CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

Chicago’s City Council thinks lenders should be required to remove snow, board windows and doors, mow grass and otherwise incur the costs typical of property owners. Personally, I think (despite tremendous sympathy for the plight of Chicago and numerous other neighborhoods devastated by vacant properties and well aware of the drain on government resources) that a mortgage holder should assume property owner-type responsibilities only AFTER the borrower defaults and the mortgage holder has legal title (through foreclosure or other means).

A mortgage holder doesn’t own the property securing its loan. The borrower does. Fundamental to mortgage finance is the idea that the borrower grants a lien on its property to the mortgage holder to secure the obligation to repay the loan. Even a defaulting borrower has legal title to its property and has the legal right of possession, including the responsibility for property upkeep and compliance with applicable laws and regs.

The American Securitization Forum (“ASF”), in its July 26 letter (pdf) to the Chicago City Council, put forth the argument that the inclusion of such a broad definition of “owner” will have a chilling effect on the willingness of lenders to provide mortgage financing to homeowners in the City of Chicago and will drive up the cost of such lending to residents in Chicago, further exacerbating the challenging real estate market conditions and the ability of Chicago residents to secure mortgage financing on favorable terms.

Moreover, they noted the practical challenges of a mortgage lender or servicer determining whether a property is “vacant” as defined under the ordinance may be administratively impossible.

And I won’t even discuss whether compliance with the ordinance as amended would conflict with IL wrongful entry or trespass criminal laws.

On August 24, the Wall Street Journal published an editorial about this “bad idea”.

Some commentators say there is no proof that lenders would increase the costs to borrowers of obtaining loans if these institutions are saddled with the additional costs of maintaining vacant properties. But that math just doesn’t add up.

Stay tuned…

By Laurie Nelson
 

Congressman Garrett noted in his remarks that the portfolios of the GSEs are a combined $1.5 trillion-- a book with a lot of interest rate risk and a lot of unrealized gain. He said this portfolio needs to be unwound sooner rather than later. He wants to see the GSEs on the federal budget-- on the books of the U.S. government-- and he noted that in private industry, there has been a movement toward on-balance sheet and questioned why this wasn't so in Washington.

Knowing his audience, he stressed that securitization has to play a huge, vital, integral part in the resurrection of the mortgage market, and he said that securitization is vital to the movement of capital around the country. He noted the unsustainability of FHA insuring 50% of new originations and the government underwriting 95% of the mortgage market. The Congressman stated he is firmly committed to a purely private U.S. mortgage market over time, free of government subsidies or guarantees. He acknowledged concerns associated with a purely private market but also said there are competing concerns with models that include government support.

Addressing assertions from critics, the Congressman asked whether home price increases and higher down payments would be so bad (possible results of the 30-yr fixed rate mortgage not surviving without a government guarantee). He questioned whether the government is able to price catastrophic credit risk and pointed to a shoddy track record. He posited that there are other ways to keep a TBA market viable aside from a government guarantee and noted that the government steps in at the end of the day perhaps because it is allowed to, and that allowing it to increases the chances the government will do so. He noted that a discussion of servicing standards in connection with QRM never came up in crafting Dodd-Frank and suggests regulators not take the servicing issue into account. In the Risk Retention breakout session later in the morning, Tom Boemio (Sr. Project Manager, Policy, Board of Governors of the Federal Reserve System) concurred and asked: Why have servicing standards in connection with the highest quality loans only-- and not the rest?

The Congressman said there is no role for government assistance except in connection with first-time home buyers, and such assistance should be on-budget and transparent. Finally, he said that the government has to play a big role because the private sector isn't-- the old chicken-egg thing. [His prepared remarks can be found here].

At the February 7 General Session that followed, Martin Hughes of Redwood Trust further addressed the chicken and the egg issue noting that "uber government support is stifling the return of private securitization." He acknowledged that government bids are attractive and there's been no incentive for banks to sell to non-agency, and that reducing the government's role would be a game changer. Addressing the circular problem, he did note that if the government backs out before the private sector is up and running, there are sure to be problems but he suggested the status quo needs to be tested. Stating that "issuance velocity leads to issuance velocity," he also noted there are too few prime loans to get real issuance velocity. Hughes agreed that, yes, investors are mad, and investors have demands and opinions with respect to servicing practices but he believes those demands can be met and that prime jumbo can have safe attractive yields.

