The argument for re-starting the private-label securitization market is suddenly dead in the water.
With all the podium pounding calling for a halt to predatory foreclosures in order to protect the middle class, there is an unexpected victim in all this: senior bond holders in securitizations.
Like the residential mortgage market in the U.S., there are a distinct set of laws and obligations set forth to protect the rights of investors. Just as HousingWire publisher Paul Jackson wrote Tuesday
"the very procedures designed to protect our nation’s property rights are now being used as a weapon against us," something even more ominous and perhaps unexpected may occur: forestalling foreclosures sets aside contract laws established in securitization.
In securitization, payouts may be sequential or pro rata but there is a waterfall where the investor of senior notes — those who chased triple-A paper — gets theirs first. It is these investors who have lived through write-downs, modifications, you name it and are now faced with another issue: junior bond holders making out better on the investments.
"The foreclosure slowdown could hurt senior nonagency MBS classes if it results in higher expenses or exposure to further declines in home prices, both factors that increase ultimate principal loss," writes Deutsche Bank
senior MBS analyst Steven Abrahams in his weekly outlook report.
"But extended timelines would help more subordinate classes where principal loss is almost inevitable but coupon income might flow for longer," he adds.
Contracts are written on the basis of fairness. In securitization, fairness is determined by one's exposure to risk in the nonagency space. In other words, investors who funded the originations of the same mortgages likely to foreclose are now faced with the more risk-appetited junior investor getting paid despite the collateral going bad. In short, it's meant to work the other way around.
According to the Aite Group
, the recent government intervention continues to lengthen the foreclosure process will only create uncertainty for the same investors who need to get back into the market to decrease dependency on Fannie Mae
, Freddie Mac
and Ginnie Mae
"It completely reorders the securitization waterfall to the extent advances must be applied to junior bond holders longer than was intended, and which servicers will get reimbursed on the back end," said Aite Group senior analyst John Jay.
As such, Jay added that junior bond holders will be receiving payments (advances) that otherwise would have gone to protecting senior bond holders later on in the deal’s life. This creates a ripple effect that reallocates losses where junior bond holders stay alive longer.
"Securitization wasn't written that way," Jay tells me.
How losses are allocated amongst bondholders is set in stone when the securitization is marketed. Anything that breaks such a contract is untenable for the marketplace.
Consider covered bonds as an example, disregarding the point that banks are on the hook for losses. Covered bonds are in need of a legal, binding legislative framework in order to get the support of investors. A comprehensive and cohesive law is seen as support to the structured finance product.
What foreclosure halts may do to securitization shows that the law isn't really the law and contracts aren't worth the paper they're written on.
Or perhaps that is the true end to all of this, the final legacy of the robo-signer. It's not a simple argument that mortgage servicers were used to massive inflows of mortgage receivables, and then became unable to cope when the business turned instead to massive default servicing.
The grandstanding of state AGs in strong housing economies (Texas
) or in weak housing economies (California
) and politicians alike shows lack of knowledge about the two-step servicing approach to housing: that the servicer of the mortgage is not the same party of the servicer of the bond, but both need be punished.
It paints a scenario where the servicer, regardless at what point in the picture, is suddenly the bad guy — struggling to convince the pitch fork and flaming torch holders that they actually operate in a socially useful capacity.
All the while inexplicably harming the good guys — those willing to lay money on the line. But why should anyone escape the rapture? After all, the primary investors already got screwed on his/her investment (their home) so why shouldn't the secondary investors also get equally screwed?
It's the surest way to bite the hand that feeds the mortgage finance market.
Jacob Gaffney is the editor of HousingWire.
Write to him