Long Live the “Originate and Invest” Models!

April 19th, 2012

By Mark P. Dangelo

http://www.mortgagebankers.org/tools/FullStory.aspx?ArticleId=30420#full

For the last five years, the idea of any form of private
securitization has been met with scorn by bankers and investors.  Whereas, there are many historical reasons to
accept the dogma that securitization outside explicit government guarantees are
too risky, this misconception continues to haunt and drag on the much
anticipated bottoming and recovery process of the housing market.  With an additional 1 to 1.5 million
foreclosed homes coming to market within the next 12 months, more than any
other year since 2009, the availability of non-portfolio capital for conforming
and jumbo loans will be critical to emptying the housing hangover bucket.  Even with record low rates, the markets are still
a hollow shell of their former glory.

How precisely should capital be added to the financial
housing supply chain?  To guarantee any
sustainable and meaningful housing recovery, after declining 75% from its peak,
the infusion of private money with knowledgeable investors must be the cure and
not the 5% .  As Congress finally finds its
post-election year nerve to tackle the final disposition of the over $150
billion conservatorship of the GSE’s, it is time to examine the explicit linkages
that made housing finance work and fail, while preparing new, transparent
investment supply chains which are adaptable for future markets and homeowners. 

The “originate and forget” models are long dead—long live
the “originate and invest” models!  Funny
thing, while everyone is concentrating on why the prior models failed and even
now who to blame, very few are gaining sufficient traction to project the
impacts and needs outside of localized market analysis and the availability of
credit to disadvantaged borrowers.  Yet,
without a proper framing of the macro markets and investment opportunities,
including secondary offerings and trading, a design for a local market may
serve as the catalyst to a new series of funding debacles analogous to those
taking place in the EU member countries. 
Indeed, real estate and housing is local, but investing is now solidly global.


Crafting and Defining the Strategies

Historically, the linkages between housing and housing
finance were waterfall in nature—with home lending falling into the buckets of
securitizations or MBS’s positioned neatly downstream from the originating loan.  Enabled by monetary and fiscal policies,
market rates and risk perceptions propelled banking portfolios’ of home assets
to decline from around 50% in the mid-1990’s to near zero by 2006.  Six years later, the GSE’s who as the crisis
hit, had a market share of around 40% of securitizations in 2007, they now
dominate over 90% of the secondary markets and debt instruments nearly all of
which is guaranteed.  The price tag to
date has been great and the taxpayer risks continue to pile on as the
government uses them to facilitate workouts and buybacks. 

Moving forward, as stated in last month’s article “Break
Government Addiction—or Risk Falling Behind in Global Markets”, any sustainable
housing recovery must be majority underpinned by private money and not
public.  With the right margins, rates,
and innovation it is possible to attain capital increases in markets by up to
50% over current levels.  Yet, to properly
align the origination to investment supply chain, there are five critical questions
that must be answered.

·        
What is the origination strategy that provides
the greatest return, while accepting valuable and frequently fluid homeowner stratifications?

·        
What investment strategies are working?  Which investment strategies are underfunded
or unanswered—by originators (and backend servicing) and their lending
strategies?

·        
Where do the strategies perform best and in what
types of markets consistent with today’s economic outlooks and lingering
housing afflictions (e.g., foreclosures and availability of credit)?

·        
What pipeline or conduit outlets work for the
banking business model selected?  How
many outlets and what types should an institution pursue beyond the channels
dominated by explicit government guarantees?

·        
What standards and guidelines will be acceptable
to ensure that risks and returns are explicitly managed and adjusted?

When the answers to the above questions are known, solutions
to significant process questions must be established and implemented including:

·        
Are the handoffs and flows between
compartmentalized origination, servicing, and funding actions clearly
understood, adaptable and auditable over time periods?

·        
Are the risk management, underwriting,
governance and investor reporting clearly defined and delineated across red
line boundaries—how can information and data be seamlessly leveraged for
accuracy and efficiency?

·        
How are the demands of the investor and
secondary markets met with securities or bonds backed by lending assets (e.g.,
MBS’s and covered bonds)?  What processes
exist to manage information discovery and dispersion on a real time basis when
compared to the old standards of months?

