CrunchedCredit

Pre-Game Reading

Matthew Clark — Fri, 03 Feb 2012 19:15:01 -0500

For those of us with a rooting interest in Sunday’s festivities, it’s been a long two weeks. By Superbowl Saturday, Coach Belichick’s game plan will be set, the Material Girl’s setlist will be planned and the most famous ankle since Curt’s Bloody Sock will (hopefully) be mended, and it is with that in mind that I’ll suggest some pre-game reading to pass the hours leading up to kickoff.

As I mentioned in my post from Miami, our industry faces a mountain of maturing CRE debt in the next 24 months. We’ve been dusting off our default letters, updating our pre-negotiation agreements and spending a lot of time talking with our Bankruptcy, Business Restructuring and Reorganization group about how we can help our clients. This week, Dechert partners Michael Sage (who just happens to be on his way to Indianapolis this weekend to cheer on the Pats) and Brian Greer published an article detailing a recent Delaware Bankruptcy Court decision confirming that in multiple-debtor Chapter 11 cases, the cramdown rules must be applied on a per debtor basis, as opposed to a per plan basis (this is really good news for lenders with performing collateral that get caught up in a sponsor’s mass bankruptcy filing). Michael and Brian see this decision as having a significant impact for securitized debt stacks. Also, next week, Kathy Burroughs, Jon Rini, Jill Lavacchia and I will be publishing an article summarizing recent case law following in the wake of the Stuytown decision and another decision striking down the assignment of bankruptcy voting rights from a junior lender. Lastly, both CrunchedCredit blogger Rick Jones and his partner and FRE Group co-chair Joe Heil were interviewed by Law360 this week – offering their thoughts on market conditions and areas of opportunity in 2012. The interviews can be found here and here.

I hope all of our readers enjoy the game, whether you’ll be rooting for NFL MVP Tom Brady and the AFC Champion New England Patriots, or that other team.

By Matthew Clark

Learning to Love Disintermediation

Rick Jones — Thu, 02 Feb 2012 17:31:50 -0500

We’ve been writing a lot recently about the likelihood that European banks and, to a lesser extent, U.S. banks would be strongly incented to sell assets to improve capital ratios. We had a client briefing in New York on the Eurobank crisis a few weeks ago. We brought together our North American and European regulatory and transactional counsel to cover a wide range of issues from the sale of assets to rescue capital. We had a lively conversation on the panel and with the audience about asset sales. It was pretty clear to one and all that if assets are not disintermediated, bankers will be defenestrated. Given the choice, we are pretty sure the banks will sell assets.

De-risking of banks’ balance sheets might be less than terrific macroeconomic policy at a time when economic activity is weak and could be very bad if it touches off a powerful credit contraction and a descent into a continent full of zombie banks. That’s bad. But, always look on the bright side of life, in a Life of Brian sort of way. In the short to medium run, the velocity of transactional activity around financial assets will go up. Indeed, we have been very busy since mid-year buying, selling or financing pools of loans bereft of the love of the bank who made ‘em.

Of course, banks can meet capital targets by either selling assets or raising new capital. Our European friends seem to have a strong predilection for meeting necessary capital ratio targets by trimming the numerator as opposed to growing the denominator. Commerzbank is a good example. The Wall Street Journal reported recently that Commerzbank is back on the regulatory griddle after actually raising significant new equity. But the bank used that equity to pay off governmental investments and avoid dilution as opposed to simply deepening the capital cushion. That seems emblematic of a continental mind set. We think it will be a while before the European banks and their regulators will broadly embrace all that new capital that is just awaiting the invitation to shore up those balance sheets and impatiently sitting in the coffers of those nefarious Anglo-Saxon private equity shops. And, by the way, this is a capital problem, not a liquidity problem. A few weeks back, the ECB deposited over half a trillion dollars into European banks, which of course they gobbled up and neatly re-deposited back in the ECB. While the markets got giddy for a day, it didn’t fix the capital problem. Liquidity is not the problem. Solvency is.

So, shedding alligator tears at the woes of the European bank market, U.S. transactional players are quite excited about the opportunities in 2012 and beyond as the slow motion train wreck that is the Eurobank crisis continues and continues and continues. And the even better news for us transaction junkies is that these assets are moving from hold-to-maturity players to folks with a much more dynamic approach to the management of financial assets. So as assets are sold by the European banks, they will enter a high velocity environment here Stateside where they will be re-financed, re-structured, re-packaged and re-sold.

The pattern we’ve seen, which we think will continue, is that the healthy U.S. banks will be the strong bid for high-quality performing loans. These institutions continue to struggle to grow their loan book and buying pools moves the needle. The more transitional, or dodgier, assets will be snapped up by the high-yield community using leverage from those self-same major banks. There is a robust bid to finance successful buyers. Most of this financing is repo based, but has proved to be very flexible structurally to accommodate the business realities of a dynamic pool of loans. What I expect to see during the year is some of this bank financing replaced on a long-term, durationally-matched basis by CMBS or CDO type structures which will be very effective stable leverage for players in the space. Lonestar’s L-Star transaction in mid-2011 is the poster child for this trade. We will see many more.

Before getting too giddy over the opportunities flowing from the European banks, remember that every rose has its thorn.

Whether buying or financing, these trades can be difficult. First, many of the banks are turning to established auction shops like Eastdil and HFF to sell pools of assets. While the optionality and transparency of the bid process may be compellingly attractive to the sell side, it creates material barriers to entry on the buy side. The pattern of recent transactions has been a due diligence period followed by a brief contract period and a brief period to closing. The ante is an incredible amount of diligence work prior to making the bid. This has and will continue to limit the number of bidders and it’s conceivable we’ll see more transactions occurring on a private, negotiated basis as bidder fatigue shrinks the pool of willing buyers.

Second, these loans are seasoned and were originated for portfolios as opposed to the secondary market. That means the documentation is all over the lot and the quality of the data captured at origination and through servicing is, in some cases, woeful.

Third, interest rate calculations and payment terms in the underlying loans are, in many cases, downright weird. It’s fascinating how bankers left to their own devices will find new and heretofore unimagined mechanics around setting the interest rate, the interest accrual period and the pay dates. Cutting through this hodge-podge of payment terms is complex to say the least. And if temporary bridge financing is to be taken out by a capital markets execution, it just gets very much worse.

Fourth, for reasons which may be somewhat cultural, the loans coming from the European banks often have restrictions on transfers in either the loan document or in the attendant hedges that makes transferring these loans to new ownership difficult. One can certainly call the borrowers and say, “May I please have a waiver, but I don’t want to pay for it”. But where that doesn’t work, the fixes are complex and typically involve workaround structures such as participations, back-to-back and total return swaps.

Finally, sellers in this market seem to be more than usually allergic to reps. Where data is not good and real, comprehensive representations can’t be had, pricing or taking on more risk become the only fixes. The rep problem is made more serious when there are questions about the long-term viability of the sellers and, in some cases, about the potential impact of sovereign immunity upon residual claims. Nothing’s easy.

So, in summary, European banks will sell assets, U.S. banks and funds will buy assets, U.S. banks will initially finance assets, long-term financing will ultimately be provided directly by capital markets execution, bankers who buy these assets will work them hard to restructure, sell, buy-down, DPO or foreclose these assets to lock in yield. We’ll be there every step of the way. Isn’t that a beautiful thing?

By Rick Jones.

