Tag Archives: securitizer

S&L Flexible Porfolio Lending

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Bailey BrosDepositAccounts.com quoted me in Types of Institutions in the U.S. Banking System – Savings and Loan Associations. It opens,

When you think of a savings and loan, maybe you think of the Bailey Savings & Loan from the movie It’s a Wonderful Life or remember the savings and loan crisis of the 1980s, when more than 1,000 savings and loans with over $500 billion in assets failed.

But there’s much more to the story. Savings and loan associations originally specialized in home-financing, be it a mortgage, home improvements or construction. According to Encyclopedia Britannica, Savings and loan associations originated with the building societies of Great Britain in the late 1700s. They consisted of groups of workmen who financed the building of their homes by paying fixed sums of money at regular intervals to the societies. When all members had homes, the societies disbanded. The societies began to borrow money from people who did not want to buy homes themselves and became permanent institutions. Building societies spread from Great Britain to other European countries and the United States. They are also found in parts of Central and South America. The Oxford Provident Building Association of Philadelphia, which began operating in 1831 with 40 members, was the first savings and loan association in the United States. By 1890 they had spread to all states and territories.

Today, explains, David Bakke, a financial columnist for MoneyCrashers.com, explains how S&Ls have evolved. “More recently, they have also expanded into areas such as car loans, commercial loans and even mutual fund investing. Currently, there isn’t much difference between them and other types of financial institutions.”

S&Ls are a type of thrift institution. Like all financial institutions they are bound to rules and regulations. They can have a state or federal charter. Those with a federal charter are regulated by the Office of the Comptroller of the Currency (OCC). The Office of Thrift Supervision (OTS) used to be the regulator before it was merged with the OCC in 2011.

Another big change that impacted S&Ls was the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). It abolished the Federal Savings and Loan Insurance Corporation, which had provided deposit insurance to savings and loans since 1934. It created two insurance funds, the Savings Association Insurance Fund (SAIF) and the Bank Insurance Fund (BIF), which were both administered by the FDIC. Those two funds were merged into the Deposit Insurance Fund (DIF) in 2006. In summary, your deposits at S&Ls today are insured by the FDIC.

If you’re wondering how S&Ls work, to put it simply, the money you deposit into your savings account, is used to fund the money the S&L doles out in loans.

Savings and loans have some advantages over other types of institutions. “Many S&Ls keep many of the loans that they originate in their own portfolio instead of selling them off for securitization.  This means that they often have more flexibility in their underwriting criteria than do those lenders that sell off their mortgages to Fannie, Freddie and Wall Street securitizers.  This means that borrowers with atypical profiles or borrowers interested in atypical properties might be more likely to find a lender open to a nontraditional deal in the S&L sector,” says David Reiss, a professor at Brooklyn Law School, that specializes in real estate.

The Future of Securitization

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SEC Commissioner Piwowar

SEC Commissioner Piwowar

SEC Commissioner Michael Piwowar’s Remarks at ABS Vegas 2016 are worth a look for all of those interested in the future of the mortgage-backed securities market. I have interspersed selections of his remarks with my comments:

As our country’s capital markets regulator, the SEC’s tripartite mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.  Securitization can transform illiquid assets like mortgages, auto loans, credit card receivables, and future sales of David Bowie albums into marketable securities.  By serving as an efficient means of allocating scarce capital, securitization supports economic growth, business development, and job creation.  Securitization further fosters resiliency by diversifying the funding base of our economy.

There are many other benefits associated with securitization, including the potential for reduced costs of, and expanded access to, credit for borrowers, the ability to match risk profiles for specific investor demands, and increased secondary market liquidity.  Because banks and other originators can move loans off of their balance sheets into asset-backed securities (ABS), securitization can increase the availability of credit for both businesses and individuals.  In many instances, securitization can allow a person to obtain more favorable terms than can be obtained from a bank or other financial institution.

Thus, the ABS market serves as a critical source of capital, providing funding for home and automobile loans, credit cards, and many other purposes.  Yet, as shown during the recent financial crisis, investors may abandon the ABS market if they do not believe they possess sufficient information to evaluate the risks associated with a particular asset-backed security and to price it accordingly.

While I generally agree with Piwowar’s assessment of securitization’s value, it is worth noting that he does not acknowledge how important robust consumer protection is to maintaining a healthy securitization market over the long run.

I found his discussion of the Dodd-Frank credit risk retention rules particularly interesting:

For the record, I voted against the credit risk retention rules.  These rules require a securitizer to retain a minimum 5% credit risk of any securitization transaction and generally prohibit the sponsor from hedging its retained interest.  I was particularly dismayed by the “one-size-fits-all” approach taken by the regulators to create a flat 5% risk retention requirement for all asset classes, except for securitizations involving so-called “qualified residential mortgages” (QRMs) for which the risk retention level is zero.  These were arbitrary choices.

