Risk Retention Rule May Be Boon for REITs

While nonbank mortgage lenders fret that MBS risk-retention language in Sen. Chris Dodd's new bill could hammer their industry even more, forcing smaller players to sell out to the megabanks, there is also a real chance that the bigger firms could suffer a bit.

And not only will the megabanks suffer, but it appears that real estate investment trusts that are itching to enter the jumbo securitization market could be a major beneficiary.

The issues, for sure, are complicated. For now, it's a given that MBS collateralized by Fannie Mae, Freddie Mac, and FHA/VA loans will be exempt from a 5% risk retention requirement-or at least that's what the industry is betting on. "A carve-out of some type, granting an exemption, will probably happen," said Anne Canfield, executive director of the Consumer Mortgage Coalition, a trade group, despite its name, that actually represents some of the nation's largest banks.

If an exemption doesn't happen, that means a bank issuing a $100 million security will have to hold 5% capital against the bond, or $5 million. Moreover, new accounting rules from the Financial Accounting Standards Board require that a bank "consolidate" off-balance-sheet assets (MBS) and hold capital against them. Just by issuing a security that means a bank must hold 4% capital (100% risk weighting) and that's on top of the $5 million. As one MBS analyst explained to me, these two retention requirements can be handled by some banks but it renders such an investment "a low-yielding asset." Banks don't like low-yielding assets.

But let's say that as expected, depositories get the exemption for Fannie, Freddie and GNMA MBS. They're off the hook in regard to agency MBS, but they are not off the hook in regard to nonconforming product. Of course, the nonconforming MBS market is dormant these days (thanks to the credit crisis) but indeed there are rumblings that jumbo securitizations are being worked on, and that this much-needed market could be up and running smoothly later this year.

If all this is true, it means that when the jumbo MBS market revives, banks will not be issuers, which is too bad because (not surprisingly) the largest funder of jumbo loans are currently the megabanks: Bank of America, Chase and Wells Fargo. It also means that if banks want to get jumbos off their books, it will have to sell to nonbank issuers. Just who will these nonbank issuers be? I know of at least one REIT and one investment banking firm that are working on jumbo MBS programs. (Rumors abound that plenty of other firms are now toying with jumbo securitizations, or at least dreaming of it.)

One REIT executive I talked to about the issue said because his company is a nonbank he doesn't have to worry about any regulatory capital requirements. This official, who did not want to be identified by name, said his firm has played in the jumbo market before and has no problem "having skin in the game."

He points out that a 5% risk retention rule plus the FASB rule will hurt banks that currently have jumbo MBS on their books.

He believes that nonbanks, REITs in particular, are sitting in the catbird seat when it comes to jumbo MBS. (Readers should keep in mind that jumbo mortgages yield more than GSE loans.)

Glen Corso, who runs the Community Mortgage Banking Project, a small trade group, concedes that indeed nonbanks, including REITs, could gain if the jumbo securitization market indeed revives. "There will be some weird outcomes on all this," he noted. "You have this 5% risk retention requirement on MBS. Then you have FAS 166 which triggers the 100% risk weighting (4% risk capital)."

Of course, the language in the Dodd bill is subject to change and it's no secret that industry lobbyists are working their contacts on Capitol Hill to make sure that any risk retention language winds up being benign. But some worry that when it comes to risk retention, Congress may not fathom the details. In a recent memo to clients Canfield summarized: "I am not sure that the policymakers have connected the dots."

Rick Thompson, who runs Envoy Mortgage in Houston, a nonbank, thinks that fear of nonbanks getting hammered by risk retention is overblown. "Mortgage banks sell through AOT (assignment-of-trade) arrangements with the large banks. Mechanically, this produces a whole loan sale, so the mortgage bank is not the securitizer.

So even if there is no exemption for Fannie/Freddie/GNMA product, unless I'm missing something, the securities issuer (think Wells, B of A, Chase) would be hit by the risk retention requirement, not the mortgage bank."

Thompson, an accountant by training, added, "If banks or anyone, for that matter, have to put up additional capital by keeping a retained interest when loans are securitized, the cost of housing credit is going up. Capital demands a return or it flees."