‘The issue we still have is the same one we've had for the past two years,’ says Jeffrey Taylor, managing director and co-founder of Digital Risk LLC, a Maitland, Fla.-based mortgage risk management firm. ‘Until the backlog of the housing market flows through the pipeline, and until we get the backlog into the marketplace to be bought at distressed prices, there won't be much demand for securitization.’
Equally important, Taylor stresses, is the not-yet-codified provisions of the Dodd-Frank Act.
‘We need to know what the risk-retention rules are going to be, what the enforcement rules are going to be,’ he continues. ‘You want to know what will bring investors back to the market? Certainty from Washington and knowing what will be the analytics in tools and services that will be needed to scrutinize the new bonds.’
Rules for risk retention and Qualified Residential Mortgages (QRMs) are also coming down the pike, observes Clifford Rossi, a teaching fellow and executive-in-residence at the University of Maryland's Robert H. Smith School of Business.
‘This is going to be the deciding factor as to whether or not we get private capital back into RMBS,’ he says. ‘The comment period for risk retention and QRMs has closed. This will be a huge game-changer, because it will force standards on what will constitute acceptable collateral for securitizations. The implication will be on the cost of securitization, who will be able to get credit and what will be the kinds of issuers.’
Whether this new scenario will re-animate the private-label RMBS market is unclear. Certainly, something is needed.
‘Private-label is a market that is almost dead right now,’ declares Taylor.
However, it still has a pulse. In March, Redwood Trust Inc. closed a $290 million mortgage-backed securitization of jumbo loans. According to Redwood, the securities were sold to institutional investors, and most of the senior securities issued in the deal, representing 92.5% of the principal amount, were rated by Fitch Inc. as AAA at the time of issuance.
This was Redwood Trust's second private-label RMBS issuance in a year. In 2010, it closed a $237.8 million RMBS deal, again involving jumbo loans. Unfortunately, these were the only two private-label RMBS transactions since the 2008 financial crisis.
This spring, Two Harbors Investment Corp., a New York-based real estate investment trust (REIT), reported it was targeting a $250 million RMBS deal for its initial securitization, with Barclays Bank acting as underwriter.
‘We believe entering into securitization is a good opportunity to diversify our business model, expand the Two Harbors brand and continue to create value for our shareholders over the long term as the residential mortgage market evolves in the future,’ says Diane Wold, Two Harbor's managing director. ‘There are clear indications that the government wants to shrink its involvement in the U.S. housing market, which should create a larger role for private capital, and Two Harbors wants to be in a ready position to capitalize on the opportunities and dynamics as the market opens up.’
To date, however, Two Harbors has not presented this issue. John Anzalone, chief investment officer with Invesco Mortgage Capital Inc., an Atlanta-based REIT that acquires, finances and manages RMBS and mortgage loans, believes the prolonged delay in reviving private-label activity can be attributed to several factors.
‘With credit standards being what they are, there are not that many loans out there to be securitized,’ he says. ‘Loans are being kept by the large banks that are making them. They are making loans that are nonconforming, so they are buyer-balanced. The major banks have a massive need for yield, and the credit standards are so tight, so those borrowers are the most pristine you can find. These are perfect assets for a bank to hold.’
Anzalone notes that major financial institutions would previously accumulate a portfolio of loans and then sell them to make room for more loans.
‘There is such a shortage of loans, and of yielding assets, that the banks are happy to [put on their] balance sheet any loans they can make,’ he says. ‘We are not nearly at the point where the volume of loans is overwhelming the banks' ability to balance-sheet them.’
If new RMBS issuances remain bleak, the same cannot be said for trading in the existing bonds, often called legacy bonds. In 2008 and 2009, the RMBS market took a tumble along with the rest of the U.S. financial sector – but in 2009, Anzalone recalls, the U.S. Treasury Department announced it would provide leverage to managers to buy legacy securities.
‘The government intervention provided a bit of a backstop to the market and gave people confidence,’ he says. ‘The program wasn't enough to cause the market to rally, but it certainly provided confidence. In 2009 and 2010, any bond you bought would have gone up in price because things had been previously oversold.’
But prices peaked near the start of the year, and the market has since become choppy, Anzalone adds.
Complicating matters was the Federal Reserve auction of the Maiden Lane II portfolio. Maiden Lane II was formed in 2008, when the Federal Reserve purchased $20.5 billion in RMBS from AIG and its subsidiaries to alleviate capital pressures on the company. Earlier this year, a stabilized AIG decided it wanted the securities back and bid $15.7 billion for them. After all, the securities were very stable, had performed well, threw off higher yields and could be held against AIG's long-term insurance liabilities.
The Federal Reserve, however, rebuffed AIG and proceeded to sell the portfolio piecemeal earlier this year. But the Fed overplayed its hand: The market could only absorb so much of the product, and the Fed was forced to halt its sale. By the end of May, the Fed had only sold $9.5 billion from its Maiden Lane II portfolio.
However, the market has been known to turn on a dime. Taylor points out that certain ‘incidents’ have spurred wild price fluctuations.
‘When the proposed Bank of America settlement was announced, those bonds rose in value for a few days,’ he says. ‘We are seeing a lot of volatility in prices.’
‘Everything that has been originated since 2008 and beyond is high-quality stuff,’ Rossi adds. ‘From the standpoint of default risk, those are going to be some of the best performers we have seen on the books in many years, going back before 2007.’
Anzalone also makes a case for the legacy bonds from 2005 to 2007.
‘These are seasoned,’ he says. ‘That's given people comfort in that you have a lot of history on the collateral performance. It's made people more comfortable with their projections as to where the collateral is headed.’
Steve Bergsman is a freelance writer based in Mesa, Ariz. His latest book is "Growing Up Levittown: In a Time of Conformity, Controversy and Cultural Crisis," published by Dancing Traveller Media.