Back to the Future: ASF Conference 2012 Returns to Las Vegas

Ralph Mazzeo — Tue, 24 Jan 2012 15:23:19 -0500

The American Securitization Forum (ASF) Conference returned to Las Vegas on Sunday after short stints in DC and Orlando. As you may recall, the Conference’s last hurrah in Vegas in 2009 was not well received by the Fourth Estate – the juxtaposition of investment bankers meeting in Sin City with the then-recent creation of the $700 billion Troubled Asset Relief Program was low hanging fruit for a media eager to assign blame for the credit crisis. Three years later, over 4,000 securitization professionals, including investment bankers, originators, servicers, trustees, accountants and of course, lawyers, are back in full force here in Vegas. The mood here stands in stark contrast to 2009 when we were staring into the abyss. We have since survived the worst of the credit crisis and have been steadily rebuilding the securitization machine. The dismay and depression of 2009 have been replaced with the sense that we can, in fact, see the light at the end of the tunnel. But how close we are to the end of that tunnel differs greatly by asset class. For example, Monday’s CLO panelists noted that they expected to see continued strong growth in 2012, building on a very successful 2011. On the other hand, the future of non-agency RMBS is unfortunately not looking as bright in 2012. Panelists discussing the 2012 Market Outlook again pointed to the regulatory as well as domestic and international fiscal issues that still need to be resolved before we can see a true recovery in securitization. Looking back at the 2009 ASF Conference Agenda, I found that the program included “substantive panels on critical policy challenges confronting the market, including TARP, TALF, mortgage finance and foreclosure avoidance legislation, loan servicing and loss mitigation initiatives, GSE reform, and what to expect from the new Congress and administration.” Well, we’ve worked our way through TARP and TALF. For better or worse (mostly worse) we now have Congress’s answer to the credit crisis – the Dodd-Frank Act. And of course, GSE Reform is still TBD or possibly RIP. So the near future will in many ways be similar to the past few years: more proposed rules and more comment letters to the SEC et al. I’ll follow up with more news from ASF which concludes Wednesday and will provide insights from the eight other Dechert attorneys here with me in Las Vegas.

By Ralph Mazzeo

CREFC January Conference Recap: Riding the Wave

Stewart McQueen — Wed, 18 Jan 2012 19:59:53 -0500

The image of the cresting wave looming behind the dais in the Loews' Americana Salon during Douglas Holtz-Eakin’s keynote address posed a central, if unintended, question that was addressed by more than one speaker during the three-day conference. Are we riding a wave to recovery or facing a deluge of maturing debt? For most of the 1,200 industry participants that occupied Miami’s South Beach for CREFC’s annual January conference last week, there seems to be no certain answer (other than almost unanimous agreement that South Beach is a better Winter destination than our Nation's Capitol).

Notwithstanding, the overall tenor of the conference seemed to be a determined optimism projected against the overarching blanket of volatility. European instability, a jobless recovery, a newly normalized, lumbering pace of economic growth and a constantly evolving regulatory framework continue to make uncertainty the only sure bet. As one might expect, a number of clients we spoke with last week are adopting a cautiously optimistic demeanor for 2012 and plan to tread the market’s murky waters slowly.

Will CMBS rebound (or continue to rebound)? Will the life co's and other non CMBS lenders be able to fill the void? How will regulatory reform be implemented? These questions are so 2010, and yet they stay with us. Depending on who you believe, CMBS output in 2012 is estimated to be anywhere from $25 billion to $45 billion (compared to approximately $28 billion in 2011). And even if the portfolio lenders have a gangbuster 2012 (which is, in fact, likely), they won't be able to bridge the void left by $360 billion of maturing debt this year. As for Washington, we can’t even determine a cogent agenda for regulatory reform at this point, much less predict what the rules of the game will look like.

Perhaps we’ll have answers (or at least a lessened degree of uncertainty) by the mid-year in June.

By: Matthew Clark and Stewart McQueen

The Return of the Liquidating Trust

Rick Jones — Tue, 17 Jan 2012 13:42:54 -0500

Recently, the Wall Street Journal highlighted the arrival of “bad loan securities.” If this is a trend, and I both hope and think it is, we clearly have to get a better deal name for these than “Insert Bank Name”, Bad Loan Securities 2012-1. Securitization of less than ideal conduit product has been with us since the birth of securitization, but reached its apogee in the RTC series, for non-performing loans, in the early to mid 1990s. That transaction architecture is being revived, and it’s about time. Both Fitch and DBRS have published criteria, or at least guidance and the other agencies are beavering away, busy working with bankers to come up with workable ratings technology.

To be clear, this is a financing tool, not a sales tool. Depending, of course, on the depths of ugliness in the pool, this is 35-55% leverage with a sponsor holding the risk piece. Nonetheless, it is peerless, durationally matched leverage that is terrifically useful for buyers of the distressed debt inventory. As the holders of non- and underperforming debt have increasingly fessed up to their marks, we’re now at a point where these transactions can be done without creating massive capital charge problems for the banks and other financial institutions holding this paper.

These structures are designed to allow an active, dynamic manager to liquidate a portfolio of loans, hence: liquidating trusts. The manager anticipates selling and resolving all of these loans and reducing them to cash in a finite and relatively short period of time. The ratings models work off individual business plans for each loan, taking into account current period income, liquidation proceeds and haircutting the bankers’ views both on the level of achievable proceeds and the time required to resolve the assets.

But these are not easy deals and we haven’t found the magic bullet to make them easy. First, these are management intensive transactions that are dependent upon the investors’ confidence in the quality and performance capabilities of the manager. Second, the quality of data available on seasoned non- or under-performing loans tends to be a bit dodgy, and that impacts the quality of disclosure and the difficulty of delivering high quality information to manager and investor. Finally, and most frustrating, is what needs to be done to achieve tax transparency. The assets typically can’t be subjected to a REMIC election because they’re not performing. For reasons, which for the life of me I cannot fathom, our Internal Revenue Code punishes pools of mortgage loans with corporate level taxation. Why are mortgages treated as the bad boys of the financial neighborhood such that they need to be rousted by the tax cop when they gather together on the street corner? The Code doesn’t pick on other asset classes in the same way. It’s inexplicable.

When mortgage loans are pooled, the so-called taxable mortgage pool rules (TMP) apply and these rules make it nigh unto impossible, in many cases, to issue more than one time-tranched class of debt. Therefore, these vehicles tend to be somewhat inefficient with only one class of equity and one class of debt. Seriously better pricing could be obtained if the debt could be both credit- and time-tranched like in most other structured finance products. Now there are ways around these problems, but none of these fixes work terribly well. So, for instance, if the loans are really bad, so that a large enough portion can be treated effectively as equity interests in the underlying collateral rather than as mortgage loans for tax purposes, you may be OK. If somehow you can be sure the loans will all be liquidated in 3 years, you may be OK. If the vehicle can be structured as a Qualified REIT Subsidiary (although watch out for dealer income that is bad REIT income in a liquidation strategy), or if the structure is entirely offshore, the TMP problems can be avoided. Each of these fixes, though, has, shall we say, material negative externalities which limit their use.

With all that said, this structure is very useful in the right situation. It’s going to be used, and it’s going to be used extensively in 2012. It is a way to move assets that one party does not want, or cannot hold, into the hands of those who want the exposure. It’s a way to tidy up the balance sheets for financial institutions, create market velocity, move risk to investors who want it and set the table for more capital creation.

Now that’s a good news story.

By: Rick Jones

January Conference 2012: CREFC Brings its Talents to South Beach

Matthew Clark — Mon, 09 Jan 2012 16:01:00 -0500

Over a thousand lenders, borrowers, servicers, lawyers and other service providers have descended on Miami for three days of networking, meeting and doing things you just can't do in DC. After a Sunday spent checking in, catching up and Tebowing, the conference kicked off in earnest this morning. I started my day with a PSA Task Force meeting - an important industry initiative. The committee is working hard to develop a standardized format for the more mechanical aspects of a pooling and servicing agreement, with an eye toward making loans work for borrowers and servicers alike (Rick offered some prescient comments regarding the importance of emphasizing the exercise as something that will, at the end of the day, make the servicing of securitized loans more efficient and user friendly). As I type, I'm listening to the opening general session, an overview of CRE fundamentals and where we are in the cycle (the common themes being the effect of the jobless recovery and the specter of $700 billion or so of debt maturing in the next 24 months). Tonight, Dechert will welcome over two hundred clients and colleagues for dinner at Asia de Cuba - we are looking forward to a great opportunity to talk to our friends. Tomorrow's schedule is similarly packed, highlighted by a keynote address by Douglas Holtz-Eakin. We will continue to blog from the conference.

By Matthew Clark.

THE NEW NORMAL / A THEORY OF GOOD NEWS: 2012

Rick Jones — Tue, 03 Jan 2012 10:56:48 -0500

It’s that time of year when we’re forced to think about budgets and business plans. The pointy headed types from the accounting department want to know exactly what we’ll be doing the second week of next May and, as I’m sure every one of you have said (or thought) when confronted with such bureaucratic insanity: If I knew exactly what I’d be doing and what the business environment would look like next year, I would (A) not tell you, and (B) stop doing this. But with that said, and notwithstanding my crystal ball is as opaque as the bottom of a Stygian cave, we need to plan.

