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Regulators deny JPMorgan Chase, Redwood Trust securitization innovation

Private market risk-sharing effort rejected by OCC

Thanks to the government-generated regulatory environment, nearly all of the mortgage securitizations since the crisis have come from government-controlled entities, like Fannie Mae and Freddie Mac.

As the government-sponsored enterprises’ share of the securitization market grew to outsized proportions, the private market all but disappeared, with private-label securitizations largely confined to jumbo mortgages.

As Bloomberg reports, last year saw a bit of innovation in the private-label securitization market, as JPMorgan Chase launched a new securitization option where some of the risk on non-agency mortgages is transferred to the private market through a risk-sharing deal.

But as Bloomberg also reports, citing a recent report from Asset-Backed Alert, the Office of the Comptroller of the Currency rejected the innovative securitization structure.

Bloomberg’s Lisa Abramowicz explains:

The Office of the Comptroller of the Currency recently spurned JPMorgan Chase & Co.'s novel attempt to reduce the amount of capital it had to hold to offset risk tied to pools of mortgages. The action shows that wrangling the regulatory bureaucracy will be anything but smooth.

In the JPMorgan case, the bank created bonds backed by a bunch of mortgages it had on its books, ranked according to risk and potential return. It then sold most of the junior slices to outside investors, hoping the maneuver would reduce the effective risk of the assets in the eyes of regulators, thus reducing the bank's capital requirements. (The bank retained the senior portions.)

Abramowicz’s article cites the coming regulatory rollback efforts of the Trump administration as a potential issue for alternative securitizations such as this one.

Again from Bloomberg:

Without weighing in on the OCC's decision, it does seem as though the agency is taking a harsher stance than its European counterparts. And its approach may very well set it up for a battle in the new U.S. presidential administration, which has been clear about its distaste for almost all forms of regulation.

The reality, though, is that a lot of banking regulation stems from disparate regulatory bodies that have a lot of discretion. Trump's team is already trying to clamp down on this.

This tension, between existing regulatory staff and the new administration, will most likely only worsen. This will lead to a good deal of confusion on Wall Street and at federal agencies alike. And the result is likely to be a messy and delayed rollback of any financial regulation.

Another piece of the JPMorgan risk-sharing deal is Redwood Trust, which partnered with JPMorgan on two of these deals to buy some of the risk.

In a client note published Monday, Nomura analyst Brock Vandervliet writes that the OCC’s denial of the deal’s structure is bad for the mortgage market.

“Redwood Trust was a partner as the buyer of the higher yielding subordinate tranches of both transactions, which were $1.9 billion and $2.6 billion,” Vanderlivet writes.

“We confirmed with RWT management that economics for its portion of these transactions are unchanged but, in our view, this is disappointing nonetheless,” Vanderlivet continues.

“At the time the transactions occurred last year, we understood (return on equity) on these investments to be in the range of 11-13%, unlevered,” Vanderlivet adds. “While it is a positive that RWT's economics are unchanged, this is disappointing for the residential mortgage space as this new structure offered potentially better execution (lower cost) for large residential mortgage originators.”

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