·        
Outside of agency selling, what processes across
the financial supply chain have been updated to accommodate new loan types,
lending parameters, consumer credit, and vast data now assembled in preparation
for private markets and secondary trading?

·        
With regulations such as Dodd-Frank and Basel
III now consuming the vast majority of available discretionary budgets and
organizational time, where will the expertise and staffing come from to address
the underlying technology solutions needed to adhere to 100% conformance?

With the business operations framed and the process
questions addressed, organizations must now concentrate their expertise on the
serious technology demands necessary for implementation, auditing, monitoring,
and continuous improvements.

·        
What front, middle and back-office processes require
automation to ensure adequate returns and operational efficiencies?  If they exist, what gap changes have been
identified?

·        
Where can solutions be implemented to promote
greater market share and margins in addition to basic cost controls?

·        
How can data capture and storage demanded by
regulatory compliance be leveraged from existing sources, while guaranteeing
accuracy, retention, and disposal across the financial supply chains?

·        
Where can technology aid with risk management
and asset pooling to promote healthy securities and bonds including the use of
asset swaps to satisfy covenants (e.g., covered pools)?

·        
What partners or providers can augment the
needed skill set changes occurring rapidly across the fixed-income market at a
time when staffs are shrinking and expertise retiring?

·        
What innovations will be required to reconstruct
or develop solutions?  Where will they
come from and how will they be adapted to ensure conformity across legacy
platforms and point-based solutions?

When taken altogether, the practice of throwing of teams of people
at the strategy solution is not the answer—at least not the only one.  As already briefly framed people, costs, CAPEX,
lost opportunity, pipeline volumes and margins, technology, data, regulations,
and reduction in lending are all material components across the financial
supply chains. 


The Importance of Creating the Originate and Invest Models

It has been 15 years since a forward looking, comprehensive
view of the financial supply chain has been undertaken outside of localized
markets (e.g., a county in FLA). 
Holistically, the view and analysis is complex and opaque as researchers
are more inclined to address issues close to home.  However, with changing regulations, the ideas
of selling portfolioed assets to the investment and ratings community now brings
greater scrutiny and demands to represent and warrant bundles as performing.

The process linkages underpinned by technology demands
continues to evade most enterprises, especially those without the larger CAPEX
budgets bringing increased market and reputation risks to those trying to keep
up or diversify.  Moreover, the
procedures needed to promote efficiency across the lending and investment chains
are designed for a market that is government dominated rather than for private
money, governance, insurance, and reporting. 

The rise of properties coming to market will create a void
of capital needed for national and local investment due to over 1 million
foreclosures that will put pressure on prices while decreasing the available
pool of applicants as capital gets harder to come by and government programs
stall in an election cycle.  Looking
forward, new asset classes and fixed income instruments have not been
considered when pricing loans or for secondary selling of loan types when
spread over a $1 trillion market. 

For forward thinking technology and process professionals,
understanding the trends and strategies of how this huge, future-framed, and domestically
important market operates with its systemic deficiencies, will allow firms to
set up investment products, services and bundled offerings which are integrated
and meaningful to Global Street buyers of debt—not just to their internal
departments or divisions.

In summary, critical, interconnected and frequently
dependent components needed to ensure robust, private secondary markets for
securities and bonds include:

·        
Volume and frequency

·        
Programs and eligibility

·        
Rates and yields (including prepayment and
reinvestment risks)

·        
Bundling and segmenting

·        
Underwriting

·        
Selling and representations

·        
Hedging and swaps

·        
Risk-return tradeoffs

·        
Governance and reporting

·        
Standardization of contracts across conforming
and non-conforming

·        
Consistency and correlation of loan types

·        
New or emerging fixed income instruments

While the above list is not comprehensive, it serves as a
guide for the chicken-and-egg originate and invest models—lenders want to lend
and mitigate risks by selling securities, investors want risk-attributed
products, and the money of fixed income and secondary sales go back into the
lending community to make more credit available.  For some of us, the 1997-2006 mindset of
“throwing loans over a fence” for investor and secondary markets never really
worked—and it has proven 100% far from wise.

