Securitization: Fixing the private label RMBS market
Issuers, investors and policymakers set their sights on jumpstarting the private-label securities market last year, but their efforts were fruitless, aside from the launch of a few jumbo deals. 2015’s pipeline is looks stronger though, and investors are better placed to trust issuers than they have been in years. Ryan Bolger reports.
Stronger underwriting standards by originators of mortgages, coupled with low yields on many fixed income investments, could increase demand for private-label RMBS this year. That would help to increase liquidity in the market and bring back the big investors which have sat on the sidelines since the market blew up in September 2008.
“We’re seeing a lot of small $5m-$10m players who are just starting to get back into this space, [but] we’re still missing a significant portion of investors, particularly the more meaningfully sized investors,” says Marc Simpson, head of JP Morgan’s RMBS conduit business in New York. “When you don’t see repeat issuers [and] repeat offerings, it’s hard to get involved and I think the [lack of] liquidity in the secondary market makes it very challenging.”
Both the supply and demand sides of the new issuance equation have been blamed for holding things up. Many bank lenders, fearful of potential liabilities, have declined to originate non-conforming mortgages.
The banks that did, limited loans to high quality jumbo borrowers — those seeking mortgages more than $415,000, which do not qualify for agency purchase as a result of their size.
Even the securitization of jumbo loans has been held up, though. Market participants have attributed that to interest rates on jumbo loans being higher than jumbo RMBS yields, meaning it has made more sense for a lot of would-be issuers to buy or originate loans and keep them on balance sheet.
Investors have been hesitant to jump back into the market that burned them with bad, and sometimes fraudulent, representations and warranties by originators that came to light only after borrowers defaulted. Many investors would like to see stronger protections against the issuance of shoddy mortgage-backed securities, despite an onslaught of enforcement actions and class action suits against mortgage originators and MBS issuers. More stringent enforcement against mortgage originators in cases when they make inaccurate representations and warranties on loans is “one of the most important areas that needs to be addressed” for the private-label market to come back, says Eric Kaplan, managing director of mortgage finance at Shellpoint Partners, a speciality finance company.
“That means holding originators’ and issuers’ feet to the fire, and I’m both,” Kaplan says. “If I make bad loans then get me out of the business. But I expect that others should be treated that way too — if that is not happening then somebody else is bearing the costs of my mistakes.”
GSEs aren’t going away
Part of the problem for the private label market’s return is the government’s unwillingness to exit. The Federal Housing Finance Agency (FHFA) has reiterated it will not push the US Treasury to remove government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac from conservatorship, and such a change would have to come from Congress. Prospects for that happening this year are bleak at best. The fact that Fannie Mae and Freddie Mac have returned to steady profitability has undercut the political will needed to bring about such a change.
The FHFA’s statement followed an announcement by its director Melvin Watt in October that the housing administrator would loosen purchasing standards for Fannie Mae and Freddie Mac. The GSEs would be allowed to purchase loans with down payments of only 3%-5%, rather than the 20% they had required since the financial crisis.
Loosening the GSEs’ purchasing standards could lead to more credit and securitizations. But that is far from a sure thing. As some market participants have argued, loans could just move from the Federal Housing Administration’s (FHA’s) programme to Fannie’s and Freddie’s balance sheet. What is sure is that the relaxed standards do little for the private-label RMBS market.
Of greater impact on the RMBS market were Fannie’s and Freddie’s guidance on when mortgage originators would have to repurchase loans from them, due to representation and warranty violations in November. The clarifications, part of the agencies’ life-of-loan exemption guidelines, were welcomed by banks, investors and regulators as a way to bolster the origination and securitization of mortgages.
“The aim of the new guidance is to encourage lenders to expand credit lending standards, and we believe that it’s certainly a step in the right direction,” JP Morgan analysts said in a note. “However, other obstacles stand in the way. Many originators were wounded by the putback claims on legacy originations and will remain cautious about drastically easing lending standards.”
The finalisation of Dodd-Frank rulemaking initiatives does support the private label market as well as the agency space. The agreement by US financial regulators on their long awaited qualified residential mortgage (QRM) rule was a relief for RMBS in 2014 and is expected to set the groundwork for private label issuance.
