," Morgan Stanley analysts said.

Merrill Lynch said today that it filed a lawsuit against XL Capital Assurance to compel XLCA, a unit of Security Capital Assurance, to meet its contractual obligations for credit default swaps. In a lawsuit filed in the U.S. District Court in Manhattan, Merrill alleged that XLCA is attempting to avoid its financial obligations of up to $3.1 billion under seven credit default swaps. The bank wants a court order that each of the credit default swaps remains in full force and effect.

Lehman Brothers reported net revenues of $262 million for its fixed income capital markets segment, a drop of 88%, caused by deterioration in the market for residential mortgages, commercial mortgages and acquisition finance. During the same period last year, the bank cleared $2.2 billion in net revenues that it completed the first quarter of last year, according to statement about it first-quarter results. The results reflect the impact of what was a very difficult market environment, said Erin Callan, CFO of Lehman Brothers. The investment bank's results were highly anticipated, given news about the collapse of Bear Stearns, which presented Lehman Brothers with fierce competition on several fronts of asset securitization and fixed-income investment banking. From a competitive standpoint, however, officials there declined to discuss how it might use the opportunity to take more market share. "It is fair to say that we have great sympathy for our colleagues at Bear Stearns. We are very sad about what happened at that organization," said Callan. Still, she said, so many other issues surround the ongoing fallout of the current capital market that it was hard to focus on the potential upside for Lehman Brothers. As for its other capital markets results, weaker demand for fixed-income investment banking led to lower underwriting activity in that segment, but its mark-to-market adjustments also materially impacted results, said Callan. Despite the ongoing volatility in the capital markets, however, the company highlighted two positive developments that helped it sustain some buoyancy during its first quarter: strong trading and robust client activity across its credit markets. Spreads on several securities asset classes underscored the market conditions, said Callan. Certain classes of asset-backed securities had widened out to levels of 140 basis points over their benchmarks, while triple-A MBS paper had ballooned to 135 basis points over and triple-A CMBS paper had widened out to 180 basis points, she said. Overall, the holding company saw its net income drop to $489 million, a 57% decrease from net income of $1.15 billion in the same quarter a year ago.

Although housing starts were down slightly as widely expected, the level was much higher versus previous projections given the steep upward revision to the January figure, according to RBS Greenwich Capital. January's starts were boosted by roughly 60,000 units compared to initially estimated. "Do not be fooled by the volatility, which is being generated primarily by the erratic multi-family segment," wrote RBS Greenwich analysts. They added that single-family housing starts dropped by 6.7% in February and January's upwardly-revised level for single-family starts was still down 3.1% versus December. Indeed, single-family starts have dropped for 11 straight months and are at the lowest level in 17 years. Other market players will also point to the dip in building permits as a sign of further upcoming weakness, but the firm's statistical analysis implies that permits are more of a coincident, but less sensitive to weather, indicator to starts than a predictor. This is why analysts said that, although the overall housing starts level is over the December reading, it is not at all clear that the homebuilding downtrend has been arrested. Analysts look for residential construction activity to continue to dip for all of this year, although analysts said starts might be comparatively near bottom. Analysts said they would not be suprised if December's reading of exactly 1 million turns out to be at or close to the cyclical low. Nonetheless, RBS Greenwich said these data are broadly consistent with the firm's view that the first quarter housing activity will drop as steeply as in any quarter so far in this cycle. "The good news is that the faster builders cut their production, the quicker inventories can be worked off," RBS Greenwich said. But, analysts warned that the inventory situation will not improve on a persistent basis until home sales stabilize. This stability will depend on perceptions of future house prices and the stance of lenders.

