RMBS and the Cost of MortgagesCommentators on both the asset and liability sides look at their own bit of the picture in isolation, and lose sight of the whole picture:
"Blimey, AAA RMBS is trading in the 150-200bp area, it used to be 10bp or so";
"Blimey, mortgages are looking expensive given the interest rate environment".
There are two key conclusions from a securitisation perspective:
1. Issuing AAA RMBS would still leave a very healthy net spread, and bring the benefits of match funding and alternative funding.
But no-one is issuing in the primary market. Perhaps because:
2. Banks can still get cheap funding from central banks under the securitise-and-repo model; and they have plenty of cheap deposits from people scared of market volatility.
The RMBS market will be back in a big way once the central banks wean banks off repos, and investors withdraw deposits to invest in higher-yielding assets.
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Someone recently raised with me the difference between a building society and an RMBS. Surely, they said, RMBS can't be as safe as a building society. I raised a few points:
-Both a building society and RMBS are , or should be, simple: in both cases a bunch of residential mortgages funded by senior debt/"shares" plus subordinated debt/"reserves"
-RMBS is match funded; the liabilities match the assets. You can't have a run a la Northern Rock on an RMBS;
-If you have thousands to invest, a building society is safer-HM Govt guarantees you up to £50k. If you have millions to invest, a AAA RMBS is probably a lot safer than a much lower-rated building society;
-BUT the only liquidity for RMBS is a market sale, whilst deposits can be withdrawn at par at any time-as long as the society has access to cash!
-RMBS yields significantly more at present than building society paper;
-An RMBS is "brain dead"-there is no possibility of a bored management looking for fun and yields by branching out into areas where they have no expertise, such as commercial property (Dunfermline) or buy-to-let (Bradford & Bingley).
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Interesting market rumours about Barclays intending to issue a 3-year UK RMBS at a yield of +150 or so. The most fascinating aspect is the proposed buy-back by Barclay's in 3 years' time. Sounds like a good deal for investors: paper backed by Barclay's at a rate higher than Barclays' own senior debt, in addition to solid AAA mortgage backing.
This might at first sight look expensive for Barclays, but a bit more analysis suggests that the bank is assisting its Gracechurch master trust. I just read a good research piece by Merrill on master trusts, which reminds us that extension risk is a big concern. Showing that refinancing is possible will directly help Gracechurch, and indirectly help Barclays and any other banks which have an overhang of RMBS, by calming the market.
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An interesting article in the FT this week ("Disclose the fair value of complex securities") written by a bunch of academics, including one Robert Merton, who on the one hand is a Nobel prizewinner, and on the other has his name written all over the debacle which was Long Term Capital Management, which almost brought down the financial system in the 1990s.
The premiss [sic] seems to be that markets are efficient. This 'picking up nickels in front of bulldozers' approach proved disastrous in the case of LTCM, and even more so in the last 2 years.
'Fair Value' is an emotive term-implicitly, any other price is 'unfair'. What is really meant is 'market price', which is often in and of itself a function of emotion rather than logic. I have recently been putting together a portfolio of high-quality AAA assets with an IRR of 20%. Is that 'fair value'? Maybe not 'fair' to the academics, but it's a rattling good deal!
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Barclay's Capital has been in the press recently with something called "smart securitisation". This is presumably to distinguish it from "dumb securitisation". Was that what BarCap was doing over the years?
Goldman has apparently been doing something similar to "smart securitisation". So what is it?
It looks as though it's driven by Basel II considerations. Regulators and others may go on about real equity in the form of ordinary shares being the desirable form of Tier I capital, but regulatory capital is still the key measure.
So the deal seems to be that you write off the bottom 20% or so; sell on the next 20 or 30% to an external investor; and keep the top bit in a rated form, thereby using less capital. “It’s not securitisation for leverage and arbitrage purposes any more" says the man from BarCap. Oh yes it is! The game is to transfer risk from regulated to non-regulated entities. Arbitrage of Basel II using securitisation is built into the system, as I wrote in an article the first version of which was penned in early 2007. (You can find this article, "Securitisation Still Works! on http://www.robinhoodfinance.com/articles.html)
One question is : who are the buyers? The IFR mentions "asset managers, private equity firms and hedge funds". I know of several operations trying to get such investors to make a start with basic underpriced AAAs, with IRRs well into double figures, and they are not having an easy time getting signatures on cheques, so I wonder how deep this market really is.
Perfectly good AAA paper has been selling at 70 or so for some time now-BarCap itself recently tendered just this price to buy back AAA bonds it had issued. I'd take a look at buying bonds in the market, and applying a modest level of gearing myself (back-to-back with a bank and its central bank?) to replicate this structure with me as investor in the driving seat, rather than buying pre-packaged stuff from investment banks. Caveat emptor.
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