“You have certainty on the regulatory side as well as an increased market opportunity for non-QM [and] jumbo products,” Olga Gorodetsky, a Treasury Department policy advisor, says of the market.
Perhaps most important for market participants was the QRMs’ alignment with the term “qualified mortgage” (QM), and as a result the standardisation of underwriting standards and risk retention requirements. QM was defined by the Consumer Financial Protection Bureau (CFPB) in 2013. The CFPB’s rule for QMs outlines the criteria required for mortgage originators to limit their litigation risks via safe harbours and rebuttable presumptions over violations of ability-to-repay standards for mortgages. The ability-to-repay determinations in the CFPB’s rule for QMs outline minimum requirements for creditors to consider when they originate mortgages. Originators that fall outside of the QM box have also followed the ability-to-repay protocol, and they have placed emphasis on documenting their ability-to-repay analysis, so as to avoid any potential liabilities, market participants say.
The result is a more standardised and stringent underwriting process, which could alleviate enforcement fears held by originators and investor concerns over the legitimacy of the representations and warranties on loans backing securitizations.
The agency RMBS space could see a disproportional share of RMBS gains from the QM rule though. That is because mortgages backed by the GSEs are by definition QMs (but not all QMs are backed by a GSE). But the rule making initiative has already fostered some private label RMBS issuance in the jumbo sector.
A series of private label securitizations of QMs hit markets in 2014 as investors took advantage of high quality underwriting standards for jumbo mortgages. Private label deals by JP Morgan, Credit Suisse, Citi, Redwood and FirstKey, to name a few, were bought by investors attracted to yields on notes backed by strong, if large loans. QMs made up the collateral pools for those deals, and non-QM private label RMBS has eluded markets so far.
The Treasury is touting a market-based solution to the supply and demand standoff between originators, issuers and investors. The plan, pushed by Treasury Secretary counselor Michael Stegman at conferences since being announced at the start of 2014, calls for a benchmark private label RMBS issuance involving a large group of sponsors. Stegman hopes the deal will total at least $1bn, to improve liquidity in the secondary market.
The Treasury has also been discussing how to structure a benchmark deal in talks with issuers, institutional investors and ratings agencies, and the regulator hoped to have a term sheet finalised by the end of the year, Stegman said.
Joining the Treasury in its efforts has been the Structured Finance Industry Group (SFIG), which seeks to standardise market practices across mortgage originators, aggregators and securitizers in hopes of attracting investors back to the market for new issuance. Along with the Treasury, SFIG has solicited comments from market participants to develop a transaction framework.
Market participants have been both receptive and supportive of the Treasury’s plan, but many are cautious to buy in to the idea that a single benchmark issuance could be repeated by other issuers and solve the market’s woes.
Speciality finance companies — including Impac Mortgage in a partnership with Macquarie Group, and Angel Oak Capital — are looking to create a new securitization market in 2015, with plans to issue private label RMBS backed by non‑QMs.
While not the benchmark-style transaction advocated by the Treasury and potentially lacking the standardisation that SFIG hopes to bring to markets, non-QM deals could spark a private label resurgence. Non-QM transactions could see strong investor demand given their potential to offer higher yields than many other fixed income products.
“We’re holding loans on balance sheet here, with some financing, and then the partner financing us would more than likely lead the securitization effort,” Angel Oak head of capital markets John Hsu says. “Fixed income is a yield-starved sector, so investors are going to look at anything with yield potential.”
Banks could follow if all goes well, but market participants say banks are hesitant to enter the non-QM space because regulators could see it as a red flag — a legitimate concern given rumours that some mortgage originators are strategising ways to structure mortgages to avoid compliance requirements.
One possible way to skirt compliance requirements that market participants are talking about is for lenders to provide business loans for borrower-occupied residential properties, as a way to workaround the CFPB’s stringent mortgage origination standards.
“It’s like a bigfoot sighting,” Hsu said of these concerns. “I’ve heard it, but I’ve never seen it myself.”