When the organizations finally accept the tight couplings
between strategies and models from the originating and investment worlds,
viable, long-term solutions can be reached and the crisis will finally turn the
corner.  With the disposition of the
GSE’s now beginning in earnest, the time is now to begin to plan out and accept
the markets without 100% government buying, securitization, and
guarantees. 

Bottom line, until origination strategies align beyond
government sponsorship and into private investor community demands and
expectations, the housing markets will languish.  Until the questions are asked and answered,
the U.S. housing market will be a government controlled and dictated one driven
by excessive regulations and arcane, political demands.  Until we prepare for a new housing future of
origination to invest with new fixed-income instruments and operational
linkages, the markets will always be a shadow of their former glory. 

We know the questions. 
Are we prepared for the answers?

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Taking Care of Business

January 24th, 2012

By Mark P. Dangelo

Innovative Relevance

http://www.mortgagebankers.org/tools/FullStory.aspx?ArticleId=28527#full

Four years after the Great Financial Crisis of 2008, senior
banking officials are continually thrown under the bus as the new Robber Barons—just
as industry captains of old (e.g., Andrew Carnegie, John D. Rockefeller, and
Cornelius Vanderbilt).  History is once
again repeating itself.

The formerly revered and sometimes feared names of Lewis
(BofA), Mozilo (CWF), and Cayne (Bear Stearns) have been ushered out with scorn
and replaced by new leaders seeking vision, directions, and regulators approval—and
a way out of billions in litigation, claw backs, and fervent attorney generals.  Whichever side you take on the financial
collapse debate, constantly shifting politics within a presidential election
year continues to make it a very unpleasant time to be a banker, let alone a
financial institution with nervous investors.  Perhaps by 2015, we can find that elusive “next
curve”.

Moving forward and with increased certainty, financial
institutions, driven by a new patchwork of thorny, disjointed global regulations
including mandated annual stress tests, are turning historically venerated institutions
into ordinary public utilities with commodity offerings.  It is under the guise of safety, soundness,
and deep liquidity where hundreds of billions of investments will be spent on
new infrastructure (i.e., hardware, software, services, security, and networks),
policies, and processes to satisfy the next five to seven years of regulations.  Reminiscent of the go-go mid-1980’s
investments, the war on profit and loss will be waged with diverse technologies
and data efficiencies—not lending and trading. 

As a result of the games being played and the livelihoods
being lost, I for one am growing exceedingly tired of waiting for the next shoe
to drop and the pundits to finally get it right.  How many housing recovery plans have come and
gone in the last 48 months from every constituency—the Administration, Congress,
the Federal Reserve, industry associations, and consumer groups?  Whether some like it or not, it is past time
to get back to finance and banking business. 
Dialogue doesn’t pay the bills—discretely focused and measurable actions
will.  Let’s look at two key actions for
2012-2013.


Loan Origination System Excellence

In an extensive interview with industry mortgage veteran Keith
Kemph, Managing Partner, Shadow Point Consulting LLC, he highlights his 2012 strategy
and operational initiatives for profitable originators and their tightly-coupled
LOS needs.

Regarding the current state of the industry and an ability
to adapt, “One word that has become synonymous with the mortgage industry is
change.  Whether it’s a) change for the
good, b) change for the worse, c) change that helps move the industry forward,
or d) the recent changes we’ve seen that move our industry ‘backward’, today to
survive the new mortgage millennium mortgage bankers must be more ‘agile’.  Bottom line, a mortgage banker’s agility (or
lack thereof) will directly impact their bottom line (cost per loan / net
revenue per loan) and subsequent survival.  Agility is required at both the philosophical
and IT infrastructure level.”

To support changing requirements and industry paradigms, Mr.
Kemph states, “Before we can address how the pending regulatory and compliance
changes will need to be supported by technology providers in 2012 and 2013, we
first need to look inwardly and be certain our ‘business philosophy’ has
successfully made the transition from the traditional mortgage banker thought
process of ‘that’s how we’ve always done
it’ to ‘what do we need to do?’  Once mortgage bankers have successfully
adopted this new philosophical framework for evaluating their business
processes, policies and procedures they will be in a better position to
articulate what exactly they need from a process or technology standpoint.  Then the mortgage banker can then start asking
their respective technology providers and personnel to assist them
accordingly.”

