Institutional investors may need a dose of confidence before returning to the private-label residential mortgage-backed securities market, but gaining the necessary confidence may require something more than a traditional rating from a credit ratings giant.
In the wake of the housing bust, credit rating agencies – including Standard & Poors, Moody’s (MCO) and Fitch – took a large share of the public blame for offering high ratings to mortgage bonds that eventually collapsed
This episode in RMBS history left investors gun-shy and litigious in some cases, suggests James Frischling, president and co-founder of NewOak Capital.
The result, Frischling says, is the potential for the agency side of the MBS market to rely on different ratings mechanisms in the future.
In other words, investors want to know their collateral pools are clean, something credit ratings agencies failed to do in the run-up to the housing bust. And if they’re not pure, they want to know how much risk investors will be taking on after signing onto a deal.
Gaining this level of clarity is a work in progress.
The recently announced GSE risk-sharing model is one area where standard credit ratings may be passed over in favor of another risk-assessment model, Frischling noted in his report.
"The current Freddie risk-sharing offering may move away from the traditional rating agencies and instead consider obtaining a rating from the National Association of Insurance Commissioners. Even if they go with a traditional rating agency, many investors say they rely far less heavily on the agencies as the financial crisis demonstrated the need for investors to do their own credit work," the NewOak founder said.
He added, "If true, it looks like some important lessons were learned from the crisis and the result might be the return of the much needed private RMBS market."
But it may be too soon to count the credit rating agencies out.
Ankur Makhija, a senior analyst with broker/dealer Odeon Capital, says it really boils down to what the institutional investor wants to do.
Makhija says credit rating agencies provide a valuable service for a modest fee. When you move to more complex models – or buy-side firms, which may be more credible – your costs increase, he told HousingWire.
“The bigger problem is when you have such a low-rate environment, there is really not that much money to go around in the new issuance of securities because those yields are sub-5%."
The takeaway: escaping the credit rating agencies model may be too costly to justify the gains of a more complex ratings model. Yet, it all depends on what the institutional investor chooses.
"The new issuance produces 1% to 3% yield, depending on the asset class, the average life and the perceived risk profile,” Makhija said. "Any additional fee is a much significant amount of money as a result. There is a tradeoff between additional due diligence and yields and investors need to decide what's more valuable to them."
Another dynamic that could impact whether they choose something more than a credit rating agency's report is whether the investor is confident in the underlying collateral from the beginning.
“Now we have the highest quality collateral available, which is being securitized, and investors are looking for more information for them to be told it is high quality, but the information is already available in the prospectus and loan-level data," Makhila said.
Investors will have to pay for additional research on RMBS offerings if they want something more than a credit rating agency report. But, in today's low-interest rate environment, that may be unnecessary, Odeon analysts suggest.
As for when the market will see more RMBS issuance, the timeframe is unclear. “I think the new issuer RMBS is going to be dependent on the rates – or the evolution of rates in the near to medium term,” concluded Makhija.