Some companies are positioning themselves for the next move in the slowly-reviving securitized jumbo mortgage-backed securities market through partnerships that bring end-investors closer to the origination process than they ever have been before.
“End-investors want a front-row seat on manufacturing quality,” said Kent Usell, managing director, W.J. Bradley Financial Services, who was recently appointed to work for a WJB broker-dealer that has been renamed and re-tasked for jumbo MBS through an acquisition structure.
Usell said end-investors increasingly want to partner with originators. He cited Ellington’s recent move to get into the loan production business as an example and said other players are pursuing similar strategies.
Investors increasingly want to be directly tied to origination so that there is more of a closed-loop system, Usell said. He describes as a catalyst for this the market’s experience during the most recent downturn, when the importance of the need for manufacturing quality became clear.
He said end-investors have found the conduit process used prior to the downturn to amass loans from independent originators for securitization through a redundant re-underwriting process an inefficient way to vet this.
Also while the market is more confident in underwriting standards and credit reformed by the downturn and ensuing regulation, end-investors are still concerned about the possibility of originator compliance risk.
As a result, a growing number now “want to be directly tied” to the origination process to the point where they are pricing assets at origination with their originator partner. Their investment motivation is their interest in the two assets that comprise a loan: both the beneficial interest and the servicing strip.
At one point, big money-center banks were interested in this space and the servicing, but due to developing international Basel III accounting standards they have become less interested and have been ceding the space to private equity groups and hedge funds, Usell noted.
Meanwhile, the jumbo securitized market has opened up a little more as, among other things, competing agency guarantee fees have risen. If these and other market trends continue to be supportive, he said there could be a field of new foreign and domestic entrants by mid- or late-2014.
Usell said based on what he has seen so far there also is likely to be “handful” of new entrants this year, assuming all the stars remain aligned. Everything and everyone from ratings to warehousing financing has to be attractive to the parties involved for it to work, he noted.
Within the still relatively small jumbo mortgage-backed securities market dominated by the pioneering Redwood/Sequoia Trust, the trend appears to be toward declining credit enhancement levels, Usell said. “The cost of warehouse financing needs to get a little better,” he added.
When asked how far those pursuing close ties with originators have gotten so far, he said, “Almost no one’s set up. It truly is a race.”
Usell said market participants are finding the marrying of the originator and end-investor cultures somewhat challenging and as a result, it takes time.
“It’s not easy to go downstream,” he said, and as end-investors are working with their originator partners they are sometime finding they have to bridge differences in jargon and other divergent perspectives to communicate.
Originating loans “is not like buying CUSIPs,” he said. “There is a learning curve on both sides.”
When asked about representations and warranties that govern the repurchase criteria that can be a sticking point for originators and end-investors, Usell said he believes these will gravitate toward whatever the agencies use due to competition with that market.
As for how his company is positioning itself amid all these trends, he said it has set out to have a foundation across the mortgage business positioned for whatever market contingencies should arise.
