Tag Archives: securitization

Reiss on Single Family Rental-Backed Bonds

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Law360 Quoted me in Newest Property-Secured Bonds Invite Scrutiny (behind a paywall). It reads in part,

The Blackstone Group LP’s recent groundbreaking move to sell bonds secured by single-family rental homes may have created the next securitization blockbuster, but attorneys say the product could attract the same type of litigation that has plagued the commercial and residential mortgage-backed securities markets.

Blackstone is among a growing group of entities that amassed large numbers of foreclosed homes after the crisis and are turning them into profitable rentals. Now some are hoping to take that profitability one step further, extending loans secured by these single-family homes and securitizing them.

This process offers benefits both to players like Blackstone and to smaller landlords that own groups of single-family rentals and can’t get traditional lenders to lend against their assets. Blackstone’s debut product — sold to a syndicate led by Deutsche Bank AG — has been very well-received, but attorneys caution that many questions remain unanswered, and REO-to-rental-backed bonds could pose litigation risks.

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Blackstone’s $480 million deal, in which it pooled 3,200 homes owned by its portfolio company Invitation Homes and used them to secured a single loan that it then securitized, made waves as the first of its kind.

Several other opportunistic real estate investment companies, including American Homes 4 Rent and Colony Capital LLC, are expected to follow suit, but they are treading lightly as the new product is assessed by the market and investors.

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The homes themselves may also be subject to condemnation or landlord-tenant litigation that could encumber the overall loan indirectly by affecting the value of the collateral, according to David Reiss, a real estate finance professor at Brooklyn Law School.

Before the recession, single-family homes were considered too expensive to be managed by a large institution like Blackstone or American Homes 4 Rent because of their geographic diversity and because it was hard to control property management on so many different homes, according to Reiss.

The financial crisis made distressed single-family homes cheaper and more attractive to opportunistic investors, and the low price may compensate for the other issues, he said.

“This is a new asset class, and it is not yet clear whether Blackstone has properly evaluated its risks,” Reiss said.  “Time will tell whether these bonds will become a significant new category of asset-backed securities or whether the financial crisis presented a one-time financial opportunity for some firms.”

The Road to Securitization

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Miguel Segoviano et al. of the IMF released a helpful Working Paper, Securitization:  Lessons Learned and the Road Ahead (also on SSRN). It opens,

Like most forms of financial innovation, there are cost and benefits associated with the securitization of cash flows. From a conceptual perspective, a sound and efficient market for securitization can be supportive of the financial system and broader economy in various ways such as lowering funding costs and improving the capital utilization of financial institutions—benefits which may be passed onto borrowers; helping issuers and investors diversify risk; and transforming pools of illiquid assets into tradable securities, thus stimulating the flow of credit—an issue of particular relevance for some European countries. However, these features need to be weighed against the potential costs, including the risk that securitization contributes to excessive credit growth in and outside of the formal banking system; principal-agent problems that amplify perverse incentives; the complexity and opaqueness of certain products which make efficient pricing problematic; and the heavy reliance of the industry on credit ratings. (3)

The authors identify lessons learned from the financial crisis as well as impediments to a renewed securitization market. They conclude with a set of policy recommendations.

I recommend this paper as a good overview. I particularly like that it looks beyond the United States market, although it does spend plenty of time looking at the history and structure of the U.S. market. The recommendations tend to be pretty reasonable, but not particularly innovative — implement Dodd-Frank-like requirements in non-U.S. jurisdictions; de-emphasize the role of NRSRO credit ratings; increase transparency and decrease needless complexity throughout the industry; modernize land record regimes, etc.

It is surely hard to get your hands around the global securitization industry, but it is important that we try to. Securitization is here to stay. We should manage its risks the best that we can.