So, I’ve been thinking. What the heck are we going to do next year? Is the CMBS market irrevocably broken? Was Credit Suisse trigger happy or prescient, stepping away from the market? Will investors buy bonds? Will European banks sell assets like it is the last hour of a bake sale? How about the US banks? Will banks make loans? Will we pare down the list of eager CMBS lenders to 10? Will the life companies replicate their boisterous 2010-2011? Will we finally see the bubble of refinancing we have been predicting to occur in two years for the past five, actually happen in 2012? Will investors commit enough money to the high yield sector and will the mezzanine market really be hot? Will we ever do a covered bond? Will we ever do a CRE CDO (like I’ve been prattling along about for quite a while now)? Live in hope; die in despair, as my daddy-in-law used to say. Will real estate people actually build new stuff and launch new projects? Do you think China would lend us a construction crane or two just for a while? Will risk retention arrive? Reg AB 2.0? What about the Volcker Rule? Will the rating agencies continue to conduct business as usual? What will the elections bring? Will the Greeks sell the Parthenon? Will the Italians sell the Tower of Pisa? Will haughty France play the poodle to Mrs. Merkel? What ultimately about Germany? Will the Europeans continue to support their champion national banks while they compete for a starring role in the next Night of the Living Dead movie? Forever?

As you can see, I’m pretty good at questions. The trouble is that, when you run a business, you’ve got to come up with some answers. As I’ve said to my colleagues around here, we need to have a view. Not taking a view is taking a view and no matter how daunting the prognostication game can be, you gotta do it.

So, with that said, this is what I think.

· No deep recession for the United States (if there is, ignore everything below).

· The job situation will continue to steadily improve, but the new normal of structural unemployment will be 6-7%, not 4-5%. The new normal of full employment notwithstanding, this will lead to continued firming of the demand for commercial real estate space.

· Private deleveraging will continue, housing will finally make a bottom, and CRE markets will modestly expand.

· Here in the U.S., we won’t fix the debt problem anytime soon. I hope Keynes was right about aggregate demand and government spending, but I doubt it.

· EU banks will sell U.S. and EU assets

· U.S. banks will sell assets in a less panicky way – portfolios will be balanced

· The EU crisis will have its own “trading range”. The EU will not collapse, no one will leave, but it will not get healthy, either. No European economic growth for the foreseeable future, or until they finally learn high taxation, protectionism and a massive regulatory apparatus is not a recipe for growth.

· EU countries will not let national champion banks fail, period.

· There will be a global tightening of credit and U.S. banks will have a material competitive advantage, if our own regulators don’t do more stupid things.

· Kicking the can down the road on bad loans is getting closer to its final denouement. More loans will get resolved, loan sales, real restructurings and rescue capital trades will accelerate

· Structured finance will be used broadly to facilitate disintermediation. Liquidating trusts, seasoned low leverage CMBS, and CRE CDOs will all be broadly used.

· There will be a CMBS business. Modestly better than 2011. What’s broken will trend toward being fixed – bid/ask spreads will come in. Rating agency models will migrate to levels at which capital formation can occur, and the gap between the CMBS bid and the portfolio bid will come in as the portfolio bid will simply be insufficient to deliver all the capital required by a modestly growing CRE sector.

· Further, regulatory action will continue to be characterized by unintended consequences being markedly more costly than the value of the intended good. This will continue to threaten the recovery and all of the good stuff above.

· The election matters, hugely. If the market concludes that Mr. Obama will remain in the White House and the Democrats may get more seats in the House and Senate, much of the good news above is materially trumped.

· Macro/global tail risks are at an all time high. Really bad stuff could completely shuffle the deck.

So what does all this mean for planning? We will see increased transactional activity in the CRE and structured finance space. Our clients are likely to be busy. There will be a premium on ingenuity, and innovation and scale will be rewarded.

So, here’s my plan: Go all in. We’ll grow. We’ll invest in innovation and deliver scale. When the risk/reward traffic lights are flashing green and the downside risks, while pretty catastrophic, still look tailish, it’s an easy call.

I’m looking forward to 2012; I think.

Dexia / Soros - Basel III and the Importance of Faith

Rick Jones — Mon, 19 Dec 2011 00:01:00 -0500

While Europe is sorting through Dexia’s assets, it is worth exploring Dexia’s fall in light of Basel III. As mentioned here previously, Dexia had been reporting Tier I capital of roughly 10%. Well done! That would clearly meet the proposed capital requirements to be phased in over the next year. So what went wrong?

Dexia had pursued a strategy of aiming to be the largest player in municipal financing. It owned gobs of sovereign debt. Down-grades and write-downs of that sovereign debt have now left Dexia well short of its Tier I capital requirements (to the tune of 1.7 billion Euros).

This is hardly a man bites dog story. The Gnomes of Basel, and pretty much everyone else, misjudged the perceived credit risks of sovereign debt. Basel I (and, to be honest, II and III) encouraged the holding of sovereign debt by assigning the lowest risk-weight to such assets, meaning a reduced capital requirement. So, the banks bulked up and then: Off the cliff we all go! Is there still a warm glow of knowing one had met international norms?

Dexia has now unloaded nearly half of its exposure to troubled sovereign debt and reduced its risk-weighted assets through the sale of its units in France, Belgium and Turkey to find additional Tier I capital.

Other European banks will need to raise nearly 120 billion Euros in the first half of 2012 to meet the new 9% Tier I capital requirement. Without help in recapitalizing from the ECB (not happening, per Mr. Draghi), these banks will need to unload assets or raise equity. While the US banks broadly sought new equity, the Europeans seem more comfortable embracing asset sales. If every bank does the same thing at the same time, we’ll see cascading cycles of lower prices requiring more sales, producing fewer Euros or dollars, requiring more sales, etc., etc.

The dirty secret is, of course, that no policy nostrum, no level of enhanced capital, no enhanced prudential regulatory regime will save the banking system in Europe or, indeed, anywhere around the world if faith in the value of risk assets is not restored. Gold bugs may rail against the failings of fiat currency, but all assets depend upon a level of faith that you and everybody else agrees that the assets have inherent value. If that collective belief system breaks down, nothing prevents the abyss.

But that’s not gonna happen, right? Right. It cannot and will not, but this whistling by the graveyard experience should chasten markets, and that’s probably good. Faith functions best when the suspension of reality required to maintain it is not too great.

In the meantime, there’s plenty to do. Loss of confidence coupled with regulatory intervention and uncertainty will create terrific arbitrage between the perceived value of financial assets in the hands of those who have lost faith or might, by reason of regulatory pressure, be a seller of necessity and those who can manage both the real and perceived risk and attendant liquidity issues. George Soros is the poster child of this arb, having just purchased $2 billion worth of MF Global’s sovereign portfolio. Toxic for MFG, home run for Mr.Soros.

So there is fun to be had for the brave and liquid and those of us who midwife the trades. I’m feeling good about 2012!

By Rick Jones.

More About that Chicago Vacant Buildings Ordinance

Laurie Nelson — Fri, 16 Dec 2011 11:28:07 -0500

In August I wrote about an amendment to a Chicago vacant buildings ordinance that I thought (and I was one of many) was crazy, despite being sympathetic to the plight resulting from the city’s blight. The City of Chicago subsequently passed a less onerous, yet still problematic, vacant buildings ordinance effective as of November 19, 2011.

In a nutshell, the ordinance requires mortgagees to pay registration fees for vacant residential properties, requires monthly inspections of mortgaged properties to determine vacancy status and imposes maintenance requirements on mortgagees, as if such mortgagees were property owners, even when such mortgagees do not own the property because they have not yet foreclosed on the related mortgage loan and therefore have not obtained title to the related property. Fines and penalties of up to $1000 per day could be imposed for failure to comply with the ordinance.

On December 12, the Federal Housing Finance Agency (FHFA), on its own behalf and as conservator of Fannie Mae and Freddie Mac (the GSEs), filed a complaint against the City of Chicago seeking a declaratory judgment and to enjoin enforcement of the ordinance against the GSEs and the FHFA, as conservator.

The FHFA's argument is that the ordinance violates and is preempted by federal law because the ordinance subjects the GSEs (in their capacity as mortgagees by succession or assignment) and the FHFA (which succeeded to the GSEs’ rights with respect to their assets) to the regulation and supervision of the Chicago Department of Buildings, and because the ordinance incorporates a taxing feature to be applied to servicers of mortgage loans on behalf of the GSEs. The complaint further alleges that the ordinance violates the FHFA’s statutory immunity from penalties and fines, in its capacity as conservator.