Hughes summarized the general sentiment by stating we need the new rules of the road-- final rules so that market participants can adapt and move ahead-- because uncertainty has been an enormous headwind. And we have uncertainty as to what the rules are and, in addition, how those rules are to be interpreted. Stay tuned for more from ASF.

By Laurie Nelson.

Translation: The FDIC is using its New Safe Harbor Rule to attempt to reshape the securitization market.  The New Safe Harbor Rule imposes significant new conditions for non-grandfathered bank-sponsored securitizations.  And the FDIC has indirectly implemented its position on securitization reforms before the Office of the Comptroller of the Currency (the “OCC”), the SEC and other regulatory agencies take action on a joint basis.  The New Safe Harbor Rule was issued over the OCC’s dissenting vote and prior to the SEC’s issuance of the final Regulation AB II. The New Safe Harbor Rule regulates substantive terms of transactions, including several additional requirements for RMBS.

Here’s what the landscape is looking like:

Permanently grandfathered are securitizations (whether issued before or after December 31, 2010) issued by existing revolving trusts or master trusts that meet the Transitional Safe Harbor Rule and that had issued securities as of September 27, 2010.

For securitizations that are accounted for as sales under GAAP and otherwise qualify under the
New Safe Harbor Rule, the FDIC will not, as conservator or receiver, exercise its statutory power to repudiate contracts in order to reclaim, recover or recharacterize as property of an Insured Depository Institution (an “IDI”) the assets transferred by the IDI into a securitization. Not so for a financing under GAAP.

Where there’s a true sale, the FDIC should not have the power to repudiate just because the value of the securitized assets may have increased. But even if they don’t prevail, an attempt to do so by the FDIC will cause delays, even if only the first time around. And the FDIC may prevail just because it’s the FDIC.

If a transaction is deemed to be an off-balance sheet transaction, the FDIC has no assets to look to and should not be able to repudiate contracts in order to reclaim property of an IDI.  David Harris pointed out that in an off-balance sheet transaction, the FDIC would have no genesis for such a claim. In the Redwood RMBS transaction done this year, Citi retained the servicing of the Citi whole loans sold into the securitization and David Harris pointed out that the fewer ties to the assets sold, the safer-- i.e., don’t retain servicing.

The panelists enumerated potential securitization market impacts of the New Safe Harbor Rule:

The FDIC’s risk retention rules are not in alignment with the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) and do not answer the questions that have been left to joint rulemaking by the Act. Because there will be at least fifteen months during which the FDIC’s risk retention rules are in effect before the Act-mandated risk retention rules are final, large financial institutions may not be able to rationalize securitizing versus other options available to satisfy their funding and capital needs.

To the extent IDIs are required to comply with the conditions and requirements of the New Safe Harbor Rule, IDIs will be placed at a competitive disadvantage vis-à-vis non-IDIs (and IDIs that can securitize without the safe harbor) possibly resulting in damaging market fragmentation.

Regulatory uncertainty and the prospect of undue compliance costs, over and above regulatory capital and accounting issues, continue to threaten the viability of an active and efficient private securitization market.

It is unclear whether the FDIC’s risk retention requirement could preclude an accounting sale, which in turn would affect a sponsor’s capital requirements.  Although the SEC has stated that it does not believe that risk retention in itself will require the consolidation of the securitization entity onto the sponsor’s balance sheet, it also concluded that final determinations are based on facts and circumstances, leaving open the question of whether a sponsor may have increased capital costs as a result of the risk retention requirement (in addition to those resulting from the retained interest itself).

Especially for RMBS, the infrastructure and controls necessary to provide the additional disclosure and to meet the other conditions in the New Safe Harbor Rule could take time and be costly.

The additional disclosure requirement applicable to privately placed deals will significantly impact that market, especially with respect to asset classes that historically have not had a public disclosure scheme (e.g., CLOs).

As Phil Collins has sung, we’ve still got a “Long Long Way To Go.” 

By Laurie Nelson.
 