Shiller on Primitive Housing Finance

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Robert Shiller has posted Why Is Housing Finance Still Stuck in Such a Primitive Stage? The abstract for this brief discussion paper reads:

The institutions for financing owner-occupied housing have not progressed as they should, and the financial innovation that has followed the financial crisis of 2007-9 has not been focused on improving the risk management of individual homeowners. This paper lists a number of barriers to housing finance innovation, and in light of these barriers, the problems of some major innovations of the past and future: self-amortizing mortgages, price-level adjusted mortgages (PLAMs), shared appreciation mortgages (SAMs), housing partnerships, and continuous workout mortgages (CWMs). (1)

The paper is more of an outline than a fleshed out argument, but it has some interesting points (and not just because the author recently won a Nobel Memorial Prize in Economics).  They include

  • Shared appreciation mortgages (SAMs), which offered some risk management of home price appreciation, were offered by the Bank of Scotland and Bear Stearns in the 1990s, but acquired a damaged reputation with the boom in home prices. U.K. homeowners who took such mortgages, and lost out on the speculative gains, were so angered that they filed a class-action lawsuit against the issuers. The suit was dropped, but the reputation loss was permanent. (5)

  • There has been some questioning of the assumption that insuring homeowners against a decline in home value is a good thing. Sinai and Soulelis (2014) have written that the existing  mortgage institutions may be close to optimal given that people want to live in their house forever, or move to a similar house whose price is correlated with the present house, and so are perfectly hedged. But their paper cannot be exactly right, given the sense of distress that homeowners are experiencing who are underwater. They are more certainly not right about all homeowners, many of whom actually plan to sell their home when they retire. (5-6)

  • The difficulties in making improvements in mortgage institutions have to do with the complexity of the risk management problem, coupled with mistrust of institutional players. The Consumer Financial Protection Bureau, created by the Dodd-Frank Act and having authority over mortgages, among other things, seems oriented towards addressing complaints from the public, and has focused its attention so far on such things as unfair collection practices, bias against minorities, and excessive complexity of financial products being used to confuse customers. These are laudable concerns, but complaints that economists might register about the fundamental success of mortgage products to serve risk management well have not yet taken center stage. (6)

  • New Development economics, Karlan and Appel (2011), Bannerjee and Duflo (2012) has shown how carefully controlled experiments can reveal solid steps to take regarding new financial institutions for poverty reduction. The same methods could be used to improve mortgage institutions, as well as rental, leasing, partnership and cooperative institutions, in advanced countries. (7)

These are just brief thoughts. It will be interesting to see how Shiller develops them further.

A New History of Mortgage Banking — Part Two!

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I know, I know, you can’t get enough of this stuff. Yesterday, I noted a couple of highlights from Mortgage Banking in the United States 1870-1940. The last part of the report carefully documents how various players in the urban mortgage market saw their market and their market shares change dramatically as a result, in large part, of the new federal housing finance regime introduced in the 1930s:

All that was required for a historic surge in homebuilding and homeownership was a housing finance system. Local institutional portfolio lenders, now buttressed by deposit insurance and, in the case of S&Ls, the FHLB’s lending facilities, took up most of the business. But the inter-regional flow of credit that arbitraged imbalances across local markets was dominated by life insurance companies and their mortgage banking correspondents. Through 1952, most of these loans were insured under the FHA program, and for good reason — that program had worked well for these intermediaries in the late 1930s. The federally insured and guaranteed home mortgage loan business for life insurance companies and, later in the decade, mutual savings banks preoccupied mortgage bankers until the unusual conditions that fostered the expansion finally ran out in the 1960s. (2)

All of this historical detail brings home a key point for us today. The technical choices we make in structuring the federal housing finance system will alter the incentives of all of the current players. As we watch to see how the Qualified Mortgage, Qualified Residential Mortgage and Ability-to-Repay rules play out when they go into effect next year, we should know that they are likely to shape the mortgage market for decades to come. We already know that some mortgage products will be common and some rare because of these rules. But we should also be aware that some types of originators will be winners and some will be losers because of these rules, although it is too early (at least for me) to tell which will be which. And such an impact may shape the nature mortgage market as much as the types of products that eventually win out when the rules are fully understood by the industry.

A New History of Mortgage Banking

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Yes, I know, a dry subject for most. But for some nerds, there are lots of insights in Mortgage Banking in the United States 1870-1940. The author, Kenneth Snowden, highlights this finding, which gives more credit to the Federal Farm Loan Bank system for the development of the modern mortgage market than do many other histories of the industry:

The Federal Farm Loan Bank system and the FHA mortgage insurance programs that restructured both the farm and urban mortgage banking sectors shared three common features:

+     They each encouraged the widespread adoption of long-term, amortized mortgage loans.

+     They each created mechanisms to stimulate the inter-regional transfer of mortgage credit and the convergence of mortgage rates and lending terms across regions.