The complaint discusses the imposition on mortgagees of a duty to accurately assess the status of a property, despite the fact that such mortgagees incur potential legal exposure if a vacancy notice is erroneously posted, or if repairs commence or a property is secured that is not actually vacant. The complaint states that as a practical matter, the conservator and the GSEs would have only limited ability to assess the occupancy of certain properties, and such effort would inevitably result in incorrect results and potential liability for mistakenly declaring an occupied property vacant.

The complaint states that as of October 2011, Fannie Mae owns approximately 156,000 loans that are secured by properties located in Chicago and that Freddie Mac owns approximately 102,000 loans that are secured by such properties, and each uses approximately 200 servicers in connection with those loans. You can see how practically speaking this could get very complicated and cumbersome for the GSEs. Examples in the complaint of how the ordinance overrides the GSEs’ (and their servicers’) discretion as regulated entities under FHFA supervision is the requirement that steel plating be used over windows, which is allegedly much more expensive than the construction materials ordinarily used by the GSEs and their servicers, and the imposition of more burdensome lawn care practices than those ordinarily utilized by the GSEs and their servicers.

In response to a December 8 FHFA directive to Fannie and Freddie, the GSEs have issued notices to servicers discussing procedures the loan servicers will need to take going forward with respect to the ordinance including making payments to the City of Chicago under protest; tracking and reporting payments made to the City of Chicago, including payments, expenditures or other costs incurred in compliance with the ordinance to repair, maintain or secure properties that have not been foreclosed upon that would not have been incurred absent the ordinance and preparing proposed pricing changes for future mortgage originations or refinances that occur within the City of Chicago to reflect the higher costs associated and anticipated with the ordinance.

Speaking of higher costs… the complaint notes that U.S. taxpayers are funding the GSEs’ losses, and such losses will be exacerbated if the GSEs are required to submit to the ordinance’s registration fees and other obligations.

In its letter to the GSEs, the FHFA states that it will be examining whether other jurisdictions impose similar requirements in violation of federal law that should be addressed in the same manner. Although, as pointed out in a recent Wall Street Journal article, the FHFA’s lawsuit against the City of Chicago may prevent similar ordinances from being imposed in other cities.

By Laurie Nelson

A Dodd-Frank Holiday Reminder: Ribbons, Reindeer and Rule 193

Devin M. Swaney — Mon, 12 Dec 2011 09:42:44 -0500

While wrapping your holiday presents, don’t forget about another regulatory gift that springs to life as of the new year: Rule 193 and the accompanying joys of Items 1111(a)(7) and 1111(a)(8) of Reg AB. The final rules for Dodd-Frank’s Section 945 – which we at CrunchedCredit.com have addressed before - are almost a year old and their effects are coming to a public transaction near you by requiring “issuers” (1) to perform (or have a third party perform) a due diligence review of a deal’s underlying assets with the aim of reasonably assuring that disclosure included in the related offering documents is materially accurate and (2) to disclose in offering documents the nature of the review, any findings or conclusions of the review and any details regarding assets that deviate from the disclosed underwriting criteria. And this is a gift that keeps on giving.

Even though Dodd-Frank got one of our Golden Turkey Awards, issuers doing public deals must heed these new rules. Some things are clear: Rule 193 only applies to registered deals after December 31, 2011 and does not extend to Rule 144A and private placements, and the rule does not detail the nature or type of the required due diligence reviews or the content of required disclosure.

One might ask: to what extent will issuers (or other securitizers) be subject to additional legal exposure? In CMBS land, we already do detailed loan-level disclosure subject to 10b-5 materiality standards. All securitizers already have detailed underwriting policies and procedures and mortgage loan sellers and sponsors understand the value of internal due diligence standards, so does this new rule really bring with it any new headaches? You bet. Here’s a few:

(1) Scope - the rule requires compliance by “issuers” but it remains unclear whether the goal of the regulators was to include other deal parties like sponsors, depositors or loan sellers within the scope of the new rule. Could the authors, having used the word “issuers,” intended to limit the scope to issuers? Unlikely, according to industry chatter so far; instead, the expectation is that the rule will apply to parties beyond the issuer, including sponsors and depositors. So loan sellers and their counsel must deal with this – at least for now.

(2) Experts - the rule permits the hiring of a third party to conduct the due diligence review but it also requires that the third party consent to being an expert for ’33 Act purposes if the issuer (or other securitizer) “attributes” the review to that third party. What if you hire and rely on your accountants to comfort diligence data? And what if your lawyers review loan documents? If you think that accountants and lawyers will sign up for expert liability under the ’33 Act, I’ve got a bridge for sale. So just steer clear of “attributing” the review to third parties, right? Not so fast: there is some unclear commentary and related discussions among deal parties, questioning exactly what types of third-party back-up reviews may require expert consent even if the securitizer does not fully attribute the review to the third party. This one is also playing out as we blog.

(3) Hot Potato (or Risk Allocation) – How the foregoing scope and expert considerations get fleshed out impacts how lawyers and deal parties will allocate risk including by way of drafting and backing up offering document disclosure, negotiating indemnification agreements and providing 10b-5/159/Reg AB negative assurance letters and opinions.

Wait, there’s more holiday spirit included in the hang-em-high stocking stuffing provisions of Item 1111(a)(8) of Reg AB. A securitizer is required not only to disclose specific asset deviations with respect to underwriting criteria but they must also disclose the identity of the entity responsible for determining that an asset should be included in a deal pool notwithstanding its deviations. Never mind the Reg AB II certifications that we recently discussed here - anybody eager to sign up for these due diligence determinations? We blogged about this last year when the rule was first published and what we thought then remains true. Rule 193 is likely to expand issuer liability and legal concern while producing little in the way of better disclosure. Just what we need right now.

Seasons greetings! And more to come.

By: Devin Swaney

Covered Bonds Redux

Rick Jones — Thu, 08 Dec 2011 04:00:23 -0500

Senators Kaye Hagan and Bob Corker’s co-sponsorship of Chuck Schumer and Mike Crappo (who says we all can’t get along) filed “The United States Covered Bond Act of 2011.” I almost think this bill gets support because no one can figure out a compelling reason to be for or against it, so why not show a little whiff of bi-partisanship? The new bill broadly tracks the bill that Congressman Garrett introduced into the House earlier this year, HR-940. We’ve written about this before (it is getting to be quite a list, see here, here, here, here, here, here, here, here, here, here and even as a Golden Turkey), and, I gotta say, my views have not materially changed. This remains an answer to a question no one has. Please, someone, tell me why this is important and useful!?

Oh, don’t get me wrong, I’m a serious fan. Representing issuers on this product will be fun. While this has been a booming business in Europe for a while (like, the last 300 years), it does not translate well in the US. In Europe, broadly, every mortgage loan is originated with the expectation that all or a part of it will be financed in the covered bond market (in German parlance, the Pfandbrief market), that reflects the capital markets environment in Europe where covered bonds are a critical part of every financial institution’s capital structure.

That’s not what we’ve got here. US banks have the benefit of robust deposits, of deep equity markets and unsecured borrowing to provide needed capital. The fundamental economic problem for this product here in the United States is that, if an institution is sufficiently highly rated so that the co-dependency problem when the institution issues covered bonds will not be overwhelming, it could raise money more efficiently in the unsecured debt market. Consequently, covered bonds are negatively accretive to the cost of funds. On the other hand, if the covered bond economics are accretive, the bank’s unsecured ratings are probably insufficiently high to support the structure. So we have a Goldilocks problem. One issuer is too good and one issuer is too bad, is there one in the middle? Maybe, but it can’t be a big market. Compounding this problem is the hostility of the equity analysts who don’t cotton to ring-walling assets away from the general creditors of the institution, and of the FDIC, which broadly hates the whole thing. From the FDIC’s viewpoint, covered bonds dip into its pocket to steal assets from the rainy day fund. There’s been some potential compromise discussed with the FDIC, but it will remain a daunting roadblock to getting something done.

Net, net, I’m not holding my breath for birth of a real covered bond market here in the United States. But if anyone can explain to me the compelling need to which this is a compelling answer, I would love to hear it. In the meantime, maybe it’s simply worth enjoying the fact that our elected representatives have found an issue on which they can just get along.

