Wednesday, April 7, 2010

Will the First Real Private RMBS in Years be a Dud?

Original posted on the Housing Wire by Jacob Gaffney:

We know of two issuers who are expected to come to market with a prime jumbo residential mortgage-backed securitization program in the next 30 days.

We won’t say whom, and in the end it doesn’t really matter; my discussions with a number of investors involved on the potential buy side of these deals suggest there remain concerns that the first real private RMBS deal may be a dud. Or it might be what’s needed to start the blood pumping. Or both. Or neither. No one can say, really.

What is clear is that the first round of private securitizations aren’t likely to cause wild celbrations on the Street. For one, mortgages need to be originated at roughly 6% at least to get any sort of capital flow; this was the case in previous securitization efforts, and it’s likely true now as well. The current (impossibly?) low mortgage rates do not quite hit that sort of watermark. The chart below indicates that. It’s from Colorado Capital (a firm not contacted for this column).

Further high levels of risk retention, and high levels of subordination, are going to be pushing costs up relative to previous securitization efforts. Due diligence firms, for example, now like to look at 100% of the loans, and not just samples from pools.

So, where can profit be squeezed out?

One could argue that the fees normally paid to credit rating agencies are lesser than they used to be, as their role appears to vastly reduced now versus then–but even this change doesn’t appear likely to translate into a higher profit margin for investors.

I’m not making this up. Conversations with investors who have been sitting on the sidelines, waiting for the Fed to withdraw from the market, are the motivation for this column.

A huge potential investor in private RMBS issuances suggested to me that his firm wouldn’t invest until rates on the long-end start rising. “We need to see a 100bps jump in coupon for this to be profitable for just the issuer,” the investor, who asked not to be named, said.

A source working on one of the two platforms set to issue the highly-watched deals isn’t concerned. Hedge funds and foreign investors will pick up the slack from the Fed, she said under condition of anonymity. She does, however, think the first prime RMBS issue is going to be more of a ’standard-setter’ than a ‘money-maker.’ If the new, more conservative structure itself proves resilient, others will look to wade into the market with similar offerings.

The road to re-gaining confidence is a long one, still, it seems.

For now, one thing is clear: the risk retention requirement proposals under consideration mean that only the biggest of banks will consider issuing a fresh RMBS into the market.

In speaking of one deal, a source suggested to me that the RMBS issue is being seen as a “loss-leader,” and that streamlined originations are being considered as one way to lower costs through the pipeline. Though let’s be honest here: there isn’t really much else to do cost-wise in the fledging private-label market right now.

The source I spoke with likened the situation to leaving a 10-year-old at home without supervision–you can prepare for everything you expect to go wrong, but something is still going to get smashed. And, for now, that seems to pretty clearly sum up a large portion of investor attitudes towards any private-label RMBS efforts.

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