Bofa Jumbo-Deal Delay Shows Bond Market on Life Support
A delay of Bank of America Corp.’s return to selling mortgage securities shows the housing bust is still limiting the market’s revival.
Its Merrill Lynch unit has been considering since last month a plan to package hundreds of millions of dollars of U.S. jumbo home loans it had acquired into securities, said four people familiar with the matter. With the firm mired in litigation over mortgages sold during the boom, executives are cautious about doing a deal, said the people, who asked not to be named because discussions are private.
While issuance of private home-loan bonds quintupled this year to $3.5 billion and is forecast to rise by as much as nine- fold in 2013, sales still pale in comparison to their peak of more than $1 trillion before the housing market slide starting in 2006. At stake in the nascent recovery are Wall Street profits, investor returns, homebuyer borrowing costs and the role of the government in housing finance.
“It would be a stretch to even call it reviving,” Jeremy Diamond, a managing director at Annaly Capital Management Inc. (NLY), whose $142 billion of assets make it the largest real-estate investment trust that invests in mortgage bonds, said at an industry conference this month. “This year wouldn’t have even been a good month in any of the 10 years leading up to 2008.”
William Halldin, a spokesman for Charlotte, North Carolina- based Bank America, which bought Merrill Lynch & Co. in 2009 after acquiring top-ranked issuer Countrywide Financial Corp. in 2008, declined to comment on the potential transaction.
Costs from boom-era mortgages have helped send Bank of America stock down 46 percent from its 2010 high. It’s racked up more than $40 billion in costs from faulty foreclosures and sold-off housing debt and faces ongoing lawsuits from insurers including MBIA Inc. and investors such as a class action suit led by the Iowa Public Retirement System.
The thaw in the non-agency market, for bonds without government backing, is being held back by the fallout from the global financial crisis it caused. Instead, programs backed by taxpayers are dominating originations, while banks are holding on to more mortgages as the weak economy limits other lending and increases their deposits.
Investors and issuers also need to overcome lingering distrust of each other and the government, Jason Kravitt, a partner at law firm Mayer Brown LLP, said at the conference held last week by the Securities Industry and Financial Markets Association.
“It’s very hard to have a market where the principal investors are on a daily basis suing the principal issuers,” he said.
For the biggest banks, the potential legal and reputational threats and impact of pending regulations “are all challenges that they have to deal with today that weren’t that relevant in the past,” said Chris Hentemann, a former head of global structured products at Bank of America’s securities unit through 2007.
The bank’s hesitation to securitize the jumbo mortgages it bought “doesn’t surprise me at all really,” said Hentemann, now chief investment officer at hedge fund 400 Capital Management LLC.
Still, the market is growing. Next year, sales may reach $20 billion to $30 billion, according to JPMorgan Chase & Co. analysts. Separate securities that government-owned mortgage insurers Fannie Mae and Freddie Mac (FMCC) are being pushed to create to transfer default risks may fuel a further expansion.
Issuance peaked at $1.2 trillion in each of 2005 and 2006, fueling the housing bubble, before freezing in late 2008 amid a home-price crash that reached 35 percent by February. The slump contributed to a global recession and more than $2 trillion in losses at the world’s largest financial companies.
All of the non-agency bonds created since the crisis have been backed by so-called prime jumbo loans, which exceed the limits of government-backed programs, rather than the subprime and other risky mortgages that stoked the boom.
The role of Fannie Mae (FNMA), Freddie Mac and other U.S. agencies has grown to account for more than 90 percent of new lending, in part because Congress expanded their upper loan limits, without dropping their base limits even as home prices fell. That’s helped to crowd out the private market. Guarantees offered by Fannie Mae and Freddie Mac cover loans of as large as $417,000 in most places and up to $625,500 in high-cost areas, down from $729,750 last year.
“The primary challenge is that Fannie Mae and Freddie Mac have such a dominant market share,” said Adam Yarnold, a managing director at Barclays Plc (BARC), the underwriter of $1.2 billion of 2012 deals.
The Federal Reserve also is helping to stifle a revival by driving down yields on their securities as it buys the debt to support the economy, he said.
The growth in non-agency issuance partly reflects investor willingness to accept lower yields on their top-ranked slices, according to Bill Roth, chief investment officer of Two Harbors Investment Corp., (TWO) a REIT (BBREMTG) that’s been buying jumbo loans it may securitize. The trend reflects the Fed’s stimulus measures pushing bond buyers to riskier debt and housing recovering. Credit-rating firms are also easing their toughened standards a “little bit,” he said.
Redwood (RWT) Trust Inc., the REIT that was the only issuer during the past two years, was joined this year by Credit Suisse Group AG. (CSGN) They also may be followed by Shellpoint Partners LLC, the lender whose owners include market pioneer Lewis Ranieri’s Ranieri Partners, and EverBank Financial Corp. (EVER)
“We’re planning on becoming an issuer next year, and we’re bullish of the opportunity that lies in front of us,” said Joseph B. Long, an executive vice president at EverBank, whose home-loan unit is run by Tom Wind, the former residential- lending head at Lehman Brothers Holdings Inc.
