The performance of securitized assets will continue to deteriorate for commercial mortgage-backed securities (CMBS) into 2011 and possibly 2012, according to a new report by Moody's Investors Service. For residential mortgage-backed assets (RMBS), performance will decline into late 2010 or early 2011. The prospects for a recovery in securitization markets remain cloudy and depend on the bottoming of the housing market and the beginning of a decline in unemployment, the report concludes. When the markets return, a higher investor risk premium will mean a higher cost for securitizations. Demand by investors will be down significantly with the anticipated absence of the once-formidable special finance vehicle buyers of Collateralized Debt Obligations (CDOs).
By Robert Stowe England
September 15, 2009
“While there appears to be a glimmer at the end of the tunnel, it is still too early to interpret improvement or slowed deterioration in a particular sector as a sign of recovery.” One also cannot be sure that “additional land mines do not await.”
That outlook is a central finding of a team of senior analysts at Moody’s Investors service in a study released this month titled “Is U.S. Securitization on the Road to Recovery?” The study can be found at http://www.moodys.com/ but requires registration.
The study analyzes the potential path tor recovery for six securitization markets:
· Commercial mortgage-backed securities (CMBS)
· Residential mortgage-backed securities (RMBS)
· Auto loan securities
· Credit card securities
· Private student loan securities
· Federal Family Education Loan Program (FFELP) student loan securities.
This article looks at the report’s analysis of the CMBS and RMBS markets.
Unemployment rates and home price deterioration trends are key determinants that will affect the duration and ultimately the bottom for securitization asset performance, the study claims.
Commercial Mortgage-Backed Securities
For CMBS, the recovery will come as soon as late 2011 or as far away as early 2012. Rising unemployment, vacancy, and capitalization rates will push down property values, make refinancing more difficult, decrease cash flows and increase long-term defaults, according to Daniel B. Rubock, the senior vice president for commercial real estate finance at Moody’s, who wrote the section on CMBS.
Moody’s reports that about 21 percent or $735 billion of the $3.5 trillionof commercial real estate lending is CMBS. The CMBS share was higher at 45 percent of $230 billion of new CRE lending in 2007, according to Moody’s. CMBS from the boom years of 2006 to 2008 will not mature until 2016 to 2018.
A steady-state level of CRE lending represents about 20 percent of U.S. Gross Domestic Product. If economic output reaches $14.25 trillion in 2010, then “normal” outstanding commercial real estate lending should be about $2.85 trillion. Further, if new originations are 11 percent of outstanding loans (as was the case in 2004, before aggressive underwriting drove up the volume of CMBS), the annual CMBS issuance may rise back to about $60 billion, Moody’s predicts, when there is a full recovery in several years.
There will also be more demand for refinancing of loans originated by commercial banks, insurance companies, thrifts and credit companies in the next few years. If CMBS cannot meet that demand, then it will slow the overall recovery in commercial
real estate lending.
The return of CMBS cannot occur before there is a return of buyers of the securities. In 2007, banks held 17 percent of outstanding CMBS and insurance companies held 19 percent. Rick-based rules require less capital for CMBS than for whole commercial real estate loans, so banks and insurers “will have a big incentive to return,” Moody’s writes.
“They will come back once spreads narrow and confidence in real estate performance returns.” One group of investors, however, may not come back for awhile and perhaps never – opportunity funds and finance companies, such as Structure Investment Vehicles (SIVs) and Collateralized Debt Obligations (CDOs), which supplied 24 percent of the demand for CMBS.
The extension into 2010 of the Term Asset Lending Facility (TALF), set up by the Fed to keep securitization markets active and liquid, will help in the process of reducing interest rate spread and improve liquidity, according to Moody's.
Accounting rules, however, will hinder the return of the market. Financial Accounting Statement (FAS) 140 requires the consolidation of CMBS deals onto the balance sheets of the participants in those deals next year and will act as a “stumbling block” along the path of recovery, according to Moody’s.
Residential Mortgage-Backed Securities
Even though the rate of deterioration in the housing market appears to be slowing, limited refinancing opportunities for homeowners mean that there will not be an improvement in the housing market before the fall of 2010.
Both the housing market and unemployment will need to bottom before the performance of private label RMBS stabilizes and allows for the return of investor demand, according to Navneet Agarwal, senior vice president and author of the RMBS section of the study.
Moody’s finds the benefits from the Making Home Affordable program of loan modifications and refinancing to be “tepid so far due in part to uncertainty about its implementation process and capacity constraints on mortgage servicers.”
When MHA gets off the ground, it will also be troubled by a high redefault level mostly because nearly 30 percent of U.S. homeowners with mortgages have negative equity.
Delinquencies continue to rise for all segments of RMBS: subprime, Alt-A options ARMs and jumbo. Prepayment rates remain depressed for subprime and option ARMs. However, they are as high as 20 percent of jumbo loans and in double digit levels for high quality fixed-rate Alt-A.
The severity of losses on liquidated loans is high for all loan segments. For subprime, severity has reached percentages in the low to mid 70s. For Alt-A, rising severities have reached into the 50s, while for jumbo loans, higher severities have topped the 50s.
These many negative factors suggest that any recovery in values for private label RMBS and any new supply for private labor mortgages is 12 to 18 months away, which puts the recovery somewhere between September 2010 and March 2011.
Since the asset-backed securities Collateralized Debt Obligation (CDO) market is likely to disappear, “future buyers will be real money investors,” Moody’s states.
On the supply side, origination will be a function of the economics of private label RMBS, improved liquidity and capital conditions for the originators and the future course of action for the [Government-Sponsored Enterprises, Fannie Mae and Freddie Mac],” Moody’s writes.
“Marginally, the inclusion of jumbo mortgages in TALF may increase refinancing options for private label mortgages and provide some relief to the market,” the report finds.
One hopeful sign: significant activity in arbitrage-driven RMBS resecuritizations, “by far the most active segment of the RMBS market.”
Primary issuance of new RMBS remains “nearly non-existent,” Moody’s says, “althoguth we have seen, in recent months, a sharp uptick in the number of residential mortgage pools submitted to us for our preliminary review.”
Moody’s reports an encouraging harbinger of an eventual recovery: “a large, money-center bank’s two private placements of RMBS backed by seasoned, high credit quality loans, and market expectations that two more such transactions are about to take palce.”
Moody’s also reports that the industry is making some progress on transparency and data quality in an effort spearheaded by the American Securitization Forum, which is coordinating its efforts with the Mortgage Bankers’ Association.
Moody’s has also published its originator review, third-party assessment, and presentation and warranty criteria that it intends to apply to newly-rated private label RMBS.
The outlook for auto loans and credit cards is brighter than for CMBS and RMBS, while private student loan asset-backed securities face “greater uncertainty.”
Moody’s report provides more detail on these securitization asset markets.
Copyright © 2009 Robert Stowe England