MORTGAGE BACKED SECURITIES 2.0 – PART ONE

Twice in the same week two entities published their recommendations on a new mortgage securitization process that would turn mortgages into tradable securities. Their motivation is to ensure that lending institutions are able to access the capital markets.

The need for a reset to MBS 2.0 is that the agencies responsible for purchasing and securitizing mortgages issued by lending institutions, Federal Home Loan Mortgage Association (FHLMC) and Federal National Mortgage Association (FNMA) were absorbed by the federal government. This action was in response to the credit crisis, increasing late payments and growing defaults by homeowners holding mortgages securitized by FHLMC and FNMA. Both agencies, known government sponsored enterprises (GSE), were public companies owned by shareholders before being taken over by the federal government.

Prior to the credit crisis the role of these agencies was to purchase qualifying mortgages, turn the mortgages into securities, and guarantee the timely payment of principal and interest, which were sold to investment banks who in turn sold them to investors. This process was established in the late 1960’s and was designed to provider lending institutions with a way to move the mortgages off their books and recapture the capital lend to home buyers.

Congress and the Federal Housing Finance Agency (FHFA) are struggling with finding a system to improve market liquidity and address the potential risks causing market disruptions. The ultimate solution will come from the federal government; particular focus will be on correcting some of the shortcomings of the original model, such as:

·        Implicit guarantee that the federal government would back the two GSE in the event of a crisis. This certainly was true……

·        Marginal impact on low to moderate income home buyers

·        Conflicts in regulations and between public and private objectives

A new securitization model is a critical step in the recovery and at a minimum, must ensure

·           Consistent, nationwide supply of mortgage financing for residential mortgages to qualified home buyers

·           Assistance to low and moderate income homebuyers, i.e. subsidized mortgages

As I wrote in an earlier blog, the ideal response to this opportunity will be a result of a collaborative effort between Congress, FHFA and representatives from the Capital Market. This mix of interests will ensure that each is represented and that the model will be a “best practice” approach to the stated objectives. At this point the following are some of the broad principles that should be addressed:

·        Securitization model that combines a federal government and private industry guarantee that timely principal and interest payments will be paid to investors on qualified mortgages

·        Transparency on the underlying mortgages in any securitized pools or tranches sold to investors

·        Investment grade rating on the securitized pools or tranches

I will review the recommendations offered and explore this topic further in another blog. Meanwhile, let me know your thoughts regarding..

What is your opinion about this?

Your ideas on the new securitization model?

Are there other viable alternatives available?

COLLATERAL MANAGEMENT OR MIS-MANAGEMENT……

Depending on the level of preparation, it could be either of the above. Traditionally collateral management was a back office function with little or no impact on the front office. But the Dodd-Frank Act (DFA), European Market Infrastructure Regulation (EMIR) and Basel III require participants to collateralize trades and other transactions.

Broker-dealers have been collateralizing clearing and guarantee funds for many years. But buy-side firms, such as hedge funds and other fund managers, have not had the same experience. They will now be required pledge collateral to support their transactions. If they don’t have appropriate or sufficient collateral they will need their custodians or clearing brokers to locate the needed collateral.

This requires custodians, clearing brokers and industry service organizations to enhance their services. As such it is a new source of revenue to industry service organizations and a new cost for their clients.

Electronic interfaces among the industry service organizations as well as investor will be critical to ensure that transactions are collateralized at minimal costs.

            What are the critical issues facing your firm?

                        How will you optimize the collateral you have?

                                    What are the available alternatives to improve collateral?