Currently, a growing number of lenders and aggregators are actively considering entry into the PLS market or at least weighing their options. Some firms assessing a PLS strategy participated in the market before the mortgage meltdown, whereas others are new to securitization all together. 

Regardless of prior PLS experience level, as securitization strategies are formed, there needs be a clear understanding of what constitutes securitization-ready assets today, and what new monitoring and reporting requirements need to be factored into securitization decisions.

MAKING THE TURN TOWARD VOLUME

There are a number of market indicators that suggest PLS may finally be ready to make the turn in terms of industry activity and fundamentals. These include interest rates, home price appreciation and movement in the lending community towards new product exploration. 

These developments are creating a more bullish sentiment among market observers. Consider some of the points rating agency DBRS made in its annual review and forecast this past January. 

“DBRS anticipates an increased demand for PLS issuance, driven by rising rates and the steepening yield curve,” the report said. DBRS was particularly encouraged by the potential for non-QM originations and deals. 

“The year 2016 marked the first time that three DBRS-rated securitizations backed by non-QM and QM rebuttable presumption mortgages were issued…DBRS anticipates that more non-QM issuers will come to the market in 2017, driven by significant pricing benefits.”

Recently, Inside Mortgage Finance looked at rated deals from two major issuers: Deephaven Mortgage and Lone Star Funds. The latest Deephaven deal pooled $250 million of mortgages: 82% of which were non-QM, primarily because of income documentation reasons, not reduced credit standards. The success of the deal demonstrates that new loan products can be originated and priced in the third-party non-agency market.

The $402-million, nonprime Lone Star deal had larger loan sizes, but also featured bank-statement loans and other alternative income loans. 

And most recently, Wells Fargo announced their re-entrance into the private mortgage-backed securities market for the first time since the financial crisis, providing a clear well-respected money center bank exploring non-agency alternatives.

There are also signs that investors are ready to embrace non-agency securities again. Writing in a recent issue of Barron’s, two leading Pacific Investment Management Company portfolio analysts noted: “Mortgage-related investments can provide an attractive complement to other assets in investor portfolios… Going forward, we expect non-agency mortgage-backed securities to be the most attractive sector from a risk-adjusted return perspective. We see prospects for returns in the area of 5-6%, given our base case forecast that U.S. housing prices will increase about 3% per year over the next two years.”

WHAT DOES READINESS MEAN?

As the stars — or at least interest rates, investor appetite and the post-election regulatory climate — align, a growing number of aggregators and portfolio lenders are now considering securitization as they expand their product mix and look for new liquidity options. Clayton has been actively involved in helping these lenders and aggregators navigate the new world of securitization, circa 2017.

One of the first questions that firms contemplating a securitization strategy need to ask is: Are our assets ready to be securitized? The rating agencies all have explicit criteria for the due diligence and loan review scope and process. This can mean that the due diligence performed for the purpose of a whole loan portfolio acquisition may not meet the standards required for a securitization. 

For instance, it is fairly common for an aggregator to determine the scope of a non-securitization portfolio loan review. This can include deciding how the sampling should be done, and how grading and reporting will be determined.

Typically, a securitization will require much more independence from the third-party reviewers. The rating agencies also have minimum requirements for years of experience for various roles (including underwriters, quality control, and deal managers) that TPRs must adhere to for staffing purposes. In addition, there are specific loan sampling strategies and other industry requirements that must be followed.

Any combination of the factors above may mean that certain loans or portfolios may have to be reviewed or re-reviewed to supplement reviews that may have already been completed for non-securitization purposes. This is not because the diligence wasn’t done correctly in the first place, but rather because it was done with a scope and process designed for different purposes.

Compliance is another issue that must be taken into account. While some issuers will be comfortable enough to go straight to non-prime deals, others will want to leverage the Qualified Residential Mortgage risk retention exemption provided under Dodd-Frank.

To do this, however, they must be able to show that the loans being securitized are Qualified Mortgages.

If, down the road, the loans are determined to not meet the QM criteria (usually it is a problem with Regulation Z’s Appendix Q), the issuer could lose the risk retention exemption. So it may be prudent to run compliance reviews on the loans that tend to fall within the gray areas of the QM rule. 

The bottom line: An aggregator considering securitization six months down the road, for example, might want to consult with its due diligence provider to make sure that the scripts and review process that are being followed will produce securitization-ready assets.

ONGOING DEAL MONITORING

Issuers that are new to the private label space or that are just coming back to the market need to be aware of specific reporting and monitoring requirements set by regulators and the marketplace.

Many of the recent private label deals now feature some form of a representation and warranty reviewer. In general, the role of the representation and warranty reviewer is to provide an independent review of certain loans based on triggers defined within the transaction documents. 

Within this broad framework, the role of the representation and warranty reviewer can have different formats from deal to deal. While most of the new issuances are private 144(a) deals, when public deals do return, issuers will need to reconcile the market trends in representation and warranty reviewer design with the role of asset representation reviewer, which is now required by Reg AB. 

Clayton was the first company to receive a representation and warranty reviewer rating. As the reviewer on a number of non-prime deals and numerous asset classes, Clayton is often asked for advice on calibrating the scope of the reviews with the risk of the assets being securitized.

IS IT TIME? ARE YOU READY? 

Economist Paul Samuelson famously said that “Wall Street indexes predicted nine out of the last five recessions.” Since the mortgage meltdown, predictions of a return to a thriving PLS market have been as frequent as they have been inaccurate. 

Whenever the market does return, and there are new and encouraging signals that a return is not far off, lenders and aggregators looking to take advantage will need to ready themselves for the new and different landscape they will enter for private label securitization.  

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