Biden victory points to new securitization backdrop
For many investors, the US election landed in the best possible place — a Joe Biden win with a split Congress, ensuring a strong pandemic plan, yet blocking radical change. But Biden’s leadership will reshape securitization markets through changes to critical regulatory agencies, setting the tone for the next four years in consumer credit, mortgages and green securitization. Jennifer Kang reports.
If the coronavirus shaped the first 10 months of 2020, the last two months were all about politics. November 7 was a watershed moment for the capital markets as Democratic candidate Joe Biden was announced as the next US president.
Rather than the “blue wave” market participants expected, which would have heralded a raft of progressive reform, the US saw a “blue ripple”. Congress is divided between a Republican-led Senate and a Democratic House, where the Republicans also picked up seats.
That means radical changes, which worried some investors, probably won’t happen. Tax increases will be minimal, the size of the stimulus will remain moderate and Congress is unlikely to muzzle the finance sector. But capital markets, particularly for consumer-faced credit, will face a very different backdrop under Biden.
Consumer watchdog gets its teeth back
While Donald Trump’s presidency scaled back regulations that affected securitization, Biden is likely to reverse the anti-regulatory stance. However, if he seeks to do so through an act of Congress, the Senate is expected to block it.
The Senate may also block regulatory appointments that require its nomination and vetting — or, at the very least, it will require moderates to take the roles.
“Because Biden will have to push nominees through the Senate for agencies like the Treasury, there will need to be some crossover support from both sides, and you will more likely get a mainstream Democrat than an extremely progressive one,” says Scott Ruesterholz, portfolio manager on the global credit team at Insight Investment in New York. “You won’t get someone like Elizabeth Warren as Treasury Secretary, for example.”
But there are still ways that Biden can wield his presidential power over the financial sector without the co-operation of the Senate. The two key federal agencies the president-elect will likely begin with are the Consumer Finance Protection Bureau (CFPB) and the Federal Housing Finance Agency (FHFA).
“Personnel is policy,” says Ruesterholz. “The regulators can have a lot of power, and they will take a more hawkish stance on regulations than we saw in the past four years.”
In a 5-4 decision in June, the Supreme Court ruled that the president has the right to fire the CFPB director at will. The court case, dubbed the Seila Law, has far-reaching implications, because the FHFA and the Office of the Comptroller of the Currency (OCC) share the same leadership structure as the CFPB.
While the Trump administration had successfully de-fanged the consumer watchdog through this court case, its achievement has backfired.
Now that Biden has won, he is almost certain to dismiss the current leaders of the CFPB, as well as the FHFA and OCC when he gets the green light from the Supreme Court.
“The key thing to remember about the CFPB is, among all the federal banking regulators we have, the President is authorised to remove its director for any reason or no reason,” says Rachel Rodman, litigator at Cadwalader in Washington DC, and previously senior counsel in the CFPB’s legal division. “That means on day one, Biden can ask for [Kathy] Kraninger’s resignation.”
After dismissing Kraninger, Biden can appoint an acting director through the Federal Vacancies Act. Two likely candidates are Rohit Chapra, the commissioner on the Federal Trade Commission, and Patrice Ficklin, the founding director of the office of Fair Lending and Equal Opportunity at the CFPB, says Rodman.
“The CFPB likely sees someone in the mould of Richard Cordray taking power,” says Greg Lippmann, chief investment officer at LibreMax Capital. “A reinvigorated watchdog after several dormant years could lead to a more challenging environment for lenders to assert their rights.”
Consumer ABS will face the biggest, most immediate impact as a left-leaning leader takes over the CFPB, beginning with stronger data sharing rules and fair lending laws. The Biden administration is also likely to go after bad actors more aggressively, particularly in areas such as marketplace lending, subprime auto and speciality finance ABS.
If any of the Dodd-Frank era “skin in the game” rule is reinstated and expanded to include marketplace lenders, this could cut securitization issuance from the sector.