By: Rick Jones

COMMERCIAL REAL ESTATE 2011 RECAP: AND THE (ANNUAL) GOLDEN TURKEY AWARD GOES TO....

Rick Jones — Tue, 22 Nov 2011 18:12:42 -0500

With Thanksgiving approaching and the holiday season in full swing, we here at Crunched Credit would like to present our annual “Golden Turkeys”.

The Golden Turkey for the Most Confounding Regulation: The Premium Capture Reserve Account

Back in March, the credit risk retention NPR was released. Perhaps the most unexpected (and unwelcomed) part of the rule was the Premium Capture Cash Reserve Account (PCCRA). The PCCRA provisions actually say that issuers may not profit from securitizations or recoup costs up front. The NPR says that a securitizer who monetizes either an IO or earns a premium on the sale of P&I bonds has to put that money aside to serve as a first loss reserve for any losses on the mortgage loans for the life of the deal--on top of the 5% risk retention requirement. Neither a PCCRA nor a reasonable facsimile thereof was contemplated in the Dodd-Frank Act. Needless to say, PCCRA has generally not gone over very well: Confound it!!

The Golden Turkey for the Best Self-Inflicted Wound: The “Bad Boys”

And by “bad boys”, we mean those who have violated the “bad boy” recourse carve-outs in their loan documents. Although most commercial real estate loans are non-recourse (i.e. the lender can only look to the value of the property securing the loan to settle the borrower’s obligations if there is a default under the loan), most contain certain “bad boy” carve-outs (for example, the borrower filing for bankruptcy or misappropriating funds) from the non-recourse nature of the loan, permitting the lender, in certain circumstances, to look to the borrower (as well as the guarantor) to satisfy the borrower’s obligations. Some borrowers, victims of the great recession, have opted to file for bankruptcy in an attempt to stop the bleeding and dam the "bad boys". Oops. Lenders confronted by misbehaving borrowers have enforced the “bad boy” provisions, and, shockingly, the lenders have been successful! The New York Supreme Court has, on 2 separate occasions in March and July, upheld the “bad boy” provisions. While putting the borrower into bankruptcy may seem like a good solution, if doing so will violate the “bad boy” recourse provisions, it will make a bad situation worse.

The Golden Turkey for the Best All-Around Performance: Europe

I defy anyone to explain European monetary and fiscal policy. No amount of magical thinking or psychotropic drug therapy can make this make sense. The explosive dysfunctionality of common monetary and fractured fiscal policies have been baked in the cake since inception and ignored by a sheer act of will. The inevitable denouement from this toxic brew was certain; not whether but when. While perhaps a common currency made sense from the perspective of keeping German troops out of Belgium, it was a disaster in a world where the business cycle was alive and well. The profligacy of European economies, the attendant sovereign debt crisis, the European banking crisis, world banking tensions and European recession can all be laid at the feet of the profound suspension of reality that this was some sort of a good idea.

The Golden Turkey for Pouring Gasoline onto Fire: Basel III

OK, I get the notion that banks need more capital, that the socialization of risk needs to be decoupled from market rewards, and that the system really did go casters up. But…on the cusp of a recovery, we have: the SIFIs (for the blessedly uninitiated, systemically important financial institutions), the Volcker Rule, Skin in the Game and Basel 2.5, Basel 3.0, and on and on. While we are desperately trying to re-start the economy, it seems ideologically bold, to be charitable, to embark simultaneously on dozens of untested, game-changing linked policy initiatives that will, if they do nothing else, constrain capital formation. Isn’t that a bit like citing the Titanic’s kitchen’s for unsanitary brioche pans?

The Golden Turkey for the Abbot Arnaud-Amaury Lookalike Contest

The good Abbot has won notoriety through the ages for the investiture of the City of Béziers during the Albigensian heresy. For, when confronted with the fact that many of the good citizens of Béziers were non-heretical Christians, he said something along the lines of, “Kill them all, God will choose the innocent”. Our illustrious chattering class seems to have concluded, on both the red meat right and the loony left, that trashing bankers makes good copy and good politics. Sticks and stone are bad enough, but an un-relenting policy of demonization makes for fertile ground for bad policy prescriptions, opportunistic litigation, and prosecutorial grandstanding. Whack the bankers, whack them all! Whack a mole! One would not be shocked if our banking sector was left with precious little energy for the aggressive pursuit of capital formation. The fact that the banking sector is working hard to do its job and support commercial real estate with capital is a tribute to our bankers.

The Golden Turkey for Unintended Consequences: 17-g-5

This is a very crowded category. The more we try to prescriptively engineer financial and market outcomes with legislation, the more we encounter the goblin of unintended consequences. You’d think at some point we’d create an OMB for unintended consequences to make a sustained effort think through the chances for unintended consequences before our elected representatives pose behind the President to get their picture taken and cop a commemorative pen. And then we all get to regret the legislative product. And the winner is: Rule 17-g-5. This is a rule introduced earlier this year which required issuers to maintain password protected data sites accessible to all NRSROs to see all the information in connection with a structured finance product rating recorded in these sites so that other, unretained rating agencies could analyze the data, publish an unsolicited rating and, therefore, keep everyone honest. Certainly, the Hobbesian instinct behind this notion to utilize the power of raw market capitalism to achieve the goal of breaking the perceived cozy relationship between rating agencies and bankers was estimable, but it didn’t work. To my knowledge, no unsolicited rating has occurred. And it’s pretty clear why. The cost of producing a rating on a CMBS transaction is enormous. If no one’s going to pay you for it, it’s hard to understand why an agency would undertake all that work to make a point. Moreover, here’s what makes this prize so well earned: the requirement that all information made available to the retained agencies be made simultaneously available to all NRSROs has meant that banks have had to become punctilious about controlling information flow to avoid violating the shared information rule. In consequence, the NRSROs are getting much less information as conversation has been cut off and everything has been reduced to written submission. Moody’s showed courage this year by writing a thought piece that said 17g-5 was reducing the quality of ratings. They are right. Now that's a useful outcome, right?

The Golden Turkey for the Best Idea Ever, that doesn’t Work: Covered Bonds

In the past few weeks, the companion bill to the U.S. Covered Bond Bill 2011 has been introduced into the Senate. The Senate bill tinkers with the version re-introduced by Congressman Garrett into the House earlier this year and, in some respect, improves the enabling legislation. We’ve been introducing covered bond bills and talking about covered bonds for years. Not much has happened. No one has actually made a compelling case that there are major financial institutions in the United States of America that want to use covered bonds. No one has ever made a compelling argument that this is accretive to the cost of capital without an offsetting negative impact on the market. Finally, there is no evidence that anyone in our dysfunctional bicameral legislature actually thinks a bill will pass anytime soon. Now don’t get me wrong, we at Dechert love the covered bond, and hope one day to be retained by serious players with serious budgets to make one of these transactions really work. But frankly, and to misquote Winston Churchill, “Never has so much been said by so many about so little”.

The Golden Turkey Send off: Here’s to you Mr. Politician

Whether you are a Keynesian economist (like many politicians pretend not to be) or a follower of F. A. Hayek (like all of the Republican potential nominees proclaim to be), one thing is for certain, we can all agree that the markets are volatile and 2011 is not the year to be an incumbent politician. So, with Thanksgiving right around the corner and the end of the year drawing closer, we at Crunched Credit would like to give a friendly send-off to those politicians who have done much to keep the news entertaining but little to calm the markets. To all of “them” (we all know who they are, even if they don’t) and to the rest of “them” still standing, “It’s the Economy, Stupid”!!!

By the Crunched Credit Team.

For The People; Against Corporate Greed and Securitizations and Stuff

Matthew Clark — Mon, 21 Nov 2011 09:31:12 -0500

Acting in response to last week’s removal of the Occupy Wall Street, er, Occupants from, well, Wall Street, a Suffolk county judge ordered that the City of Boston obtain the court’s leave prior to relocating the current Occupants of Boston back to their dorm rooms. The order is temporary, and the judge intends to hear arguments on the merits in early December. While the Commonwealth has enjoyed a particularly temperate autumn, average temperatures dropped precipitously last week – a fact that, coupled with Dewey Square’s proximity to the Harbor, may see to it that the issue becomes moot. As one Occupant wrote: “Mom – protest’s gr8 but freeeeeeeeezing lol (^_^) – pls send fleece and UGG boots (check bedroom next to Xbox)!!! GTG – c u at xmas :-)”.