When discussing existing operations and investments, “As it
stands today, a majority of mortgage bankers have already gone out and
purchased a new LOS at some point in the last three or four years.  Still other tech savvy mortgage bankers have
successfully patched together a fairly efficient set of processes that deliver
compliance.  Considering this and how
mortgage bankers will continue to operate on razor thin margins for the
foreseeable future, they will not be able to afford an initiative of uprooting
their existing technology and starting from scratch in order to meet changing
regulatory requirements.  Furthermore, mortgage
bankers are keenly aware that while each vendor offers various bells and
whistles, after all the hard work, time, money, and effort the mortgage banker
still holds the bag.  Loosely translated
this means that the mortgage banker still assumes 100% responsibility for their
‘loan decision’ on each and every loan regardless if the technology provider is
compliant, or not.  As a result, it’s no
wonder mortgage bankers are carefully evaluating risks versus costs when making
decisions surrounding technology investments.”

Mr. Kemph emphasizes, moving into the definition of and deployment
for business and consumer mandates, that “There will be growing demands within
the industry for LOS providers to offer more cost effective access for clients
to self manage their own LOS environments and platforms.  This will require technology providers to
become more organized and efficient in managing professional services, while
delivering technology in an agile architectural envelope which is both client
and vendor integration friendly.  Otherwise,
outsourced professional services, consulting firms, and 3rd party
vendor software services will see THE increased demand, as they help
organizations deliver maximum productivity and revenue using compliance as the
wrapper.  It’s my opinion that either by sheer
luck or a true strategic approach, firms and partnerships similar to Optimal
Blue, Secondary Interactive and Motivity Solutions, are fine examples of
organizations that may be ahead of the curve in this regard.“

So what should be done to guarantee investment returns?  Mr. Kemph concludes, “While technology
providers have historically played an important and significant role in helping
mortgage bankers to operate more efficiently, for the next two years they are
going to need to align themselves with vendor partners.  They must seek out best-in-class customer
service and low cost and high efficiency firms, who also provide easy access to
framework architectures at a reduced cost surrounding platform management.  Five years ago, the CEO of a leading mortgage
technology service provider privately stated, ‘It’s ok for our clients to put
pressure on us and dictate what they need – the pressure to reinvent ourselves
is a good thing for the industry.’”

As Mr. Kemph touched on above, the demand for technology to
business process integration will become a cornerstone and key competency of
any future banking strategy—that is they must be proactively linked to promote
the best fit at the least cost.


Transforming Business Process Management (BPM)

In transforming organizations using BPM, Pedro Fong,
Managing Principal, Innovative Relevance® directs his expertise against the
extensive adjustments and development of business processes needed to
efficiently orchetrates technology investments, data reuse, and operational
integrations.

For Mr. Fong, the remedies of prescriptive solutions are not
a panacea due to the complexity of legacy environments.  “Constant change seems to be the ‘new normal’
in our post mortgage meltdown economy. 
Yet, exactly what does that mean for BPM folks?  This new equilibrium can refer to a variety
of new business processes that have to be either reengineered or created from
scratch for a business to profitably operate. 
If you are lucky your business partners should have standard business
processes that were documented and instantiated within the organization well
before your arrival—or not.  Either way
businesses are going to need BPM expertise that can step up and help
organizations navigate through the different methods and techniques available
today to achieve their business needs. 
Unfortunately the answer of whether to BPM or not is ‘it depends’.  Moreover, BPM is not going to be a ‘silver
bullet’, but it can be a way for an organization to capture its thought
leadership and map out a strategy.  This
is an approach that can be communicated out on what the new normal means to the
organization and how it’s going to impact its operations and profitability.”

By selecting the right instrument for the task at hand, “Everyone
understands that simply deciding that you are going to ‘do’ BPM and purchasing
a tool, does not mean that your BPM approach will help you achieve your
business goals.  BPM at its core is
really a way for IT and the business partners to communicate through the use of
a ‘process tool’ or common language that will help their organizations become
better aligned to achieve their goals. 
Once aligned, IT and the business can focus on the people, process, and
technology changes required.  The
implementation of any new business process (will be read by the organization as
‘change’) whether it’s a small tweak, a process redesign, or the creation
processes to support a new business; they all have to be approached
methodically.”