“If such a rule becomes applicable to the fintech space, those issuers don’t have the balance sheet or the capability to take a slice of their own deals,” says Jason Merrill, investment specialist at Penn Mutual Asset Management in Horsham, Pennsylvania. “This in turn could diminish issuance, and this impact could affect other sectors as well across the securitized markets.”
A climate presidency
In such a highly regulated environment, survival will come down to who can adapt quickly, market participants say. For example, lenders with a focus on environmental, social, and governance (ESG) factors will be better suited to ride out the changes.
Biden has vowed to make good on his green energy ambitions. That could help market sectors including solar loans and Property Assessed Clean Energy (PACE). Even auto ABS bonds could benefit if any green package includes rebates and incentives are provided for green cars, says Merrill.
Other winners in the ABS space under Biden could include container and railcar ABS, as the new president’s trade policy is likely to be less combative than Trump’s.
“The noise around the transportation sector — railcar and container — will go away,” says John Kerschner, head of US securitized products at Janus Henderson Investors in Boulder, Colorado. “As Covid fades and international trade picks up, we won’t have to worry about a trade war.”
GSE reform in limbo
The mortgage market is anticipating big changes, with FHFA director Mark Calabria at risk of dismissal.
Similar to the Seila Law, there is a case on the FHFA’s leadership structure under review by the Supreme Court. Sources predict that Calabria’s dismissal would come sometime in the first term of Biden’s presidency, and as soon as the first half of 2021.
“We will probably feel the impact most poignantly and more immediately on the residential mortgage side of the securitized universe,” says Dave Goodson, head of securitized fixed income and a senior portfolio manager at Voya Investment Management. “We’ve already seen some forces put into motion.”
In a race against time, Calabria issued the government sponsored enterprises (GSE) reform capital rule on November 18, the final step before releasing Fannie Mae and Freddie Mac.
Whether the GSEs stay privatised or not is not really the issue, sources say. What’s concerning is the uncertainty the mortgage market will face until Biden appoints a new director. Calabria will keep walking the path of privatisation, but a new director will probably halt or reverse the effort.
“Fannie and Freddie will probably remain in conservatorship for the foreseeable future, which the world seems to be okay with,” says Kerschner. “On the downside, mortgage investors will like to see a resolution, but there is still uncertainty hanging over the market.”
Nonetheless, market participants say Biden is well aware of how important the agency RMBS market is, making any radical, harmful changes an unlikely outcome.
“I find it difficult to see the Biden administration doing anything that would upset the apple cart of agency RMBS because it’s a very important part of the housing market. Treasury secretary Mnuchin is also very cognisant of its importance,” says Ramon de Castro, credit analyst and team leader on the T Rowe Price securitized products research team. “Agency MBS and CRT investors want to make sure agency RMBS credit remains prudent and transparent. They would not want to disturb that.”
With GSE reform out of the picture, the FHFA under Biden will see a reversion towards Obama-era policies, using Fannie and Freddie to attack income inequity and promote affordable housing.
A light at the end of the tunnel
While the pandemic remains a wildcard, investors are carrying on with a sense of realistic optimism that a vaccine will come and the economy will recover.
Market participants expect 2021 to be a more normal year, when issuers think about returning to their regular issuance programmes, bolstered by continued support from the government and the Federal Reserve.
“There is a sense of realism now that we know there is a vaccine coming from three different providers that will be available in a more definite time period,” says John Cho, head of term ABS at Société Générale in New York. “People feel more comfortable with what will happen in 2021 and there is a light at the end of the tunnel.”
This continued sense of optimism is what keeps market participants confident that issuance will increase across securitized products next year. A handful of issuers who were hiding out in the first half of the year have already made a return in the past few months.
“Led by a highly accommodative Fed, 2020 issuance staged a strong comeback following March and April’s financial turbulence, which we expect to continue due to a combination of low rates, strong consumer and residential loan demand, and abundant capital on the sidelines,” says Justin Gregory, portfolio manager at Hildene Capital Management. “The demographic shift of the ‘flight to the suburbs’ brought about by Covid-19, provides a tailwind to the auto and residential sectors that should lead to robust new issue supply.” GC