Standard & Poor’s projects private-label residential mortgage-backed securitization issuance will hit up to $13 billion in 2013. Most would consider this a great feat, considering issuance totaled half of that in 2012.
However, when you fold back the layers of the market, challenging obstacles remain in play.
“The private securitization market is still facing difficulties from regulatory uncertainties, such as qualified mortgage and qualified residential mortgage origination standards, and from the significant role of (Fannie Mae and Freddie Mac) in the mortgage market,” analysts at the credit ratings agency noted. “We expect private issuance to grow slowly until the government-sponsored enterprises lower conforming loan levels and the GSEs begin to assume a smaller role.”
Standard & Poor’s also expects the diversity of sponsors and originators involved in new issue transactions will increase substantially.
As it stands now, there are really only two issuers in the private-label RMBS issuance game. That’s a far cry from the $1.19 trillion in the heyday of the housing bubble in 2005 when dozens of banks, mortgage lenders and others were issuing private-label RMBS. The top five issuers in 2005/2006 no longer exist in the market. Back then, Countrywide Financial was the top issuer with $153 billion of issuance volume for that year. Similarly, the top three underwriters during the height of the housing market are no longer players in the RMBS issuance market either. For instance, Lehman Bros., which went bankrupt amid financial crisis scandals, insured $128 billion in 2006. Fannie Mae, Freddie Mac and Ginnie Mae today back more than 90% of mortgages in the U.S.
The first issuer is Credit Suisse. The Swiss bank made its way on the private securitization market scene in 2012 by closing three deals, totaling just under $1.5 trillion and recently priced its first private-label 2013 deal for $425.7 million (see page 50).
California-based Redwood Trust leads the space, issuing at least one deal a month with an average transaction of $600 million. The real estate investment trust closed seven deals in 2012 with a total value of about $1.6 trillion and is on track with its goal, as it embarked on its third deal of the year in February.
However, the fourth deal, coming in April, is expected to be a little smaller. As of press time, the deal had not yet priced, but even if it does come in light, it is still too early to tell if the shrinkage is a trend. The platform Sequoia Mortgage Trust 2013-4 reported a total loan balance of $805.1 million, more than $200 million higher than the three previously priced transitions by Redwood ($22.35 0.4308%). The unpaid principal balance is $576.4 million.
Kroll Bond Ratings pre-rated the deal, giving the majority of the deal’s tranches AAA ratings.
Fitch Ratings also pre-rated Sequoia Mortgage Trust 2013-4, with the expected outlook slated as ‘stable’ with all the tranches also receiving AAA ratings.
Recently, Moody’s Investors Service used Redwood’s structural framework of its deals as a guide for other issuers to follow who wish to achieve AAA ratings.
“Redwood’s 12 post-crisis transactions to date exhibit the combination of strong representation and warranties and R&W enforcement regime, together with high quality third-party reviews and strong originator practices are consistent with Aaa (sf) ratings,” said Senior Analyst Kathryn Kelbaugh and Vice President Yehudah Forster of Moody’s.
Additionally, the analysts noted that weak deal structures can prevent top ratings for new RMBS issuance, even if the deals have strong prime loan pools and satisfactory originators and servicers.
For an RMBS to earn a top rating, investors should be protected against the risk of loss due to fraudulent or defective loans as well as have access to “robust and reliable data that provides transparency concerning loan terms, borrower credit and property valuation,” according to the Moody’s report.
“Issuers can create a strong RMBS framework in a multitude of ways, and we therefore assess credit risk and assign ratings based on each deal’s individual merits,” said Moody’s Forster. “Within the framework, one or more weak elements increase the risk that fraudulent or defective loans will be securitized. Where we detect weaknesses in one or more elements we will weigh whether the weakness can be mitigated with increased credit enhancement or whether the weakness is of such a magnitude as to limit the achievable ratings or preclude us from rating the transaction.”
