|
Mid-Year Inside Look at the Securitization Market - A Borrower's Market With Volume Down, Narrowing Profit Margins, Rate Uncertainties and Razor Thin Margins: (Private briefing at GSP offices by Co-Head of Originations from major Wall Street firm - typically among the top 5 in volume origination.) (1) Is Wall Street Making Money: 1999 was a highly profitable year on Wall Street for securitization lenders. 2000 is turning out to be a razor thin year on profitability. (2) Less Product: With interest rates up because of Fed tightening, some borrowers have withdrawn from the market and are taking a "wait and see" approach. All in mortgage rates are generally in the low to mid 8% range and refinancing is less compelling unless borrowers need to do so. 2000 Mid-Year Volume: $27.5 billion compared with $35 billion for 1999. (3) What Makes Up the Securitization Market: (1) Fixed rate CMBS loans; (2) "Jumbo" ($75MM and up) fixed rate loans which may go into pools with the standard loans or are so large as to be "one-off" placements, and (3) LIBOR based "floating rate" 2 to 3 year loans that go into pools or are also securitized separately on a "one-off" basis. (4) Where Is the CMBS Break-Even?: The estimated break-even for fixed rate, "full dollar" loans is 10 yr T's +2.20% (not including corporate overhead). The rule of thumb is 1 pt. in profit is equivalent to 15 bps in rate. (5) The Impact of the Unrated Portion of the Securitization Pools and the Influence of the B Piece Buyers: 88% of a typical securitization pool consists of investment grade bonds ranging from AAA to BBB-. The non-investment grade portion has a blended yield in the 14% to 15% range and consists of: BB (approx. 12% yield), B (approx. 18% yield) and the "unrated piece" (2% of the total pool yielding in the 24% to 26% range). Pools are scrutinized by both (a) the rating agencies, and (b) the buyers of the non-investment grade paper. The problem is there are only 4-6 so called "B piece buyers." In most cases, only 2 or 3 are in the market to look at a particular pool because the examination process is extremely labor intensive. They are sophisticated and tough negotiators. Their leverage is the ability to reject mortgages from the pool that they consider too risky, forcing the originators to hold those mortgages "on book". These loans may become tainted, regardless of the originator's opinion of quality. Kicked out loans are often sold at deep discounts and are called "whole loan sales". Why aren't there more buyers? The process requires: A very specific knowledge base and a large and sophisticated underwriting staff, a major commitment of resources is necessary to enter the market. (6) The Swap Market: All fixed rate loans are priced off of the Swap Market, where institutions trade fixed rate income streams for floating rate income streams and vice versa. In what has been a rising rate environment, Swap spreads have widened because of rate uncertainty. The swaps had held at 70-80 bps for an extended period of time leading up to early 2000, they are currently at 121.5. This means that the fixed rate mortgage spreads are at their widest levels in recent years. (7) The Outlook for the Originators: With declining production and razor thin margins the question is "will the market see a shakeout in originators?" Some smaller shops have closed down this year. The originators are feeling the pressure. On one hand many have lowered their DCR's to 1.20 for all 4 of the basic "food groups" (apartment, retail, office and industrial) and will go to 80% LTV to "win the business" and then run the risk of "kick outs" from the unrated buyers. There is sufficient origination history with bond pool performance that originators are classified by the bond buyers. Therefore, the bonds are priced and trade with "Branding" as one component. Interest Rate Update: This week, the bond market is cheering: (1) the Fed's decision not to raise the discount rate this week, (2) reports continuing to indicate a cooling economy, (3) lower profit forecasts from major industrial and technology companies leading to a "flight to quality" as some investor funds exit the stock market -- the 10 yr. T closed at 6.03%. What's Next? Several influential reports including: Unemployment (July 7th), PPI/Core PPI (July 14th), and CPI/core CPI (July 18th)… the latter two may reflect inflationary pressures from rising gas/energy costs, leading to more volatility. Stay tuned… (George A. Smith, David R. Pascale, Jr.)
|