Ironically, just last month the Supreme Judicial Court of Massachusetts had a decidedly different reaction to one homeowner’s occupation of Massachusetts real estate – and in the process cast doubt on the state of title for thousands of owners of foreclosed homes. In late October, the SJC decided Bevilacqua v. Rodriguez, 955 N.E.2d 884 (Mass. 2011), extending its holding in Ibanez to a (former) homeowner that had purchased REO from a securitization trust [See here for our prior thoughts on the Ibanez case].

The facts of Bevilacqua are, by now, too-familiar: a securitization trustee executes a foreclosure deed in June, 2006 but doesn’t take assignment of the mortgage from MERS until three weeks later (an assignment that, importantly, is actually placed of record). Under Massachusetts statute, only a mortgagee or its executors, administrators, successors or assigns can execute foreclosure – the late assignment meant the trust had foreclosed before it owned the mortgage, invalidating the resulting transfer. And, in Massachusetts, you (usually) can’t sell what you don’t own.

On appeal, Bevilacqua argued, among other things, that he should be entitled to the protections against adverse claims afforded a bona fide purchaser purchasing for value – a legal theory protecting unwitting purchasers who take title without notice or knowledge of a defect in the power of vendor to sell. The Court rejected this argument – a scrub of the Registry’s records would have shown the trustee to be, at various times during the summer of 2006, either a complete stranger to title, a mere assignee of a mortgage, or a party that had foreclosed in error. (It’s interesting to note that at least part of the Court’s analysis here rests on the fact the assignment from MERS to the trustee was placed of record – something the Ibanez court found that, while good practice, was unnecessary as a matter of Massachusetts law.)

Like Ibanez, the Bevilacqua decision seems exactly right on the merits and exactly wrong in practice, and will almost certainly result in corrective legislative action to prevent the divesture of thousands of innocent – albeit decidedly not bona fide – purchasers of foreclosed Bay State homes.

As an aside, in divesting Bevilacqua, the SJC made a point of relaying the Land Court’s observation that accepting Bevilacqua’s theory that his deed was sufficient to establish record title would render the “Brooklyn Bridge” problem insoluble. As the Land Court wrote: “in the classic example, a litigant could go to the registry, record a deed to the Brooklyn Bridge, commence suit, hope that the true owners ignored the suit or ... could not be readily located and [would thus] be defaulted, and secure a judgment.” Of course, last Thursday, that same crafty litigant would have found his bridge teeming with thousands of displaced Occupy Wall Street Occupants – a scenario the legal ramifications of which confound the mind.

As one Occupant wrote: “Dude, where’s my title policy?”

By Matthew Clark and David Pildis

Summary of a CREFC After-Work Seminar: The Return of the Public Deal or the Regulator Strikes Back?

Devin M. Swaney — Mon, 07 Nov 2011 11:29:07 -0500

What’s with all these public CMBS offerings? And what about all that rule-making? The registered market has otherwise been frozen since the pre-crisis days, and the cloud of heavy-handed regulation looming over our heads is anything but an invitation to dust off your public shelf. Moreover, given that some of those regulations may be (or have been) applied in the 144A context, shouldn’t one be concerned about the private market before we even think about re-entering the public space? And all of that is without even considering the general mid-year market slump. To address these critical questions and the state of the galaxy as we know it, CREFC held an after-work seminar recently, hosted by Dechert, entitled “Review and Outlook for Public CMBS Offerings.”

The seminar consisted of a panel of industry specialists representing issuer, investor and legal perspectives: Paul Vanderslice, Managing Director, Citigroup; our own Rick Jones, Partner, Dechert LLP; Tom Doherty, Executive Director, JP Morgan; Ken Cohen, Managing Director, UBS Investment Bank; Brian Furlong, Managing Director, New York Life; and Bruce Martin, Research Analyst, Fidelity.

The group considered investor motivations related to the public/private distinction, including whether the appetite of some investors in registered securities is driven by limitations on the amount of private paper that they can soak up or driven by a particular desire to diligence the additional information that is available in a private context. In addition, the panel emphasized the industry’s (thus far unsuccessful) effort to demonstrate to regulators that the CMBS space, in comparison to other asset classes, has traditionally provided voluminous (and adequate) disclosure with respect to underlying assets and deal structure, whether in a public or private context. So maybe the line in the CMBS sand is not so bright when it comes to a) disclosure - because public and private books are not that different; and b) investor satisfaction - because some investors just want and can handle more information, while others have limited capabilities to buy private deals.

With respect to CMBS 2.0, the panel noted some trends across the board for public and private deals: among other things, the inclusion of (1) mortgage loan seller representations and warranties and related exceptions, (2) enhanced (e.g., Reg AB-compliant) asset-specific and party-specific information, (3) investor Q&A forums and (4) the role of the operating trust advisor (which we at CrunchedCredit.com have previously discussed).

Unsurprisingly, the group could not avoid discussions of risk retention and premium recapture - hot topics that CrunchedCredit.com has also addressed before. Additionally, the presentation provided timely regulatory updates, including life with (1) Rule 17g-5 (i.e., no talking to, and instead posting of materials for, the rating agencies), (2) Rule 17g-7 (i.e., comparing a deal’s reps to rating agency benchmarks), (3) Rule 15Ga-1 (i.e., reporting and disclosing repurchase demands) and (4) Rule 193 (i.e., requiring issuers to know their assets).

More generally, the panel expressed a common industry sentiment regarding the many regulatory efforts currently on the table: just make the rules and we will figure it out from there.

If you missed this after-work episode and the related installment of updates, the instant replay is available here on CREFC’s website. And one thing you can count on is that there is plenty more to come!

By Devin Swaney.

Always Look on the Bright Side of Life: How Dexia's Failure Could be Good for Capital Formation

Rick Jones — Mon, 24 Oct 2011 12:00:00 -0500

The other week, I was musing in this blog about the likelihood of more AIB and Bank of Ireland type auctions of U.S. Dollar denominated assets by European banks. In the Wall Street Journal, on Friday, September 23rd, the headline was “Banks in France Cut Dollar Loans”. The article focuses on two of France’s biggest banks, BNP Paribas and Société Générale, jettisoning U.S. Dollar denominated assets.

And then, the news about Dexia broke on October 10th. Dexia is a huge French-Belgian bank, though with a lesser profile here in the States than its more famous Parisian and Brussels-based sisters. The French, Belgian and Luxembourgian governments immediately swooped in to guarantee deposits and provide credit support and began chitchatting about a good-bank, bad-bank fix. The reaction in the markets has been curiously muted. Dexia is huge. Its reported balance sheet is more than 500 billion euros. (And, of course, Dexia had been reporting Tier 1 capital of 10% a couple of months ago. How’d that happen? But that’s a different story.)

The failure of Dexia seems to have been a reasonable excuse for a modestly full-throated panic about the ongoing European debt crisis around the world and here in the States. To the contrary, it was largely a non-event. That’s startlingly odd, as it seemed to be a pretty loud “tell” on where we’re headed. A sovereign debt crisis begets a European bank liquidity and capital crisis which, among other things, begets a need for U.S. dollars. So, what must happen? The European banks will sell riskier assets in general and particularly U.S. Dollar denominated assets.

This is all clearly, horribly bad for the banking system and capital formation. But as we wait for the apocalypse to arrive, it does deliver opportunities here in the States. The European banks, and ultimately other sovereign and near-sovereign banks around the world, will discover that selling commercial real estate assets in the U.S. is a terrific way to re-charge dollar reserves, demonstrate liquidity and repair capital ratios.

So the beating butterfly wing of sovereign debt (maybe that’s actually a beating buzzard wing) will, in the short term, generate increasing transactional activity here in the States for those willing to buy portfolios of performing and non-performing loans in search of yields. The major auction players are salivating. As a transactional lawyer, this seems a fine way to while away the time while waiting for the debt crisis to play itself out.

