As the private-label mortgage bond market comes back to life, real estate investment trusts may play the lucrative central role that belonged to banks and Wall Street firms during securitization's pre-crisis heyday.
Consider the watershed deal late last month from Redwood Trust. Citigroup was everywhere to be found on the assembly line-except the middle.
At one end, Citi's mortgage unit originated the $238 million of loans and services them. At the other, Citi's investment bank underwrote the bonds.
But Redwood, a Mill Valley, Calif., REIT, put its balance sheet on the line.
Tremendous Reserves
New accounting rules require banks to hold securitized loans on their balance sheets. This makes securitization unappealing to them because banks now must reserve for losses on the loans, and the transactions are reflected fully in capital ratios. REITs, though, have been holding securitized assets on their balance sheets for years, and are not subject to the same regulatory capital requirements.
"REITs are in the sweetest of spots," said Dave Hurt, a senior vice president at First American CoreLogic, a mortgage data firm owned by First American Corp. of Santa Ana, Calif.
By selling the mortgages they write to REITs, which would in turn securitize them, banks could remove the loans from their balance sheet. That would still bring in a source of revenue for the banks to put back into the production of more loans.
Redwood's deal was the first of its kind in about two years-backed by freshly minted jumbo home loans, without a federal guarantee from Fannie Mae, Freddie Mac or the Government National Mortgage Association. (The few private-label securitizations since the crisis began consisted of loans that were several years old; only mortgages with a long track record of making payments were saleable while the credit markets were frozen.)
Before the housing market went bust and the credit markets came to a screeching halt, Citi and other commercial and investment banks regularly securitized non-conforming loans themselves.
"The prior regime allowed an issuer to create a special purpose vehicle and to de-consolidate them and remove them from the balance sheet," said Michael Youngblood, founder and principal of Five Bridges Advisors LLC, a mortgage and fixed-income advisory firm. "It gave an entity like Citibank [the ability] to originate loans, sell them to a trust, issue securities, repay itself and remove them from the balance sheet. In the future, they will remain on balance sheet."
And that "could make it more onerous from a capital standpoint for banks to securitize," said Matthew Howlett, a vice president at Macquarie Capital.
But not for REITs.
"There's no capital-charge issue for a REIT. They don't have to hold a certain amount of capital against their balance sheet," Howlett said.
Youngblood agreed. "REITs are natural holders of mortgage loans and securities," he said, adding that they have already essentially been complying with the new accounting rules.
Aside from the accounting rule changes, lawmakers and the Securities and Exchange Commission have proposed requiring issuers of asset-backed securities to retain "skin in the game"-a minimum percentage of the credit risk of assets they sell to investors. And the Federal Deposit Insurance Corp. has proposed weakening the protection of securitized assets from asset seizures in bank failures.
"The regulation bills out there make it more difficult for banks to securitize as well," Howlett said. "If the proposals end up being more onerous than we thought, banks may end up selling more loans then securitizing them."
"Now you'll find that the REITs will be in the position to take the first loss piece and generate some very significant [internal rate of returns] over that," said Sam Lieber, president of Alpine Mutual Funds, which invests in REITs. "It's potentially a very interesting time for the REITs."
Signs of Life
For now, most market players are just happy to see some signs of life.
The Redwood transaction "is an important first step" in rejuvenating the business, Youngblood said.
And as long as there is demand from someone to buy and securitize the loans, banks will produce them, which observers called an encouraging sign for the overall housing market.
"I think the banks will be indifferent as long as they can make money on the production," Howlett said. "It doesn't matter right now who's doing [the securitization], because it's good for the market in general."
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