Regulation, RMBS dominate ASF discussions

The location, in Washington DC, of last week's American Securitization Forum (ASF) conference was aimed at bringing the industry closer to the US regulators. Indeed, much of the resulting discussion focused on regulation - in particular the proposed retention requirements - as well as how to kick-start the private label RMBS market.

Hal Scott, Nomura Professor and director, programme on international financial systems at Harvard Law School, set the tone for the conference by identifying what he believes are the impediments to promoting market discipline - lack of disclosure and the 'too big to fail' mentality.

Steven Joachim, evp of transparency services and international affairs and services at FINRA, confirmed that enhanced disclosure is a critical issue. He outlined the Authority's three efforts in this regard: expanding TRACE's coverage to include agency debentures on 1 March; examining whether to expand TRACE to include structured debt; and monitoring the effectiveness of the ASF's Project RESTART.

Scott also pointed to the potential dangers of allowing accounting rules to drive regulatory capital rules. "The two approaches merged during the thrift crisis, but there were negative consequences. The rules serve different purposes: investors need information to judge investments, while regulators need information to judge solvency," he explained.

However, the 5% retention rule (SCI passim) was inevitably the main topic of discussion in the regulatory arena. The proposal was criticised for not differentiating between different risk assets and issuers, as well as failing to motivate issuers enough to strengthen reps and warranties and underwriting practises.

John Kiff, senior economist in the IMF's global financial stability division, noted that the 5% retention requirement is too blunt and its application is too inconsistent. "Will it be applied to the notional or the actual risk exposure? Where will it be applied in the value chain?" he asked.

Further, there appears to be no acknowledgement of the impact that other structural features of securitisations - such as excess spread - could have on performance. "When combined with accounting changes, retention could work against restarting the securitisation market," Kiff added. "I believe the authorities should undertake appropriate impact studies before such a rule is implemented."

According to William Moliski, md at Redwood Trust, it isn't clear whether the 5% is supposed to support a transaction's reps and warranties or its first-loss piece. "If it's targeting reps and warranty violations, it should force issuers to strengthen their due diligence efforts. If it's for the first-loss piece, the concern is that certain borrowers will be shut out of the credit markets."

The other main topic of discussion at the conference was non-agency RMBS, in particular the twin issues of loan modifications and revitalising the new issue market. Paul Colonna, president and cio, fixed income at General Electric Investment Corp, confirmed that loan modifications make it difficult to predict cashflows.

He continued: "There are two factors driving valuations: the macro environment in terms of housing and consumers; and uncertainty regarding loan modifications. I'd like to these removed in order for new issues to return."

Nancy Mueller Handal, md, structured finance at MetLife, suggested that - without principal forgiveness - foreclosure rates will only increase again in the future when mortgage rates rise. "But this is a sensitive issue: there is moral hazard in cutting principal payments, so gates and safety measures need to be built in," she argues. "The strengthening of HAMP documentation is one step, but we should also look at forgiving principal in tandem with a long-term refinancing programme, where borrowers can earn their way into forgiveness. I don't see this occurring any time soon, however."

Laurie Goodman, senior md at Amherst Securities Group, agreed that loan mods will only help at the margin and that principal reduction is key. She observed that negative equity is the single most important driver of homeowner defaults, followed by the existence of second liens.

The US Treasury is believed to be working with servicers around what form any potential principal reductions should take.

Tied in with any discussion about the broader US RMBS market is the future of Fannie Mae and Freddie Mac. James Lockhart, vice-chairman at WL Ross & Co, indicated that there are three potential paths for the GSEs: nationalisation and a merger with the FHA or Ginnie Mae; improvements based on the utility model; or the establishment of a private-sector firm.

Armando Falcon, ceo of Falcon Capital Advisors, said that the solution should be whatever is in the public interest. "The future of the GSEs is premised on their ability to deal with systemic crises and some sort of government mechanism needs to be in place to do this. It makes sense to use the infrastructure that's already there and back out of the market as it recovers and private sector support returns."

However, Annaly Capital Management cio and coo Wellington Denahan-Norris noted the importance of separating out the two GSE missions - affordable housing and promoting stability/liquidity in the mortgage market. "What's good for the public is an interesting concept," she added. "There is agreement that it's great when house prices appreciate and when government entities are receiving lots of tax receipts from the one-way movement in housing. But affordable housing is not the same as giving away credit - you need to be a responsible citizen to qualify."

She continued: "Much more capital would be dedicated to the market if there wasn't so much meddling to facilitate a one-way move in house prices. Lower prices make housing affordable, which in turn would reduce the inventory overhang, but this is being stalled by policy intervention."

Away from the RMBS market, credit card and student loan ABS were identified as providing relative value opportunities. Nichol Merrit, director at TIAA-CREF, noted that there is sharp tiering between on- and off-the-run names and this is likely to become even starker when TALF ends in March.

"Off-the-run names will widen further, but on-the-runs should be OK. The differential between senior and subordinated bonds still has room to compress," she said.

Another area that is likely to provide relative value opportunities is the FDIC's forthcoming securitisation programme, according to Dan Castro, partner at Huxley Capital Management. Issuance from the platform is expected in Q2/Q3, but he recommended that investors get in early and take advantage of any complexity premium associated with it.

In terms of market liquidity, meanwhile, Citi md Ish McLaughlin voiced his concern that the securitisation investor base remains fairly concentrated - with around 80% of volume being purchased by 20% of investors. "It's too narrow a base to build a market on: a number of large investors still haven't come back to the market," he concluded. "TALF ran so quickly that it didn't facilitate a deeper investor base. If investors can't get their arms around the product now, when better quality collateral is being originated and better credit enhancement is available, they probably won't ever get their arms around it."

CS