If organizations reuse the same tactics and principles of
operation, they will fail.  So what
should be done?  “The ‘new normal’ is
challenging the FSI in ways that cannot be addressed with the same old
approaches and tools that banks have used in the past.  The banks that choose to dust off their old
approaches to meet these new challenges will at best continue to struggle or
worse fall by the wayside.  The new
normal requires FSI organizations to look at everything and rethink how they
will meet the challenges (e.g., new regulations, risk management, increase
profitability, consumer perception, and ever changing technologies) that are
being thrown at them at a high rate of speed and still run the bank as a for-profit-business.  Changes will continue to be lobbed at FSI for
the foreseeable future and banks will not have the luxury of implementing them
at the same slow and steady pace that they have been operating in the past—as
new regulations now number in the dozens per week.”

By internalizing nimble, compartmentalized building block business
processes, “Only the process savvy, agile organizations will be able to keep
pace with changes as they sweep across their FMBO’s (i.e., front, middle and
back office).  These organizations will
not only know their business but they will know how all the processes are
wired, what processes are shared across business units, the data that is being
passed through each point in the process, how that data is used, how fresh or
accurate the data is—where else should they be leveraging that data to support
other business processes?  Banks will
need expertise to identify how to interconnect their current vertical stove
pipe business units to create a more efficient and profitable
organization.  Understanding how to
maximize existing business processes is going to be a key starting point for
all of the banks.  Nonetheless,
understanding how to successfully implement those new business processes will
determine which ones will be the leaders and which will just be running with
the pack—or not at all.”

* * * * * * * *

The need for solid directions cannot be underestimated for
this coming year.  With a projected
recession for the second half of 2012 spurred by EU crisis after crisis, and underpinned
by the realization of why a $1 trillion IMF fund is needed to deal with lending
demands, it is clear that business as usual or a return to normal is a
mirage.  The deployment of new structured
products (e.g., US covered bonds, non-GSE MBS’s) and robust secondary markets
(for liquidity, risks and pricing transparency) are also a critical aspect that
many domestic corporations have yet to appreciate, let alone create plans for
implementation.

Moreover with foreclosures now projected to be greater than
1.5 million in addition to the hidden REO stealth inventories for 2012, the
downward pricing on housing even without the prospect of rising energy
pressures (e.g., gasoline > $5 gallon) will not allow the market to find a
new equilibrium.  With consumers once
again diving into savings to support the recovery, the market’s ability to
reach origination and refinancing volumes equal to just two short years ago may
take another five or seven years to reach.

The need to get back to business has never been greater.  Very little of the past is a guide for the
future as the forecasts continue to be wrong. 
To deal with the vast uncertainty of consumers, markets, and
politicians, technology and data must be the cornerstones for critical
transformational actions.  Taking care of
business has to start with LOS excellence, BPM, and the downstream needs that
are tightly-coupled with every new, non-government backed structured
product.  The realization of lead,
follow, or get out-of-the-way has never had great resonance.

 

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Private Securitization Markets Are Too Important for Politics

July 18th, 2011

By Mark P. Dangelo

Since the 1780’s, covered bonds have been a favorite for
investors seeking dual resource within a highly rated, senior-asset class.  In 2011, institutional and insurance firms
(i.e., sophisticated investors) are projected to double their purchase of EU covered bonds (CB’s) to over $60
billion – some denominated in dollar and others in Euros.  What’s more, new CB issues offered to
investors in the first-half of 2011 were oversubscribed by a factor of three to
four.

In March 2011, the Garrett-Maloney
legislation (H.R. 940) was
introduced in a bi-partisan effort to break-through a three year political
battle regarding the establishment of legal protections and guidelines for a
U.S. CB market.  As reported, U.S.
Representative Barney Frank sought to
amend H.R. 940 at the behest of a specific U.S. regulator, but it passed out of
committee by a vote of 44-7 in late June. 
Needless to say, the amendment actions from the co-author of Dodd-Frank (DF) generated strong reactions and rebuttals from those
understanding the importance of the CB legislation to the future financial
supply chain.