The Federal Reserve cut interest rates today by 75 basis points. The Fed's latest move brought the federal funds rate down to 2.25 percent, the lowest point since late 2004. It also marked the Fed's second back-to-back cuts of three-fourths of a percentage point. The Fed has also cut the funds rate six times since last September, with the reductions becoming more aggressive since January. Despite this latest cut, market participants who were expecting a 100 basis point cut in rates, said today's move is not sufficient to help out the beleaguered financial markets. However, this puts the Fed in a better position to help out given the recent creation by the Fed of the term securities lending facility, or TSLF, among other things, participants said. "While the Fed was slow to clue in to how quickly things could unravel, recent events show Bernanke & Co. now fully comprehend the risks to the economy and to the financial system," said Max Bublitz, chief strategist at SCM Advisors. He added that today's Fed action has had a greater impact than it otherwise would because the Fed had previously expanded the number of financial institutions that could access cheaper liquidity. "With the TAF, TSLF, and PDCF in place, today's less-than-expected rate cuts will be felt more directly and more fully by those institutions involved in the process of creating credit," Bublitz stated.

Mission Capital Advisors has hired Terence Bundy as an analyst. Bundy will focus on commercial sales and trading, business development, trading project management and due diligence. The new hire joined Mission Capital Advisors from Merrill Lynch, where he was an analyst of global markets and investment banking within the company's loan securitization group that focused on fixed, floating and stand-alone CMBS executions. Before Merrill, Bundy was a collateral analyst for Deloitte & Touche LLP, dealing primarily with the CMBS market.

Wilbur Ross is purchasing H&R Block's Option One mortgage servicing unit for $1.1 billion. The platform currently services about $53 billion in subprime mortgages. WL Ross is paying $41 million for the mortgage servicing rights, $942 million plus $100 million of retained receivable for the $1.1 billion of advances and $65 million for $85 million of other servicing related assets. The advances are expected to increase to about $1.2 billion and the increment will be purchased at a 3% discount as well. Ross said he will continue to acquire prime, Alt-A and subprime servicing, as he sees value in the industry despite the current turmoil. Previously, Ross agreed to acquire $42 billion of mortgage servicing rights from American Home Mortgage Investment Corp. The combination of the two platforms would total $95 billion and would create the country's second largest subprime servicing portfolio, after Countrywide Financial. Ross also said he would offer comparable positions to a number of the employees of Option One's servicing business, which is based Irvine, Jacksonville, Las Vegas and Pune, India. The deal is expected to close by May 30.

The Bear Stearns effect was felt across the Atlantic when the Bank of England announced its £5 billion ($10.01 billion) injection into the short-term money markets shortly after JPMorgan Chase said it will be buying the troubled investment bank. However, the surprise injection of reserves appeared to do little to bring sterling overnight rates closer back to bank rates. Market sources instead reported that the spread between the two widened after the announcement of the extra funds. The Bank of England is not due to make its next decision on headline interest rates until April 10.

Bear Stearns said yes to being bought by JPMorgan Chase for less than $250 million, both firms said, according to published reports. Reports said that the all-stock deal puts Bear value at roughly $2 a share, based on JPMorgan's closing stock price last Friday, the banks reported. By contrast, Bear Stearns shares, which dipped $27 on Friday, closed at $30, said reports. JPMorgan stated that it will guarantee Bear's trading obligations as well as its subsidiaries, said the reports. The discussions between the companies, which were overseen by the Federal Reserve and the Treasury Department, were rushed to reach a deal before stock markets opened in Asia at 8 p.m., Sunday Eastern time, said the reports. The companies' announcement said that the Federal Reserve would provide special financing for the transaction and that the Fed had agreed to fund up to $30 billion of Bear's less-liquid assets, said the reports. JPMorgan's bid represents a 97.5% discount to the $80 book value that Bears stated, reports said. JPMorgan seems to believe that Bear is worth far less than the value of the troubled firm's headquarters located in Midtown Manhattan, which is reportedly worth about $1 billion, the reports said. Bear Stearns was No. 12 in the public ABS manager rankings for 2007, according to the ASR Scorecard Database. Bear sold $30.88 billion and had a 4.7% market share. It was in 13th place in 2006 with $36.16 billion in deals and a 4.6% market share.