But why wait for the RFP? If I’m a buyer of financial assets or an institution anxious to finance someone else’s purchase of financial assets, why wait for the call from Eastdil, Auction.com, or CBRE that another plum assignment has fallen into its lap and they’re fixing to auction loans? Why not approach the likely seller banks to do a less visible transaction that will generate less notoriety? Why not go to the banks and offer financing to potential bidders baked in? Why not convince the banks to do the hard work necessary to produce clean portfolios to maximize price, as opposed to dumping not-ready-for-prime-time portfolios of stuff onto the auction block? Why not think about proposing alternative structures to potentially inefficient whole loan auctions? There are numerous structured finance solutions to these problems which might be a better fix for institutions intent on maximizing the value of dollar assets and do it in a structure that creates less visibility and notoriety while offering the chance to participate in the upside?

There are rewards for being proactive.

By Rick Jones.

Supreme Judicial Court Casts Doubt on State of Title for Thousands of Massachusetts Homeowners

Matthew Clark — Wed, 19 Oct 2011 18:54:17 -0500

The fallout from Ibanez continues in the Bay State. As I (fearfully) predicted earlier this year, the SJC of Massachusetts (in its second foreclosure-related ruling of 2011) has affirmed a lower court’s decision in Bevilacqua v. Rodriguez. The SJC ruled Tuesday that Mr. Bevilacqua lacked clear title to a home he purchased from U.S. Bank (which had obtained title via a challenged foreclosure proceeding). The court was critical of the bank’s failure to adhere to the proper assignment procedure. Which poses the question: Is Mr. Bevilacqua paying the price for the robosigners? More analysis to come from the CrunchedCredit team in the coming days.

By: Matt Clark

2011 ABS East Conference

Laurie Nelson — Mon, 17 Oct 2011 16:19:19 -0500

Ahh, Miami. I'd say it's good to be back here at the Fontainebleau for ABS East 2011 but it's been pouring and exceptionally windy so my time outdoors will be limited. Dechert attorneys Mac Dorris, Ralph Mazzeo, John Timperio, Cindy Williams, Larry Berkovich, Lorien Golaski, Andrew Pontano and I hosted a well-attended cocktail party Sunday night. It was great to catch up with our friends/clients in person.

Monday morning began with a general session where some blurbs about risk retention from this October 14 New York Times article were projected on two very large screens. I later attended the “Evolving Risk Retention Requirements” panel before lunch. It's been a while since the joint regulators released the credit risk retention NPR back in March of this year. In response, hundreds of comment letters were submitted. Click here for the ones posted by the SEC. We have blogged repeatedly on this topic here at CrunchedCredit.

Recently there has been chatter that the regulators may re-propose a new risk retention rule for comment in lieu of promulgating a final rule.

Today's panel not surprisingly reiterated much of what we've been posting on this blog about credit risk retention, namely that the number one point of contention with the rule is its mere existence. Second is that pesky premium capture cash reserve account (PCCRA). One panelist restated, as many comment letters have, that banks are not in the business of storing costs and profits until they can perhaps recoup them down the road, and that although some investors may have liked the general idea of the PCCRA, for the most part they have acknowledged the PCCRA just doesn't work. Not to mention that such a beast was not even contemplated in the Dodd-Frank Act. This panel seemed to agree that the PCCRA would be a game ender. If it was intended to combat horizontal risk retention manipulation, one panelist noted that's a legitimate goal and is supported. But if the consequence is preventing an issuer from recouping its costs and making a profit, where's the incentive to do a deal in the first place?

The NPR also enumerated arguably conservative criteria for the Qualified Residential Mortgage (QRM), each of which such mortgage would be exempt from the risk retention requirements. One panelist asked-- if you define an exception so narrowly, have you eliminated the exemption that Congress intended? And he reiterated the purpose of the QRM-- to ensure safe and sound underwriting, not to establish a gold standard for residential mortgages.

Panelist Tom Deutsch, the Executive Director of the ASF, noted that industry groups tended to focus on the price differential when commenting on the risk retention NPR, whereas consumer groups came to the same conclusion about the rule (it needs some major overhaul), but in a different way. Consumer groups, he said, speak in terms of social inequality and argue that the QRM will create a two-tier structure with social policy implications-- that those who fall outside the QRM won't get as good a deal, not entirely unlike the GSE conforming loan limit structure. Tom noted that QRM isn't relevant until GSE reform occurs anyway, because the GSEs aren't subject to the risk retention rules as long as they are in conservatorship, and that GSE reform is not happening in the near future. Another panelist discussed the small pool problem that may occur if few QRMs are originated. He pointed out that loans may need to be warehoused longer to amass larger pools. It has been proposed by those in the industry that securitizations blend QRM and non-QRM in a securitization and calculate the risk retention requirement based on a weighted average basis.

There are compelling arguments that the regulators got this one wrong. And with so many comment letters addressing so many points, if the regulators put out a final rule that looks pretty much like the NPR, they will be accused of not taking into account all the solicited comments received. On the other hand, if the regulators put out a final rule that barely resembles the NPR, they will take flack about not soliciting public comment. The regulators were given
an arduous task in a relatively tight timeframe. And much is riding on the final outcome.

By Laurie Nelson.

Reg AB II Revisited: Fourth and Goal

Devin M. Swaney — Mon, 10 Oct 2011 13:10:35 -0500

Not only is football back, but so is Reg AB II. Just as enduring as our love of tailgating and touchdowns is our love of transparency in the capital markets. On the heels of yet another Reg AB comment deadline (see re-proposed rule here (pdf)) now is a good time to check the score. Dechert continues to participate in committee (and subcommittee) discussions with industry specialists and we were happy to serve as nose tackle for the drafting of CREFC’s response/comment letter (see CREFC comment letter here (pdf)). So where do we stand with shelf registration eligibility requirements now that Dodd-Frank and its related regulations have addressed some of the issues included in the second round of Regulation AB from April 2010 (i.e., Reg AB II)?

There is still plenty to talk about with respect to Reg AB II, but some issues are now being dealt with elsewhere. Risk retention was addressed by March 2011’s Dodd-Frank rules and on-going ’34 Act reporting by ABS issuers was addressed by Dodd-Frank’s Section 942(a) and Rule 15Ga-1. Both of those issues have been removed from the scope of Reg AB II. The previous discussion concerning confirmation of reps and warranties has evolved, as detailed below, into a discussion about the role of a credit risk manager and procedures related to repurchase dispute resolution. At least one thing that is still clear: credit ratings are to be eliminated from the shelf eligibility test.

But, again, there is still plenty to talk about. Following is the current Reg AB II playbook and some of the straight talk:

Proposal – The chief executive officer or executive officer in charge of securitization of the depositor would have to file a certification concerning the disclosure contained in the prospectus and the design of the securitization.
- Straight Talk – The CEO already signs the registration statement. Is a CEO realistically involved in offering document disclosure and the details of deal structure? Should an issuer’s CEO really be charged with ensuring the design of a deal, when the mechanics of the deal are disclosed to investors?
Proposal – The underlying transaction documents would have to contain provisions requiring the appointment of a credit risk manager to review assets upon the occurrence of certain trigger events.
- Straight Talk – Operating trust advisor, part 2? Aren’t existing deal parties capable of doing this? We at CrunchedCredit have written about this issue before (see here).
Proposal – The underlying transaction documents would have to contain provisions requiring dispute resolution mechanics for repurchase requests/demands.
- Straight Talk – In CMBS land, the number of repurchases has been low. Is this really an area for regulation or should private parties sculpt their own resolutions?
Proposal – The underlying transaction documents would have to include certain investor communication provisions.
- Straight Talk – Some investors already have access to other investors. Mandating access to communication through 10-D reporting raises anonymity concerns with respect to the same investors whose interests the regulations are intended to protect.
Proposal – An annual evaluation would have to be filed with respect to compliance with registration requirements.
- Straight Talk – Requiring annual certifications instead of quarterly ones (as originally proposed) is an improvement but there’s still a 90-day delay in getting your shelf back after you cure non-compliance, which could stifle deal flow.
Proposal – The underlying transaction documents, in substantially final form, would have to be filed by the date the preliminary prospectus is required to be filed.
- Straight Talk – In the pre-crisis registration context, we got used to post-closing filings of servicing agreements, pricing documents and other material transaction documents, and in recent deals some issuers have been providing a red PSA at the time of the preliminary offering document, so this doesn’t seem revolutionary, but shouldn’t we limit the required documents to those required as exhibits to the registration statement?

Also, what about Reg AB II when it comes to Rule 144A resales and Reg D issuances? Still on the table is the idea that investors, upon request, can require a CMBS issuer to provide information that would have otherwise been required had the deal been publicly offered. Assuming that result, what are the benefits of the private placement market?