Globally, the implementation of legislation to establish a far-reaching
U.S. CB’s marketplace have been positively portrayed or actively supported by a
number of institutions and industry associations.  A few names of note include: SIFMA (Securities Industry and
Financial Markets Association), ASF,
MBA, BoAML, Barclays, RBC, OCC, NRSRO’s, Goldman Sachs, and even PIMCO.

It is worth noting; a robust U.S. CB program solution set was
reported as part of the original DF to stimulate private securitizations, but allegedly
at the request of the FDIC and supported
by legislators it was pulled from the final vote. 

What has been the result of languishing CB legislation and
regulatory, political manipulation? 
Another year has gone by with the government guaranteeing over 95% of
the housing finance market, and the Federal
Reserve continuing to maintain a large balance sheet of over $2 trillion. 

Frequently noted, there were only two private
securitizations in all of 2010.  The
potential implications of this void are that trillions in private money waiting
for quality, secure instruments were invested in foreign markets.  With $3.5 trillion of non-U.S. CB’s already in existence, it would appear there is ample
justification to create a robust U.S. market – to keep private money within the
domestic landscape.

Moreover, factoring in the worries surrounding sovereign
debt and the pending downgrades of government bonds, which will eventually happen
if the U.S. debt ceiling is raised without an austerity plan, the amount of
triple-AAA securities available continues to fall globally since late 2009.  If the U.S. debt is downgraded one or two
notches, then the impact to banks asset ratios will fall, sparking a flash-crash
to find replacements and shore up regulatory demands (e.g., BASEL). 
Where will the “secure” money rush to and what will be the fallout
across the financial services supply chain funding? 

U.S. covered bonds are not a panacea for the lack of private
securitizations — and the removal of big-government from the housing and asset-backed
(ABS) markets.  However, they do represent a piece of the
solution for private securitization, leveraging a 225 year old instrument
(i.e., using something familiar to create something new and beneficial).  Like any fresh solution and especially with a
modernized financial instrument, there are concerns and myths that have
surrounded the usage of CB’s within the United States. 

Let’s review a few of the often sited challenges (C) and their responses (R).

(C): Since U.S. CB’s are only useful for residential mortgage
securitization, why are they important when the housing market is still
shrinking?

(R): Under current House legislation, U.S. CB’s would cover nine
asset classes – residential mortgage, home equity, commercial mortgage, public
sector, automobile, student loan, credit or charge card, small business, and
other (as defined by the U.S. Secretary
of Treasury) – resulting in a wide range of quality assets appealing to the
varied needs of investors and institutions. 

(C): So what can U.S. CB’s do for a beleaguered housing market and
financing?

(R): With limits and restrictions on the amount of CB’s that can be
issued against balance sheet assets (yes, CB’s are on-balance-sheet
instruments), the total amount of issues would be gradual.  The impact would likely be noticed six months
after legislation is signed into law. 
For example, if an additional $250 billion of U.S. CB’s were issued in
2012, it would represent a significant potential to securitize assets (and make
loans available).  This could be very
beneficial and timely with the reduction in conforming loan limits expected to
take place in October 2011 across 250 housing markets.  For those working in origination and customer
contact, U.S. CB’s offer new financing capabilities / options directly linked
into the servicing, secondary, and investor worlds.  CB’s are not MBS’s.

(C): CB’s only benefit larger institutions effectively shutting out
small banking issuers.

(R): H.R. 940 took this challenge head-on by allowing eligible
issuers to pool assets.  This provision
would allow any depository institution, bank holding company, nonbank financial
company, or issuer sponsored by eligible institutions, to issue U.S. CB’s on a
pooled basis.  With a wide-range of
eligible assets, smaller organizations can pool assets within classes to create
“jumbo” issues – that is greater than $1 billion within a cover pool.

(C): U.S. CB’s would lessen the importance of the GSE’s and FHL banks.

(R): In their current form, U.S. CB’s would provide alternatives
for investors, issuers, and for government decisions on the systemic structure
of finances.  It would be another option
and tool for use with the final disposition of the GSE’s, and the removal of
taxpayer liabilities and losses on guarantees. 
CB’s have a potential to positively impact costs to consumers, and the increasingly
burdensome, evolving government regulations (e.g., QRM) on what constitutes loan acceptance.