On a similar note, banks have attempted to make their mark in the private-label RMBS world once again, but have faced delays.
For instance, JPMorgan Chase kept the banking giant’s jumbo deal under wraps and, as a result, delayed its first deal post-recession due to several structural issues that are slowing down the process of completion.
JPMorgan also updated its view on RMBS issuance, noting that volume is expected to fall somewhere between $20 billion and $30 billion in 2013.
John Sim of JPMorgan Securitization Product Research believes other entities will make a comeback in the market this year, including REITs as well as big banking companies such as Wells Fargo and Bank of America.
REO-TO-RENTAL INTEREST RISES
The prospects of REO-to-rental collateral backing securitizations looks bright this year. However, no such activity has occurred, S&P said.
“We expect that such activity will be concentrated with only a limited number of large aggregators with relevant management experience and economies of scale having the capacity to take advantage of the strategy,” the analysts said. “We also expect the duration of the REO-to-rental securitization activity to be relatively short, as distressed home prices, which make the strategy particularly attractive, rebound in the local economies targeted.”
Analysts at Barclays said the housing bust that began in 2007 highlights the depth of the oversupply of single-family homes. The research firm projects 4 million in distressed liquidation over the next three years and 6.4 million over the next five years.
According to Keefe, Bruyette & Woods, real estate investment trusts alone raised up to $8 billion for REO-to-rental investments, suggesting potential acquisitions of up yo 80,000 properties. Still, this amounts to less than 15% of unsold REO inventory.
Rick Sharga, executive vice president at Carrington Holding Co., estimates there are roughly 500,000 REO homes not yet sold, another 1.1 million homes in some stage of foreclosure and 3.5 million borrowers who are seriously delinquent on their loans, but not yet in foreclosure.
FUTURE STILL UNCERTAIN
Although market interest in new prime issuance has improved limited volume seems to be a key issue, sources told HousingWire.
The deals issued since 2009 by Redwood as well as Credit Suisse are low loan-to-value ratio, strong borrowers and pristine loans, leaving a limited option for investors: Invest in agency RMBS issued by Fannie Mae, Freddie Mac or Ginnie Mae or invest in super safe, low-yield deals, said Scott Sambucci of CoreLogic Advisory Services.
A big uptick in RMBS issuance is expected in the second half of 2013 once originators and investors figure out what the final Consumer Financial Protection Bureau’s rules are, specifically the Qualified Residential Mortgage standard, due out sometime this year. The QRM will detail which type of mortgages will be exempt from a requirement that lenders retain a 5% stake into loans packaged into securities.
On Jan. 9, the CFPB unveiled the Qualified Mortgage rule, creating two types of qualified mortgages with different legality standards that require a lender to determine a borrower’s ability to repay. The first QM-loan classification includes a safe harbor provision, which eliminates the ability-to-repay litigation risk for qualified loans. The second type comes with a rebuttable presumption of safe lending, applying to higher-cost loans.
Now the private-label markets awaits the release of QRM standards, which will determine if the nation can sustain a healthy securitization market, said Jon Woloshin at UBS.
“We don’t know where that stands, and we certainly hope that we’ll get clarity on that. But as we noted, the balance for regulators is the balance of keeping skin in the game and not putting excess risk on, versus making the QRM rule so stringent that it basically shuts out people willing to securitize mortgages,” he said.
Similarly, a looming risk for investors in regard to the QM rule is the cap on origination fees of 3%. As a result many players in the private-label market could blow off the QM rule entirely.
When an investor weighs the risk and reward of falling in line with QM and QRM guidelines, the blurred distinctions between loans that have a safe harbor from ability-to-repay litigation and the rebuttable presumption may be too much for investors.
“Under the CFPB’s final ability-to-repay rule, a qualified mortgage that is not a higher-priced loan will be entitled to safe harbor, and a qualified mortgage that is a higher-priced loan will be entitled to only a rebuttable presumption of compliance. As a result, the market for higher-priced mortgage loans may be limited, at least initially,” law firm Ballard Spahr said in a legal alert to clients.