Residential mortgages, commercial mortgages, credit card receivables, and automobile loans each have distinct and different attributes associated with their underlying borrowers.  Rather than carefully examining these attributes to determine an optimal credit risk retention rate for each asset class, prudential regulators in Washington, D.C., took the easy way out – they simply set it at the maximum statutory rate and ignored the authorization from Congress to create lower risk retention requirements or use alternative methods to align interests.

Perhaps the prudential bureaucrats had their own conflict of interests in setting these requirements.  After all, a prudential bureaucrat has a strong interest in self-preservation.  Will a prudential bureaucrat get credit if optimally tailored risk retention rates increase economic growth and provide additional opportunities to families and businesses across America?  No.  Will a prudential bureaucrat take the blame if the next financial crisis – and there will be one eventually – relates at all to securitizations?  Probably.  Hence, what better way to side step responsibility than to refrain from using reasoned judgment and rely solely on the most risk-averse interpretation of statute instead?

Bureaucratic self-preservation might also explain the decision to adopt as broad of an exemption for QRMs as possible, so as to minimize any political fallout from the real estate and housing industries.  Few will disagree that residential mortgage-backed securities played an important role in the 2008 financial crisis.  For those in the audience involved in RMBS offerings, you must be quite happy with the broad exemption from the risk retention rules.  For those of you in the audience who are involved in other types of securitizations that had little, if any, part in causing the financial crisis, you are probably wondering why you were unfairly targeted.  Unfortunately, unlike Las Vegas, what happens in Washington does not stay in Washington. (footnotes omitted)

Piwowar gives short shrift to the benefits of clear and simple rules, but it is still worth paying attention to his critique of the “one size fits all” risk retention rules. If researchers can demonstrate that these rules are not optimally tailored, perhaps that would provide a reason to reconsider them. This is, of course, a long shot, given that the rules have been finalized, but Piwowar is right to shine light on the issue nonetheless.

Candid and thoughtful remarks from regulators are always refreshing. These make the grade.

Frannie Reps and Warranties Crisis Brewing

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The Inspector General of the Federal Housing Finance Agency released an audit, FHFA’s Representation and Warranty Framework. Reps and warranties are a risk-shifting device that sophisticated commercial parties use in transactions. If a party makes a representation or warranty that turns out to be false, they other party may have some remedy — maybe the ability to return something or to get some kind of payment to make up for the failure to live up to the promise.

For instance, a lender may sell a bunch of mortgages to a securitizer and represent that all of the borrowers have FICO (credit) scores of 620 or higher. If it turns out that some of the borrowers had scores of less than 620, the securitizer may be able to make the lender buy back those mortgages pursuant to a rep and warranty clause. The IG undertook this audit because of recent changes to the reps and warranties framework for Fannie and Freddie. Before these changes were implemented,

the Enterprises’ risk management model primarily relied on reviewing loans for underwriting deficiencies after they defaulted as the representations and warranties were effective for the life of the loans. In contrast, the new framework transfers responsibility to the Enterprises to review loans upfront for eligible representation and warranty deficiencies that may trigger repurchase requests. If the Enterprises fail to do so within the applicable period, their ability to pursue a repurchase request expires if it is based upon a representation and warranty that qualifies for repurchase relief. (2)

The IG’s findings are disturbing. It “found that FHFA mandated a new framework despite significant unresolved operational risks to the Enterprises.” (3) It also found that

FHFA mandated a 36-month sunset period for representation and warranty relief without validating the Enterprises’ analysis or performing sufficient additional analysis to determine whether financial risks were appropriately balanced between the Enterprises and sellers. Freddie Mac, in contrast to Fannie Mae which provided analysis limited to a 36-month period, provided FHFA with the results of an internal analysis of loans that indicated loans with a 48-month clean payment history were significantly less likely to exhibit repurchaseable defects than loans with a 36-month clean payment history. Thus, losses to the Enterprise could be less with a longer sunset period. Therefore, FHFA cannot support that the sunset period selected does not unduly benefit sellers at the Enterprises’ expense. (3)

This is all very technical stuff, obviously. But it is of great significance. Basically, the IG is warning that the FHFA has not properly evaluated the credit risk posed by changes to the agreements that Fannie and Freddie enter into with the lenders who convey mortgages to them. It also implies that this new framework “unduly” benefits the lenders.

The FHFA’s response is unsettling — it effectively rejects the IG’s concern without providing a reasoned basis for doing so. Its express rationale for doing so is to avoid “adverse market effects” and because addressing the IG’s concern “may not align with the FHFA objective of increased lending to consumes . . ..” (32)

Whenever federal regulators place increased lending as a priority over safety and soundness, warning bells should start ringing. Crises at Fannie and Freddie (and the FHA, for that matter) begin with this kind of thinking. Increased lending may be important today, but it should not be done at the expense of safety and soundness tomorrow. We are too close to our last housing finance crisis to forget that lesson.