Stay frosty, Marines! It has been said that sunlight is the best disinfectant, but I’m not sure I can see the scoreboard through the sun’s glare. The good news is that we have shed some of our Reg AB II baggage. A touchdown for the free market? Don’t get too excited: Dodd-Frank has left quite a few issues on the horizon (and some others are already upon us). A pick 6 for the regulators? Or is the score tied? Regardless of the score, as we move through the regular season, we are making progress working through the issues on our Reg AB II checklist.

By Devin Swaney.

Thoughtful Refinancing or Lipstick on a Pig?

Devin M. Swaney — Fri, 30 Sep 2011 12:08:05 -0500

A few weeks ago the Congressional Budget Office (CBO) released a white paper entitled “An Evaluation of Large-Scale Mortgage Refinancing Programs,” analyzing the potential impact of a so-called stylized refinancing program (more on that in a minute) that would promote widespread mortgage refinancing (or so they say..more on that too).

While the stylized program analyzed by the CBO is not an analysis based on a legislative proposal (and instead is an analysis based on a CBO-developed probabilistic model of borrower behavior, estimated from the historical performance of GSE and FHA mortgage loans), the analysis, nevertheless, serves as a basis to assess whether (any similar) refinancing program would have a significant impact on the U.S. housing market.

The stylized program analyzed by the CBO is aimed at helping those distressed borrowers who do not qualify for the current federal refinancing programs (i.e., HAMP, HARP and the FHA) by loosening eligibility requirements. The thought is—loosen eligibility requirements (e.g., relax LTV tests, waive appraisal requirements, limit borrower income tests, include existing loans guaranteed by the GSEs and FHA, etc.) and more distressed borrowers will be able to refinance their mortgages and avoid default. After all, even those contestants who are not smarter than a fifth grader know that avoiding default is beneficial to both the distressed borrowers and the economy at large.

Under these loosened eligibility requirements, the CBO estimates that the program would cause 2.9 million mortgages to be refinanced, resulting in 111,000 fewer defaults on loans and an estimated savings for the GSEs and FHA of $3.9 billion on their guarantee exposure, and from the borrowers’ perspective, the estimate savings within the first year is estimated to be $7.4 billion. Wow—you say…things are looking good. But (and wait for it because it is a BIG BUT), the CBO estimates that federal investors in MBSs, including the Federal Reserve, GSEs and Treasury would experience an estimated loss of $4.5 billion. And, now for the BIG BUT, non-federal investors (i.e., everyone else involved) would experience an estimated loss of $13-15 billion.

All of this loss for what (here is where we feel a sense of déjà vu):

a program that doesn’t help delinquent borrowers (i.e., borrowers most likely to default)—actually, the program specifically excludes delinquent borrowers and borrowers that have been late for 30 days within the past year—and sounds a lot like the existing federal programs HARP and HAMP, which have been criticized for not helping enough borrowers;
a program that will have a net benefit on the economy of about 0, as the losses to investors will negate the gains to borrowers;
a program, that in the end, probably won’t reach too many distressed borrowers, because many borrowers that wanted to refinance and could, one way or another, have already done so (remember, mortgage rates have been historically low for a few years now);
a program that may end up increasing the GSEs and FHA guarantee exposure, as lenders will likely not agree to refinance unless the “put back” options and standard reps and warrants about the loans themselves are eliminated; and
a program that does nothing for borrowers with significant negative equity to reduce the incentive for “strategic” default or the susceptibility to delinquency caused by life or other economic realities (think unemployment rate 9.1%).

We want to see an end to borrower delinquency and foreclosure as much as the next guy, but creating another program that has about as much chance of success as the Cubs winning the World Series is not the direction in which our hopes should be pitched.

By: Krystyna Blakeslee and Devin Swaney

And the Momentum is Going Which Way?

Rick Jones — Tue, 20 Sep 2011 09:38:40 -0500

My team and I have spent the better part of the past eight weeks dealing with Irish loans and other portfolios of…stuff. While the conduit market was imploding, pipelines were being aggressively repriced and loan production was shifting into a very low gear, there has been a full scale feeding frenzy for portfolios of seasoned loans. While new loan originations were being dragged through the knot hole of torturous and ultimately paralytic analysis, millions of dollars were spent in high speed car chases for billions of dollars of seasoned loans in awkward, brief and brutal auctions.

Cognitive dissonance anyone? These are alternate universes. In the Ordinary Course Loan Origination Universe, every proposal suffers the death of a thousand cuts: “OK, maybe it’s a pretty good loan but I need to really understand what happens if the anchor tenant leaves, the president of the management company gets arrested and an asteroid hits Ohio. What exactly happens in the cash flow?” In the Alternate "Bid ‘Em Up Universe", crappy reps, document defects and weird deal features? Fine! Win the bid!

In the meantime, back in Alternate Universe A, getting a loan approved and closed still seems to be just plain tough. Spreads are volatile, hedging simply isn’t doable, and for the human beings involved in the trade, risk and reward is highly asymmetrical: an attaboy on the upside and a pink slip on the down.

Alternate universes make terrific grist for sci-fi potboilers, but are somewhat more disturbing in real life. And since it is, in fact, our real life, this bears musing about some.

A couple of things flow from this phenomenon. First, and this may fall into the no-duh category, the sale by sovereign or near sovereign banks of U.S. commercial loan portfolios is not going to be a one-month wonder. It is dead nuts certain that more portfolios of commercial mortgage loans will come to market here in the United States. The success of the Irish banks in August is certainly going to encourage the weak and the lame, particularly throughout Europe, to monetize their U.S. commercial mortgage loan portfolios to re-patriot funds and burnish liquidity. Just yesterday, one of the major French banks announced a $45 billion de-risking initiative. Wanna bet that some of that risk will be US CRE? Will there be auction fatigue on the institutional buy side? I sort of think not. For every institution that spends a zillion dollars and comes up empty, another will still see opportunity. In light of the realities of the Ordinary Course Loan Origination Universe, the siren song of get long fast by being able to put a billion dollars of seasoned loans on the books in one fell swoop will be compelling. Hey, and since the team is not building the book by onesies and twosies, we’ve got the resources to swing for the fence.

The other trend that I think we can tease out of the recent portfolio auction frenzy is that it will continue to support the rapid growth of the shadow banking market. With all the uncertainties in the formal banking market place brought to us by Dodd-Frank, Basel III, the braying of the attorneys-general community, an increasing taste for private litigation in the financial markets and the general populist anti-Wall Street narratives coming out of the Administration (egged on by a swath of the chattering class), the appetite of the major money center banks for these auctions may have a natural limit. These transactions are public circuses and highly visible. They will attract a high level of attention from the regulatory communities. How long until the regulators and the political class begin to test out the populist screed (loudly) that buying other people’s loans does not contribute to jobs?

So as deal fatigue wearies first movers (the major banks), and political exposure and regulatory attention begins to increase around bank to bank portfolio sales, the door will open for more of the fund-based shadow banking community to play a significant role in dis-intermediating the sovereign and near sovereign banks from their U.S. real estate portfolios. We’ve already seen many of the major players take a run at these portfolios this August and it’s likely to continue as competition from the banking sector lags. Moreover, where a bank might buy and hold and reap the benefits of banking economics from adding to its loan count, the non-bank market buys these assets with dynamic plans in hand. Plans to do something with these assets to earn an outsize return on its investment. Seasoned loans will be restructured, re-bundled and re-securitized. Seasoned loans will be aggressively reduced to REO for re-positioning, re-development, re-sale and re-finance. The process, net net, will transform sedate pools of portfolio assets into highly dynamic portfolios of financial assets subjected to the tender mercies of the non-bank community. It should be fun.

We’ll have to learn to live with this cognitive dissonance for a while. Eventually, though, that dissonance will become unsustainable and the two worlds will re-integrate. Will it be where institutional lenders, both banks and shadow banks, are risk-on and are aggressively growing portfolios, or a world in which risk-off is the watchword and the flow of capital will be reduced to a trickle?

I’m betting on the former because the latter is simply too depressing to contemplate. One requires growth, the other retrenchment. I’ve done retrenchment and it’s just not fun. Sometime in the next few months we’ll see whether the risk is on or the risk is off. Stay tuned.

By Rick Jones.