+     They each established federal chartering systems for privately financed European-style mortgage banks to create active secondary markets for long-term, amortized loans. (2)

This history provides a lot more detail than one finds in standard histories of the American mortgage market, including much about the early history of securitization. Writers in this area (myself included) tend to think that securitization was birthed in the 1970s, but Snowden documents some proto-securitizations in the early 20th Century. I will come back to this report in a later blog post, but I highly recommend it to serious students of the mortgage markets.

Individual Liability for RMBS Misrepresentations

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Judge Cote (SDNY) issued an Opinion and Order in Federal Housing Finance Agency v. HSBC North America Holdings Inc, et al., 11-cv-06201 (Dec. 10, 2013).  The opinion relates to the potential liability of individuals who signed various documents containing alleged misrepresentations that were filed with the Securities and Exchange Commission. These misrepresentations, if true, may violate the Securities Act of 1933. Individuals who signed off on the alleged misrepresentations could be liable as “control persons” or other key individuals under the Act. The alleged misrepresentations were contained in offering materials for RMBS purchased by Fannie Mae and Freddie Mac.

The issue in the case is a pretty technical one: “the motion requires the Court to decide whether the SEC radically altered Section 11 liability for individuals who sign registration statements in the context of the shelf registration process when the SEC promulgated Rule 430B in 2005.” (5) Less technically, the motion requires that the Court decide the scope of potential liability for individuals for misrepresentations made in documents that they DID NOT sign that were supplemental to documents that they DID sign. The Court found that individuals could be held liable for such misrepresentations as had been the case before Rule430B had been promulgated.

I am not a securities law expert, so I assume that Judge Cote is right in stating that the defendants were arguing for a radical change to  the Securities Act of 1933 liability regime. I am also on the record in support of liability for individuals who are responsible for material aspects of the financial crisis. But I have also expressed concern about incredibly broad liability provisions. As a non-expert in this area, I was surprised that individuals could be held liable for misrepresentations that were made after they signed off on the preliminary documentation for securitizations.

More on Misrepresentation

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NY Supreme Court Justice Schweitzer (NY County) issued a Decision and Order on a motion to dismiss in HSH Nordbank AG, et al., v. Goldman Sachs Group, Inc., et al., No. 652991/12 (Nov. 26, 2013) that builds on the NY jurisprudence of RMBS misrepresentation. The decision notes that “The gravamen of the complaint is that Goldman Sachs knew that” its metrics and representations regarding various RMBS “were false, but did not alert Nordbank.” (2) In particular,

Nordbank alleges that Goldman Sachs knew that loan originators had systematically abandoned underwriting guidelines described in the Offering Materials. It alleges that Goldman Sachs knowingly reported false credit ratings, owner-occupancy percentages, appraisal amounts, and loan-to-value ratios. It alleges that although Goldman Sachs represented otherwise in the Offering Materials, Goldman Sachs never intended to properly effectuate transfer of the underlying notes and mortgages that collateralized the Certificates. (2)

The Court found that Nordbank “sufficiently alleged that Goldman Sachs had knowledge that originators were deliberately inflating appraisal values to artificially obtain understated CLTV ratios that corresponded with lower risk.” (9) As a result, “the complaint sufficiently describes actionable misrepresentations regarding appraisal values, loan-to-value ratios, and owner-occupancy rates.” (9)

Nordbank also alleged

that it has suffered losses totaling more than $1.5 billion as a result of the alleged misrepresentations regarding the loans’ conformity with originators’ underwriting guidelines. Specifically, Nordbank alleges that it has been unable to transfer notes and mortgages that have declined in value because of the poor quality of the underlying loans. The representations at issue allegedly resulted in higher rates of default, an impaired ability to obtain forecloses, and ultimately, a lower cash flow to Certificate-holders like Nordbank. Because Nordbank has sufficiently alleged a chain of causation leading from the alleged abandonment of underwriting standards to a decline in the market value of the Certificates, the complaint cannot be dismissed for failure to allege lost causation. (20)

As this decision was on a motion to dismiss, none of these findings result in actual liability for Goldman Sachs, but they do provide a road map for what liability could look like.  As I have noted in the past, it will be interesting to see how this body of law will affect the securitization process going forward.