Shellpoint, which filed documents in October with the Securities and Exchange Commission for a potential deal, said that its products include jumbo mortgages and loans for good- credit borrowers that fall outside of Fannie Mae and Freddie Mac guidelines.
Reflecting the higher demand, the difference between rates on jumbo 30-year fixed-rate mortgages and smaller loans has narrowed to about 0.6 percentage point, from as high as 1.8 percentage points in 2009. The gap averaged 0.3 percentage point in 2006.
The decline in Fannie Mae and Freddie Mac’s upper loan limits made the private market more important this year. The firms also raised their guarantee fees, allowing Redwood to offer better rates on some loans they can finance, said Michael McMahon, a managing director. It may become more competitive next year because the companies’ regulator has pledged further fee increases.
Jumbo borrowers are taking out more loans amid record low borrowing costs and being encouraged to choose fixed rather than adjustable-rate mortgages by a narrower gap between short-and longer-term rates, Everbank’s Long said. Banks that use funding such as deposits prefer to hold ARMs, he said.
Closed-end residential loans held by commercial banks rose to $1.61 trillion as of Nov. 28, from about $1.53 trillion at the start of the year, Fed data show.
Wells Fargo & Co. (WFC) said it retained $9.8 billion of mortgages eligible to be packaged into government-backed bonds last quarter to boost its interest income as the Fed’s buying makes investment in the securities less attractive. BNP Paribas SA (BNP)’s Bank of the West is seeking high-quality jumbo loans to put in its portfolio, accepting down payments as low as 10 percent for borrowers with “a lot” of liquid assets, Stew Larsen, its mortgage head, said.
“We would not bump our head on any limitations for a number of years of aggressive originations,” he said.
Banks may be even more likely to hold on to the loans they make rather than securitize because of new rules called for by the Dodd-Frank financial overhaul law, which will require issuers to retain stakes in non-agency deals.
“If you take the preliminary version of the rules it looks like banks will have a difficult time executing a securitization,” Yarnold of Barclays said. The regulations may interact with accounting and other requirements to require banks to hold capital against all of the underlying loans, he said.
That risk retention won’t be required for Fannie Mae and Freddie Mac securities, which “contradicts” with the government’s aim to shrink their role, Susan Mills, the head of the institutional clients group for residential finance at Citigroup Inc.’s securities arm, said at the conference.
Regulators may also stunt sales by leaving bond investors vulnerable if lenders don’t follow new rules meant to ensure borrowers can repay their debt, she said. Another change will create new risks for officials who will need to attest to the accuracy of information in documents used to publicly register securities, she said.
“Having signed a lot of registration statements in my career, and being named in a lot of lawsuits, there’s not a person in my firm that’s going to sign it,” she said.
Issuers have paid for some mistakes. Bondholder claims that the mortgages backing Countrywide’s securities never matched their promised quality led to a pending $8.5 billion settlement with Bank of America. Lingering distrust means loans are now subject to 100 percent due diligence by third-party firms, and ratings companies more closely scrutinize originator operations, Everbank’s Long said.
Various “rating agency processes have changed post-credit crisis, so it takes longer to bring a new deal to market,” said James Raezer, head of mortgage finance in the Americas at Royal Bank of Scotland Group Plc (RBS)’s securities arm, which underwrote one of this year’s Redwood deals. “That has to be taken into consideration.”
Bond buyers including Pacific Investment Management Co. and BlackRock Inc., which helped negotiate the Bank of America settlement, have said government steps to aid delinquent borrowers while sparing banks will also curb their interest.
Scott Simon, Pimco’s mortgage head, said the revival will at the same time be constrained by the borrowers having high credit scores and down payments, which creates refinancing risks for investors. So far, the limited amount of sales has meant underwriters can find enough who don’t understand the extent of the danger to senior-ranked bonds bought at premiums, he said.
“You will blow through the people paying too much pretty quickly,” said Simon, whose firm manages the world’s largest bond fund.
Investors are eager to purchase junior-ranked slices offering higher returns if defaults stay low, said Hentemann of 400 Capital. Improved loan quality makes today similar to a period in the mid-1990s when doing so proved smart, he said.
“From a credit buyer’s perspective, it’s a fantastic environment,” he said.
In Redwood’s deals since 2010, loan-to-value ratios averaged 63 percent, translating to down payments of 37 percent for home-purchase loans, and credit scores were 771 out of a possible 850, the JPMorgan analysts calculated.
The quality of transactions next year will be “marginally weaker,” with loan-to-value ratios continuing to rise and credit scores drifting lower, Moody’s Investors Service said today in a statement. The pools will also “contain more loans with riskier attributes, such as those secured by investment properties,” the ratings firm said.
“Lender guidelines have not materially loosened recently, but growing investor appetite for prime jumbo RMBS and a limited supply of ’super-prime’ borrowers has incentivized lenders to originate more loans near the fringes of their underwriting criteria,” Linda Stesney, a managing director at Moody’s, said in the statement.