Thursday, February 11, 2010

The FDIC's mother of all bank re-securitisations?

Original posted on FT Alphaville by Tracy Alloway:

FT Alphaville first mentioned reports that the FDIC, the US body in charge of guaranteeing American bank deposits, was looking at `the mother of all bank securitisations’ back in October.

The Federal Deposit Insurance Corporation has accumulated some $36bn worth of assets from the plethora of failed US banks. One of the ways the organisation could sell off those assets is via some form of securitisation.

The FT picked up the story last month:

People involved in discussions said the plan to use the troubled assets to back securities – “securitisation” – is at a preliminary stage. A final decision, which could come in weeks, will depend on finding a structure to provide a sufficient return to the deposit insurance fund . . . One option being considered by the FDIC is selling bonds with a US government guarantee in order to ensure they have triple A credit ratings.

The structure is the really interesting thing here.

One of our astute commentators suggested back in October that the FDIC would likely pursue something similar to Resolution Trust Corporation’s (RTC) strategy during the savings and loan crisis.

Back then the RTC put some of its portfolio of mortgage loans into a trust, then issued a series of mortgage-backed securities (MBS) collateralised by the subject loans, with some credit support provided by cash reserve funds, subordination, overcollateralisation, etc.

The credit support was important since the RTC-issued MBS did not in fact carry a full government guarantee. Instead, the RTC had to use other forms of support to get decent credit ratings on the MBS.

Using securitisation, the RTC was able to sell more than $42bn of assets — almost 22 per cent of the mortgages and over 10 per cent of its total assets. Notably, however, the strategy was not without its critics, some of whom have even accused it of playing a role in the current financial crisis.

In any case, this week we’re hearing something a little different about the FDIC’s securitisation programme; the possibility of using a re-Remic structure.

Structured Finance News reports that while the FDIC has pushed back its securitisation plan into the second quarter of this year, there is talk of using the re-Remic method to do it:

There also has been talk in the market place of FDIC doing a “re-REMIC” of outstanding MBS or ABS. At press time, a telephone call to the FDIC’s press office had not been returned.

As a reminder, re-Remics are basically a way of recooking collateralised debt obligations (CDOs) to achieve higher ratings on some of the newly-formed tranches.

They’d be an interesting way to bypass the potentially contentious government guarantee aspect — but they are of course, not without their own risks and ratings issues (see below).

Rating Re-Remics

According to research by Amherst Securities, about $43bn worth of re-Remics were created between January and November this year; Most of those made after investors found themselves holding onto RMBS securitisations with “cashflows that do not fit their needs” — which is a nice way of saying the securities had been downgraded.

Here’s a bit more detail from Amherst’s mortgage team, led by Laurie Goodman:

. . . the less than investment grade securities are, in some cases, no longer eligible investments for the institutions that purchased them. In other cases, they occupy the very limited “less than investment grade” allocation. For regulated institutions, the downgraded securities often require “other than temporary impairment” charges to be taken, and require higher capital charges. Re-REMICs allow for the transformation of cash flows on a downgraded bond into cash flows which better meet the needs of investors; the original security is re-tranched into: (1) a new, properly enhanced AAA security + (2) a junior bond

. . .

Most of this year’s $43 billion has been arbitrage re-REMICs; deals in which a dealer buys the bonds, carves them up, then sells all the pieces. These deals have been very dependent on the front bond obtaining a AAA rating. Exhibit 2 shows that over 95% of the re-REMIC transactions have been backed by prime and Alt-A collateral. Option ARM and subprime deals are quite rare (on those deals, it can be difficult to create enough AAA bonds to make the transaction economically advantageous).

One of the really interesting things then, is how ratings agencies are rating these relatively new securitisation structures, bearing in mind that one of the reasons the things were created in the first place was to bypass those ratings downgrades.

The below table from Amherst is instructive:

Rating agency activity - Amherst

The vast majority of re-Remics are coming to market with a single rating by a single agency. Much of that is due to individual quirks between the agencies’ criteria for rating the securitisations.

Fitch, for instance, no longer rates deals backed by Alt-A collateral (something Amherst finds perplexing, but could well turn out to be a prudent move). S&P will only rate re-Remics in which it can also rate the underlying bonds, while Moody’s won’t rate re-Remics where it’s in the process of re-rating the underlying bonds.

With the vast majority of re-Remics carrying only one rating, then, the issue of rating consistency becomes much more important. Back to Amherst:

The fact that most re-REMICs are getting done with only one rating produces ratings between AAA re-REMIC tranches that are inconsistent; i.e., not all AAA ratings are created equal. With S&P making it difficult to obtain a rating on a deal where they did not underwrite the underlying bond, Fitch unwilling to rate Alt-A deals, and Moody’s in and out of the market—some deals may have 4 firms willing to rate the securities, while other deals may have only one willing rating agency. And if only one rating agency is willing to rate a security, that remaining agency may be very conservative. As a result of the ratings patchwork, some of the ratings look too aggressive to us, while others too conservative.

Which basically translates into one big caveat emptor for would-be re-Remic investors.

But if you want to see just how the ratings can vary, while getting a good granular look at two re-Remic deals, click here to read the tale of WFMBS 2007-8 2A 11 and RAMP 2004-RS6 AI6, and much more, in the full Amherst note.

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