No seminar can be complete without a discussion of "skin in the game" and the goal of improved underwriting. Only time will tell on whether we will see a horizontal or vertical slice requirement or a variety of alternatives. There was also talk about the residential mortgage reform provisions in Dodd-Frank. In a nutshell, no loan can be made unless, in a reasonable and good faith determination, the borrower has the ability to pay. At first glace it makes pretty darn good sense. In practice, however, it’s difficult for a lender to predict whether a borrower can in fact repay a loan. Will a lender be penalized for failing to accurately assess a borrower’s earning potential? Applicable Dodd-Frank criteria includes the borrower's credit history, current income, financial obligations, DTI, LTV and other factors including expected income. A lender needs to focus on regularity of income but can consider irregularity…. It was noted that no member of Congress could get a loan today when, even though the above-mentioned criteria aren't weighted, expected future income needs to be taken into account.

The safe harbor for qualified mortgages basically means non-traditional mortgages are out. Thirty year fixed is the new black. If a loan doesn't meet the definition of a qualified mortgage and it's in foreclosure, a claim can be asserted against the assignee (for any claim the borrower could have made against the original lender). The likely result is that lenders will originate only qualified mortgages.

Of course, if you originate a "qualified residential mortgage" under Dodd-Frank you can be exempted from the related risk retention requirements. Since historical performance data is required for any “qualified residential mortgage,” no new loan product type will ever be exempt from Dodd-Frank risk retention requirements. Expect more thirty year fixed. Consumers will certainly have more protection but they will also have access to much less credit as the markets struggle to reconcile competing regulations and deal with unintended consequences.

The usual themes were reiterated – disclosure, transparency, skin-in-the-game — as was the likely consequence — that there won’t be as many loans to securitize. There’s a lot of rulemaking going on in the District and will be for the next 6 months to a year. We can expect changes— and pain.

By Ralph Mazzeo and Laurie Nelson.
 

You might recall that Representative Garrett almost succeeded in getting covered bond legislation into the Fin Reg package that passed last month . Lacking one vote (pdf), and facing scrutiny from the FDIC, the language found itself on the cutting room floor when Fin Reg ingloriously exited the reconciliation process. Notwithstanding these setbacks, Garrett’s latest attempt to push this legislation through appears to have some momentum in the Senate as well—Senator Bob Corker (R. Tenn.) has asked for the Senate Banking Committee to hold hearings on the topic. In addition, H.R. 5823 has drawn the strong support of industry groups such as the Commercial Real Estate Finance Counsel, SIMFA and the American Securitization Forum.

Covered bonds function as a cross between an unsecured corporate bond and an asset-backed security, representing both a direct-recourse obligation of the financial institution that issued the bond, and an obligation secured by a specified pool of assets that remain on the financial institution's balance sheet. They are old (like, centuries old) and safe (well, they are supposed to be). Under H.R. 5823, eligible issuers (including FDIC insured depository institutions, bank holding companies and other approved non-bank financial companies) would be permitted to issue covered bonds secured by a pre-defined set of eligible assets (such as commercial or residential mortgage loans) pursuant to an approved covered bond program.

Although H.R. 5823 (again, which is likely to continue to morph as it works its way through the House and Senate and into the Oval Office) is similar in many respects to the previously introduced versions, there is one key pragmatic difference worth highlighting—a difference that will certainly delay the establishment of a covered bond market in the United States. Representative Melissa Bean (D-Ill.) introduced an amendment in the committee process requiring multiple Federal agencies (instead of the Comptroller of the Currency as originally proposed in H.R. 5823) to jointly establish a covered bond regulatory oversight scheme. Workable? Hardly … it’s a bad idea. Given what Fin Reg has already saddled the agencies with, when will they get around to a jointly produced workable oversight scheme? I am not overly optimistic.

Aside from what H.R. 5823 provides in its current form, the more interesting debate is whether any covered bond legislation will create a robust new alternative source of capital for banks and other eligible financial institutions. With deals getting done in 2009, and several more in the pipeline before year end, it’s not at all clear that issuers will jump on the bandwagon. Although there appears to be investor appetite for covered bonds in the United States, and the structure of covered bonds accomplishes Congress’ desire for skin in the game, it’s just not clear eligible issuers will want to keep all of their skin in this game, or whether a covered bond market will provide a cheaper (or even a cost competitive) source of capital. Only time will tell, assuming H.R. 5823 ultimately becomes law. For our part, we welcome the opportunity to do new types of deals.

The good news for proponents of covered bond legislation is that both the House and the Senate seem interested, at least for now, in passing some form of covered bond legislation. We will continue to monitor this proposed legislation as it works its way through the House and the Senate.

Stay tuned…

By Stewart McQueen.