Pipeline

'Shadow' Boxing

As the economy brightens and capital issues resolve, one question is whether banks will now step out of the shadow of the so-called shadow banking system.

In separate investor presentations this month, the chief executives of two banking powers based in the southeast offered competing views on the issue.

Generally defined as the constellation of securitization vehicles, broker-dealers, money market mutual funds and the like that competes with traditional depositories, the shadow system cut banks' share of lending in half over the final 25 years of the 20th century.

BB&T Corp. CEO Kelly King predicted that the reversal of disintermediation — the process by which banking companies' share of financial sector assets dropped from about 60% in the mid-1970s to about 30% during the past 10 years, according to data from the Federal Reserve — would be "huge."

"We're now getting ready to go through a couple of decades where" the banking industry will "get most of that market share back," he said, arguing that nonbank competitors lack the wherewithal to meet risk retention requirements.

In mortgages, "we're seeing clients come back," King said. "We'll get more loans, better quality loans, better priced loans."

Capital One Financial Corp. CEO Richard Fairbank argued, however, that while deposit funding is essential, traditional banks — "all the way up to regional banks" — lack a proportional capacity to produce assets and are naturally "unbalanced."

He predicted a wave of consolidation as banks gradually "come to terms" with their predicament, and argued that his company, with its national lending platforms, is positioned to benefit.

"What happened to the assets? The assets were taken off the shelf of banks over the last 20 years by national players like Capital One and so on in many of the consumer businesses," Fairbank said. "A lot of it was taken away by the" government-sponsored enterprises and "I don't see any prospect any time soon for that going in the other direction."

Put-Back Road Map

If Ally Financial Inc. can make peace with Fannie Mae, maybe other lenders can too.

On Monday Ally, formerly known as GMAC, said it had agreed to pay $465.1 million in cash to Fannie.

In return, the GSE would release the auto and mortgage lender from all mortgage repurchase liabilities. That includes loans that Ally originated and services for Fannie as well as private-label mortgage-backed securities Ally sold to Fannie.

Also, Fannie's conservator, the Federal Housing Finance Agency, agreed to withdraw subpoenas it had issued to Ally in July for information about private-label MBS the company sold to the GSE. (In July the FHFA sent such subpoenas to 64 companies.)

Jaret Seiberg, an analyst at MF Global Inc.'s Washington Research Group, said the settlement suggests other lenders will settle disputes with Fannie and Freddie Mac in the year ahead. (Ally reached a similar settlement with Freddie in March.)

First off, he noted that Ally's cash payment is tiny compared with the loans in question — just 5% of the remaining balances and an even smaller fraction of the original $292 billion of principal. "We believe FHFA … would like to see the cash come into the enterprises," Seiberg wrote in a note to clients Tuesday. "And the banks and the enterprises want to put this fight behind them. That is a recipe for more settlements like the Ally deal."

Ally also said the payment was "modestly in excess of reserves previously taken." To Seiberg, that suggests the settlement was strictly business, rather than a pound of flesh extracted for Ally's well-publicized role in last fall's foreclosure robo-signing scandals.

"Ally had already pegged its potential exposure. This was paying that bill to Fannie Mae," he wrote. "If this was a political deal, then we would have expected it to be significantly in excess of what the company thought it should pay" and "there would have been politically popular conduct commitments related to originations or servicing associated with the settlement. Those side deals do not appear to be present."

The implication, Seiberg wrote, is that "there is not political pressure on the big banks to write mammoth checks to make the put-back issues go away."

However, Ally also said the settlement does not absolve it for "any failure to comply with any requirements of law applicable to foreclosing on property serving as collateral for any applicable mortgage loan."

And Seiberg cautioned that the Fannie-Ally deal is not a model for resolving banks' disputes with other, nongovernment investors in private-label MBS.

Eye on GSE Reform

With the administration's blueprint for overhauling the GSEs due in January, Barclays Capital has offered its own vision.

In a December report, analysts with the firm wrote that an industry proposal to replace Fannie and Freddie with bank-owned cooperatives that would create mortgage securities carrying an explicit federal guarantee would not solve "the problem of privatizing profits and socializing losses," even if the destination of the privatized profits would change.

"The government's track record of pricing risk adequately is poor," they wrote, and "the taxpayer would remain accountable for any losses greater than" cushions established through guarantee fees paid to the government and equity interests in the cooperatives. Moreover, the approach would further concentrate the industry among the banks that own the cooperatives, which seems "at cross-purposes" with efforts to address "too big to fail."

Still, the prospect that price-setting would be "commandeered by the political process" would apply under a fully nationalized system. The Barclays analysts argued that it is not "politically feasible or fiscally appropriate" for the government to permanently absorb the entirety of the GSEs' $5 trillion book of business. While the case for a continuing government role has been made by the evaporation of private lending during the crisis, the Barclays analysts wrote, "encouraging the resurrection of private-sector financing alternatives should be a critical part of GSE reform."

They recommended criteria for standardized mortgages and risk retention in securitizations to undergird the transition. But, in view of the enormity of the government's role and the time needed to build a sufficient pool of investors without a government guarantee, "it should be a decades-long process, at least."