More than five years after sales of U.S. mortgage-backed securities froze, banks, investment firms and others in the business are seeking to accelerate a revival of issuance by reducing mistrust among market participants.
The Structured Finance Industry Group will tomorrow hold a four-hour roundtable with about 35 executives in New York on when and how lenders or other sellers of mortgage securities without government backing can be forced to repurchase loans that fail to match their promised quality, for reasons such as overstated borrower incomes or inflated property appraisals.
The closed-door meeting shows how contract terms known as representations and warranties are among matters needing to be addressed as the market is rebuilt. Issuers and underwriters including Credit Suisse Group AG (CSGN), Bank of America Corp. (BAC:US) and Wells Fargo & Co. (WFC:US) will hear from investors such as DoubleLine Capital LP, Loomis Sayles & Co. and Grantham Mayo Van Otterloo & Co. and six leading rating companies, an online posting shows.
“The time to have these discussions is now, and not over dinners, drinks and individual phone calls,” said Eric Kaplan, a managing director at Shellpoint Partners LLC, the lender backed by mortgage-bond pioneer Lewis Ranieri. “A lot of work has been done. The question is whether it’s enough. We don’t want a repeat of the housing crisis, where everyone got hurt.”
The topic will become even more important as the government, which is now backing about 85 percent of new mortgages, attempts to scale back its role and loan standards loosen from the tight levels seen in the wake of the housing crash, he said.
Issuance has been building after the worst financial crisis since the Great Depression, when non-agency mortgage-bond sales halted amid tumbling home values, soaring defaults and allegations the debt’s quality was knowingly misrepresented as sales peaked at about $1.2 trillion in each of 2005 and 2006.
About $12.5 billion in deals tied to new loans have been completed this year, up from $3.5 billion in all of 2012, according to data compiled by Bloomberg. While sales in 2013 probably won’t surpass $15 billion, they could exceed $50 billion next year, according to a Barclays Plc report last week.
Limited issuance backed by high-quality mortgages means the industry has yet to grapple with a growing divergence in how different deals subject mortgages to forced buybacks, Kaplan said. While some buyers are accepting new terms friendlier to sellers, “some very large and important investors” haven’t been purchasing at all, he said.
“We need to fix these issues,” said Vincent Fiorillo, a DoubleLine bond manager who will participate in the roundtable. “It’s probably going to be a pretty interesting set of conversations.”
Some issuers are using contracts with expiration dates for warranties because of concern they otherwise risk bearing losses created by a new housing collapse or recession, not loan misrepresentations, with some agreements limiting buybacks in cases such as a borrower losing a job.
Investors want better ways for breaches to be discovered and cured, after holders of debt created by Bank of America’s Countrywide unit found its trustee, Bank of New York Mellon Corp., initially unwilling to investigate their claims, before reaching a proposed $8.5 billion settlement with the issuer.
The event tomorrow also includes representatives from trustee businesses such as at Citigroup Inc. (C:US) and US Bancorp (USB:US), as well as trading units at dealers including Morgan Stanley (MS:US) and Deutsche Bank AG (DBK), law firms and due diligence companies.
$449.4 Billion Losses
Patrick Tucker, a spokesman for the SFIG at Abernathy MacGregor Group, said other panelists were unavailable to comment. Aside from speakers, about 150 people are expected to attend the event, he said.
Representations and warranties “dominated” an industry conference this month in Miami, particularly the benefits to older bonds, the Barclays analysts led by Sandeep Bordia and Jasraj Vaidya wrote. Realized losses on mortgages within non-agency securities totaled $449.4 billion from 2006 through 2012, according to Moody’s Analytics.
Processes that helped limit loan buybacks are just one of the “significant hurdles” the market faces, which is “a shame, because we want to invest in the sector,” Chris Ames, a senior portfolio manager at Schroder Investment Management North America Inc., said this month in a commentary.
Jason Callan, Columbia Management Investment Advisers LLC’s structured-products head, said that expirations on warranties make sense because defaults caused by underwriting flaws will likely happen within a few years. At the same time, he said it’s not clear that the limitations should apply to all fraud types or happen as quickly as some sellers seek.
Tomorrow’s talks will be about “drilling down” to understand what details matter, Shellpoint’s Kaplan said. The industry, which through the separate American Securitization Forum trade group proposed model contract language in 2009, probably won’t ever use a single set of terms, he said.
It’s not enough for standards to evolve because the $9.3 trillion mortgage market is so big and policy makers may act to reduce the government’s role before the issues are settled, said Richard Johns, the SFIG’s executive director.
“It forces the industry’s hand a bit to help it along,” he said.
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