Securitization

As bad as the subprime mortgage meltdown has been, market analysts don't question that there will be a recovery. The concern is really about how soon the bounce-back will happen. The toll the mess has taken on the reputation of mortgage brokers, however, is a different matter.

The Federal Reserve has urged the use of loan modifications to stem the tide of defaults that could result from the current subprime mortgage troubles, and servicers appear to be responding.

Hard money lending has traditionally been used as a short-term funding option for borrowers who have been seriously delinquent on a prior loan and are unable to refinance into a new, conventional loan.

Mortgage flows in the early part of the week were below average and mixed. The rally in Treasurys last Monday, to even lower yields following the previous Friday's shocking employment report, brought additional convexity buying from servicers. Buying support also came from real money. Last Tuesday's selloff moved the convexity bid to the sidelines and generated better selling as investors again focused on various risks. This included news that Countrywide Financial was seeking another capital infusion. Uncertainty about Federal Reserve action on Sept. 18 added to general nervousness in the market. Further adding to mortgage woes were poor dollar rolls on the high funding costs. As far as overseas investor participation was concerned, it remained lackluster into midweek. Originator selling was also light, with roughly a $1 billion per day average.

The European Central Bank's announcement last week that it would hold off on any further rate hikes in the current market led market players to suspect that the Bank of England will follow suit. And while a slowdown on rate hikes is expected to improve consumer sentiment, some players believe the current market crisis could take more than two years to run its course.

Saying that securitization and its benefits require functioning capital markets, two industry groups last week outlined measures designed to improve market conditions for the ABCP and structured investment vehicle (SIV) sectors.

The volatility continuing to grip the structured investment vehicle (SIV) sector has forced at least one program to liquidate assets, while others brace for a similar fate. IKB Credit Asset Management (manager of IKB's Rhinebridge SIV) announced that it had liquidated $176 million of securities, becoming the first "conventional" SIV to do so. Cheyne Finance, an SIV with assets with a face value of approximately GBP6 billion ($12.9 billion) run by Cheyne Capital Management, a London-based hedge fund, also faced liquidation.

While even a couple of weeks ago European loan market participants were hoping for their market (which has barely seen a drop in the way of primary issuance over the past month) to get going in September, the word is now that it will take longer, much longer than that for new loans to be structured and priced. And when fresh transactions do come, sources say they will be vastly different from the funky stuff that Europe has so recently been witness to.

A small handful of home equity loan deals, a credit card transaction and a pending auto deal kept the ABS market from coming to a complete standstill in the last couple of weeks.

About this time last year, all signs indicated that the market for structured investment vehicles (SIVs) was up and coming. In the second half of 2006, the sector had about $250 billion in debt under management. According to Moody's Investors Service, that jumped to $400 billion by a week or so ago. The rating agency estimated that SIV-lites, a less closely managed and slightly simpler version of SIVs, had about $12 billion outstanding by the same date.

After a tumultuous summer in the subprime mortgage market sapped CDO liquidity, market participants are now faced with the challenge of salvaging earnings, which includes trimming down the payroll.

The subprime mortgage meltdown has had a much deeper impact on the jumbo loan market than many thought it would, leaving analysts to wonder what the best solution is for galvanizing the slumping sector. While many economists believe help will come from the Federal Reserve, some lawmakers want Fannie Mae's and Freddie Mac's loan restrictions loosened to aid the jumbo market.

When the CPDO structure was first introduced, with the launch of ABN Amro's SURF deal in August 2006, there was concern that the structures might not hold up in a volatile market, given that they are highly levered and market sensitive.

President George Bush's proposal to allow a certain segment of subprime borrowers to refinance into loans insured by the Federal Housing Administration is being seen as a measured first step to help troubled borrowers, although one that will likely only have a limited impact. The FHA modernization steps are expected to help about 240,000 homeowners refinance and avoid foreclosure, but it is considered a drop in the bucket when more than a million loans could default.

The flight to quality in the credit markets has made pricing in the area a difficult issue, and has brought buyers and sellers of risk instruments to an impasse as to the value of structured products, according to a report by Moody's Investors Service. The ratings agency says, furthermore, that this process of untangling prices could take months to work through. "Before the credit markets can resume normal functioning, the creation of a new price consensus between (and among) buyers and sellers of risk instruments will be required," says the report, which was co-authored by Vice Chairman Christopher Mahoney. This won't happen quickly, according to the report, because many capital market participants are facing inventory problems with structured finance securities such as subprime, Alt-A-related RMBS, CDOs, and certain leveraged loans. The holders of these loans are not willing to dip to bargain basement sales, and meanwhile, on the other side of the fence, the buyers won't touch the offered prices because they think prices are still erratic and could erode further. The report focuses on what's missing from the market, says Mahoney, "which is fluidity, a readiness to engage and trade." As a result, he says, he thinks a more robust secondary market will develop, as levered players will be forced to sell illiquid securities at low prices. The report is called "From Illiquidity to Liquidity: The Path Toward Credit Market Normalization." It is the first in a series of planned reports in which Moody's will discuss systemic problems revealed by the subprime meltdown.

JPMorgan Chase restructured its 17-year-old ABCP program, called Jupiter Securitization Co., not - say sources familiar with the situation - as a defensive move against the currently volatile ABCP market, but so its sellers could avail itself of accounting procedures under FAS 46.

Much of the trouble proliferating through the major indices last week could, in part, be traced back to the ABS industry. This is where fast money and high-risk structures fed a long period of growth in the housing market, which many market participants now concede was unsustainable.

Liquidity issues that destabilized the delicately balanced ABCP market in recent weeks migrated north into Canada. Similar to problems that unfolded in the U.S. ABCP market, lack of investor confidence in the debt capital and credit markets widened spreads on all types of Canadian ABCP.

(The is the second installment of a two-part series. The first installment discussed the valuation challenges presented by the current difficult supbrime mortgage environment. This installment focuses on the other valuation complications resulting from troubles in the sector. )

The upsurge in housing over the past few years has given way to an unprecedented amount of questionable activity in the mortgage market, including fraud. And while regulators have ramped up their combative efforts, fraud's growing breadth has proved to be alarming for U.S. RMBS.