July 2016 - Lessons Learned

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TH E M R EP O RT | 61 O R I G I NAT I O N S E R V I C I N G A NA LY T I C S S E C O N DA R Y M A R K E T SECONDARY MARKET THE LATEST Chase RMBS Purchase Doesn't Foretell of Industry Trend Similar purchases might not be appealing or beneficial to other banks, according to an industry report. J PMorgan Chase's recent $1.9 billion residential mortgage-backed security (RMBS) transaction may not spur demand for similar transactions from other banks in the next few years for several rea - sons, according to a report from Moody's Investors Service. According to the report released in June, not all banks will see the benefits or have the same costs as JPMorgan Chase when securitizing loan portfolios. Though deals like Chase's could offer banks risk- weighted capital relief, the report said banks will also consider the effect it will have on shareholder equity returns (ROE), as well as other unweighted leverage ratio capital requirements. In fact, the report said, with many of these deals, shareholder ROE could actually decline significantly. In a market where banks have seen ROE below the cost of capital since 2007, this will likely be a huge deterrent to similar RMBS purchases. Banks would need to return capital to the shareholders or choose to redeploy proceeds of the transactions into assets for those shareholders if they want to keep ROE steady. But even this, the report said, poses a problem. "Reinvesting released deal pro - ceeds into assets yielding more than the non-retained securitiza- tion bonds could alter banks' investment portfolios and risk profiles, something they might be unwilling, or unable, to do." Though under the Basel III regulatory framework, banks may be able to use RMBS purchases to reduce risk weights and the burden of certain regula- tory capital requirements, they also need to keep in mind the impact that securitization will have on other capital limitations. The Fed's supplementary lever- age ratio (SLR) constraints will be a big consideration. "The banks are already in excess of their 5 percent SLR requirement, with their most recently reported, fully phased- in ratios as follows: Bank of America (6.8 percent), JP Morgan (6.6 percent) and Wells Fargo (7.6 percent)." Another big concern for banks will be the weak secondary market, which has experienced significant decreases in liquid - ity as of late, and high RMBS governance, which requires deal agents as well as compensation for those agents. According to the report, both of these issues will likely keep most major banks from following in JP Morgan Chase's footsteps—at least for the short term. "Anecdotal evidence from investors indicates that a lack of secondary market liquid - ity is giving investors pause before they invest in subordinate tranches of RMBS securitiza- tions. Investors have asked for yield premium to account for lower market liquidity, but de- termining how much that should be is likely to be challenging." SFR Securitizations Reap Benefits of Falling Homeownership First-time homeownership is down due to a lack in housing affordability for those in their 20s and 30s, translating to increased demand for rental properties. A drop in first-time home- ownership in the U.S., due to the lack of afford- able housing, has given single-family rental (SFR) securiti- zations a credit positive boost. Moody's Investors Service said in a report that housing afford- ability for first-time homebuyers has been decreasing since 2000. This phenomenon has, in turn, provided a higher demand for rentals in the market. Moody's reported the lack of affordability for first-time home - owners, due to a decrease in personal income and rising home prices, has hit the Generation Y cohort especially hard as those in their 20s and 30s seek to form households and purchase homes. "A dearth of 'for-sale' invento - ry of mid-to-lower price homes, combined with ongoing tight credit conditions, forces many to remain in rentals," Moody's said. "In addition, many potential first- time home buyers are burdened with high student loans that further constrain their buying capabilities. As a consequence, demand for rentals is remaining very strong for the limited num - ber of available rental properties." The U.S. Census Bureau reported that the rental vacancy is now at 7 percent, down from 11 percent in 2009. Moody's believes the "drop in vacancy bodes well for the SFRs that we rate, especially regarding anticipated future enhanced rent - al revenue as Gen Y renters are a large component of SFR rent- ers. This also portends higher liquidation proceeds on potential sales of SFR properties." The report noted rental rates will continue to benefit SFR securitizations. Moody's said the increasingly unattainable goal of homeownership for many and the low national rental vacancy rate will raise rental demand and rents, both of which bode well for SFR cash flows. "Stronger demand for rental properties will benefit SFR secu - ritizations by enhancing borrow- er and transaction-specific rev- enue streams and net cash flows, while also potentially increasing recoveries on foreclosures of underlying properties, should the need arise," the report said. "The continued financial strength of borrowers and compliance with transaction performance metrics are more likely in this healthy industry environment."

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