However, many believe that the CFPB’s mortgage rules are critical steps in getting Fannie Mae and Freddie Mac out of the housing finance sector, allowing for the private-label market to stake its claim, said Gyan Sinha, a partner at KLS Diversified Asset Management, a partner and portfolio manager of structured products.
From an investment standpoint, having the final rule of QM and the forthcoming ARM standards is a positive. The idea of having a minimum amount of collateral is central to the idea of creating pools of loans because the behavior of those pools will be predictable and transfer into the secondary market, creating very safe securities, Sinha noted.
“Clearly the ability to forecast when losses are likely to be is a key element, you can’t create safe assets with risky loans unless you understand the risk being moderated,” Sinha said.
Thus, creating a second market to support housing finance is essential if the nation wishes to move away from the influence of government-sponsored enterprises. While Sinha stated it’s a tall order, it’s not impossible.
However, many experts noted at the American Securitization Conference earlier this year that the GSEs are here to stay, providing a limited window of involvement for private players.
Both Fannie Mae and Freddie Mac posted hefty profits for the past three quarters — the first time in a long time — which is not surprising given rises in guarantee fees. Fannie Mae reported net income of $1.8 billion for the third quarter of 2012. Freddie Mac reported net income of $11 billion for 2012.
Profits are handed over to the U.S. Department of Treasury, under terms of the federal government’s support agreement as amended and effective in August 2012. This provides greater incentive to keep both government-sponsored enterprises intact, according to Vice Chairman James Lockhart III at WL Ross & Co., a private equity firm.
Ed Pinto, a resident fellow at the American Enterprise Institute, said he expects Fannie Mae and Freddie Mac to remain dominant in the market for the next seven or eight years due to the QM rule and pending QRM standard.
With the continued GSE dominance in the mortgage finance market, the private sector will remain on the sidelines, hindering private-label RMBS issuance.
BASEL III'S IMPACT
Another factor impeding the private-label RMBS issuance uptick is Basel III, which places stringent capital requirements on banks for “Tier 2” mortgages — any negative amortization, interest-only and adjustable-rated mortgage loans.
Basel III will eventually impact borrowers in the form of higher costs for credit access, according to Partner Jermone Walker at SNR Denton and Garret Ahitow, executive director of regulatory capital management at JPMorgan Chase.
Under the current rules, residential mortgages receive identical capital treatment, but under the proposed rules, risker loans would further restrict capital.
Similarly, James Garnett, head of risk architecture at Citigroup, cautioned that Basel III rules for capital reserves at financial companies may lead to a reshaping of investment banks.
The proposed rules would require gains and losses on securities held as “available for sale” by a bank to move through its regulatory capital levels while the current rules impose a “filter” to prevent value fluctuations in the securities from passing through to regulatory capital. In short, Basel III would remove this filter.
“The elimination of the filter will create inaccurate reports of actual capital strength; it will mean that capital will look like it is increasing as interest rates fall and decreasing as interest rates rise — but neither result will reflect reality,” Garnett said.
While Basel III finalization is pending, the requirements are expected to have a negative impact on the securitization.
Even if the private-label market receives other issuers, the volume isn’t enough for the private-label market to make its comeback. With lingering factors including the GSEs staying put, mortgage finance litigation and pending Basel III rules, there are too many forces pushing against RMBS to see issuance make a significant stance in the market this year.
“Overall, the long-awaited recovery in U.S. housing markets should benefit housing and mortgage sectors. Although it won’t necessarily occur in 2013, we expect to see something of a shift back from the dominance of agency mortgages and securitization to increased private issuance,” S&P said.
The credit ratings agency analysts cautioned, “Still, the recovery remains fragile, and a worsening of economic conditions resulting from a failure to negotiate a budget and avoid the fiscal cliff, among other potential obstacles, could impede further improvement.”
