Mortgage Backed Securities: Comeback Kids?

Thanks to the Fed’s monetary policies, private capital is flush with cash

Weekly market view from NewOak Risk Advisory & Financial Services


“In 2005 the non-agency residential mortgage-back securities market was creating over a $1 trillion in product; by 2008 the machine essentially shutdown,” says James Frischling, President and Co-Founder of NewOak.

Five years after the financial crisis, Government Sponsored Enterprises (GSE) and FHA are responsible for over 90% of all mortgages. Mortgage market participants question when, or if, the private label mortgage market is going to make a return.

Unsustainable levels of government invovlement

The Federal Housing Finance Agency recognizes the unsustainable levels of government involvement. There’s even genuine bipartisan support for GSE reform (and let’s face it, there isn’t much bipartisan support for much of anything nowadays). However, with Fannie Mae and Freddie Mac making so much money, what government officials say may be different from what they do.

Thanks in a meaningful way to the Fed’s monetary policies, private capital is flush with cash and strengthened balance sheets. They have also identified that, as a result of the GSEs raising guarantee fees and tightening credit standards, the opportunity to re-engage in the private mortgage market represents a compelling opportunity.

The territorial lines that divided up the roles and responsibilities of the private label market are now very much blurred. Hedge Funds that once invested in private label mortgages are now originating them. Private equity firms have entered the REO-to-rent space and there’s equity interest in creating new or re-capitalizing old mortgage insurers. Even the largest provider of loan due diligence and surveillance, Clayton Holdings, is expanding it securitization group in preparation for the return of the private mortgage market.

Despite the capital available and renewed interest in the private label market, restoring investor confidence is a critical piece of the puzzle. In order to accomplish this, transparency in the manufacturing process will need to be dramatically improved. If this can be achieved, there’s significant investor appetite in the private label market.

Bank Liquidity Coverage Ratio: Could Minimum Requirement Prevent Credit Crises? a result of the GSEs raising guarantee fees and tightening credit standards, the opportunity to re-engage in the private mortgage market represents a compelling opportunity

“The Federal Reserve’s latest proposed rules to strengthen banks and the largest institutions’ liquidity status have been anticipated for sometime, but should be continually assessed for its effectiveness to avoid a credit crises,” says Ron D’Vari, CEO and Co-founder of NewOak Capital.
Certain sized banks and systematically important financial institutions (SIFIs) will be required to hold a certain amount of liquid assets. These assets must be equal to or greater than projected cash outflows minus projected cash inflows during a defined short-term stress period. The ratio of liquid assets to projected net cash outflow (Liquid Coverage Ratio, or “LCR”) is required to be a minimum level.

The BIG liquidity squeeze

The severe liquidity squeeze during the credit crisis has been attributed to counterparties unable to extend credit to each other due to the lack of reliable information on the parties true capital positions. Hence firms relying on short-term funding were unable to roll over this funding. Many otherwise liquid positions were unable to be unwound by weaker entities. This added to the liquidity squeeze. As a result global central banks had to intervene.

Minimum capital and LCR rules will inevitably impact bank’s lending behavior and risk taking behavior, both short and long term. This impact has already been seen in mortgage servicing rights (“MSRs”). Many larger banks have already or divested part of their servicing portfolios. Citigroup is the latest example.

By identifying certain assets as liquid and eligible as capital, and others as not eligible, there may be further squeeze on liquidity at the onset of a future credit crisis – even though the institutions may be initially well capitalized. The true impact will not be known until the next crisis.

One can argue that no realistic minimum LCR and standardized risk-based capital can prevent the erosion of confidence in a significant asset bubble burst. However, net-net the probability of such occurrences have been lowered by increasing the capital and liquidity requirements – assuming they have not caused other assets to become less liquid.