(C): The Federal Reserve does not recognize CB’s as collateral at the “Discount
Window”.

(R): Since 2008, the Fed has provided distinct margin requirements specifically
for these assets.  If the U.S. CB market grows,
it is anticipated that the Fed would continue its acceptance and potential
expansion of these U.S. assets – and the favorable rates these
over-collateralized instruments have historically received.

(C): CB’s are not a quality asset since they do not have government
guarantees.

(R): CB’s are considered a dual recourse asset class – they have
the backing of an over-collateralized asset pool and the soundness of the
issuing institution.  They typically
carry a rating from several NRSRO’s
and they are on-balance sheet, senior secured debt (usually lessening the risk concerns
for institutional and insurance investors).  These asset classes are not tranched like
traditional MBS’s and asset classes cannot be mixed (e.g., auto with home with
commercial).  Any non-performing asset in
the cover pool is required to be replaced.

(C): When will U.S. CB’s as defined by current legislation become law?

(R): This is the most frustrating aspect of the last three
years.  Since July 2008, when Secretary
Paulson announced the U.S. Covered Bond program and best practices (and backed
by public commitments from BoA, CitiGroup, Wells Fargo & Co., and JPMorgan),
there have been no issuance of U.S.
covered bonds.  The House is now able to
move forward, but no corresponding bill has been introduced into the Senate
(although news reporting states that Senator
Schumer plans to do this).  Best estimates
place a U.S. Covered Bond Law sometime in Q4 2011.  The greatest unknown and threat is the White
House’s current appointment to become the FDIC Chairman.

(C): Secondary markets are not important for U.S. CB’s.

(R): There are three critical taxonomies for CB’s: 1) issuers and
investors, 2) trading and settlement, and 3) FMBO (front, middle and back office).  Each of these segments promotes not only the CB
issuance, but the need for on-going market liquidity, transparency, and data
dependencies.  Hence, there is a critical
need for an open and robust secondary market. 
Across the three categories are 10 major processes: 1) risk management
and investment principles, 2) discovery and research, 3) controls and strategy,
4) technology, 5) compliance, 6) asset / cover pool management, 7) financial
management and issue integrity, 8) reporting and servicing, 9) pricing,
transparency, and liquidity, and 10) clearing and settlement.

(C): The lack of definition and development of processes will limit the
deployment of U.S. CB’s

(R): To ensure that every institution has an equal opportunity to
participate in the U.S. CB markets, the use of pilots and consortiums will
become prevalent in the next 6 to 12 months. 
Within the areas of technology, compliance, and FMBO, knowledge
workforces and operations must be shared to deal with the demand for best-practices
(see U.S. Treasury publications), while lessening capital outlays and organic,
organizational challenges.  Equally,
secondary market exchanges will be adapted to allow for active trading of
issues and to properly assess the on-going risks, performance, and liquidity
(including the use of fixed-income workstations for discovery and analytics).

A U.S. Covered Bond Law holds great promise when considering
the needs to reform housing finance, improve asset quality, and reduce the
opacity that dominated private financing “innovations” since 1998.  While the Financial Depression of 2008 forced
a retrenching of private securitization and steered banking institution
priorities away from these on-balance-sheet assets, U.S. CB’s hold a key to the
future for weaning domestic markets away from government life-support and
draconian regulations.  It is one of
several solutions that will be required to restore private securitizations.

If the housing and finance markets are to recover and
eventually grow, private money and investment once again must be welcomed with
confidence and proper risk-attribution.  Evidence
of this comes in the form of social media discussions on the topic, LinkedIn groups (see #U.S. Covered Bonds), and countless
tweets on the subject.  Of course, there
is three years of Congressional testimony, numerous whitepapers, countless
websites, and daily and weekly articles in places like the Financial Times.

The principles and frameworks encompassing CB’s proven for
hundreds of years – and updated for our domestic markets, regulators, and
behaviors — offers one of the needed options institutions, homeowners, and
investors have been seeking. 

The politics surrounding the U.S. CB’s must end in 2011 –
three years in “development” is enough.  The
final question is, “When will Congress and the White House finally act?”  When will the U.S. get its new legislation
addressing an asset class used for centuries by other countries?

 

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