RMBS Investors Still Seek Assurances on Lien Priority

Buyers of private-label mortgage backed securities still have a beef with the federal mortgage modification plan, which allows investors with a second-lien on distressed properties to jump ahead of first-lien holders in terms of payment priority.

However efforts to revive legislation to reassert the priority of first-lien holders could receive a warmer reception, given banks improved health and policymakers stated goal of shift mortgage financing to the private sector.

The Home Affordable Modification Program (HAMP) altered primary mortgage loans backing RMBS transactions without touching those borrowers’ second-lien debt, typically home-equity loans. That gave practical priority to the second-lien debt.

It’s hard to say definitively how much this inversion of lien priority has slowed the revival of the private label RMBS. There are plenty of other things holding the market back, not to mention the lack of high-quality loans that can be used as collateral and disagreements about the appropriate representations and warranties as to their quality.

In fact, deal making has slowly picked up steam. Until recently, Redwood Trust had been the lone regular issuer of RMBS backed by previously unsecuritized mortgages. Those mortgages have been high quality jumbo loans with low loan-to-value ratios and high borrower credit scores that are in little danger of requiring loan modifications, and they represent only a small slice of the mortgage market and so a potentially revived RMBS market.

However Credit Suisse issued a $415 million deal earlier this year backed by similarly high-quality mortgages. And JP Morgan is currently in the market with its first RMBS offering in years, a $616 million deal that’s backed by high quality mortgages but, according to Moody’s Investors Services, contains some structural weaknesses.

JP Morgan recently forecasted that private-label RMBS volume could reach $30 billion this year, five times the $6 billion seen in 2012. The private-label market’s volume peaked in 2005, at $740 billion.

Still, lien priority remains a critical issue for many potential investors. “Until we get a bit more clarification [on lien priority], that’s probably going to limit how much non-agency product we’ll see,” said Arnie Phillips, senior portfolio manager for global fixed-income at the Sacramento-based California Public Employees Retirement System (Calpers).

No Compensation for Uncertainty

Calpers, once one of the biggest investors in private-label RMBS, reportedly liquidated a portfolio of more than $3 billion non-agency bonds in 2010. At the time, Curtis Ishii, senior investment officer for global fixed-income, told Asset Sales Report that the pension fund was “pretty much done with that market.”

Calpers may have softened its position since 2010; Phillips told ASR that the pension fund would still consider investing in RMBS. “A lot of it comes down to pricing. If lien priority hasn’t been rectified, then we just have to get compensated for it,” he said. “It’s not a deal killer, but the hurdle rate is very high for us to be interested.”

Pricing for Redwood’s recent deals, however, has been extremely tight, as some investors with starving RMBS allocations have pounced on the limited supply. Whether those investors represent sufficient capital to grow the non-agency RMBS market enough to draw mortgage financing away from the GSEs, remains to be seen, especially if big institutional investors see little value in the non-agency market.

“The last couple of RMBS deals have yielded 50 basis points or less than Fannie Mae jumbos---that’s insane,” said Scott Simon, who heads up mortgage- and asset-backed securities investing at Pacific Investment Management Co.

So what efforts are afoot to restore priority to the claims of primary mortgage holders? Tom Deutsch, executive director of the American Securitization Forum, said investors would like to see the issue addressed nationwide, rather than on a state-by-state basis, and that leaves the ball in legislators’ court.

“Legislative initiatives are likely the best hope,” he said, adding “I’m not aware of any initiatives from regulatory bodies that would affect lien priority at this point.”

Deutsch said there are proposals being discussed on Capitol Hill that focus on the originator of the second-lien loan either getting permission from the first-lien debt holder or paying some kind of enhanced risk premium to the first-lien lender.

“If you have a first-lien mortgage with an 80% LTV and take out a 20% LTV second-lien loan, you would have zero equity in your house and you’re likely to default on both loans, and that reduces the net-net value of the first-lien mortgage,” he said.

Reviving Reform Legislation