The overall securitization market may be on government life-support, but its smaller neighbor - the Re-REMICs market (re-REMICs is shorthand for resecuritization of real estate mortgage investment conduit securities) - is going gangbusters.
Unlike the mortgage-backed securities market, demand for re-REMICs didn't freeze completely after the subprime meltdown and the financial market blowout last fall. Since January, business has been especially brisk - one estimate puts it at $90 billion worth of deals - and seems to be establishing a baseline for the broader market to start increasing private-sector originations of residential mortgage-backed and other asset-based securities.
Here's the idea: take some tranched mortgage-backed securities, pull them apart, and reorganize the rated tranches (AAA, AA, A, on down to junk status) into new bonds in order to minimize the capital needed to back them. A bank looking for capital improvement, for example, could re-REMIC a current BB-rated security (risk-weighted at 350 percent under Basel II) into a triple A-rated tranche representing 70 percent of the original security (risk-weighted at 28 percent), a BB tranche (risk weighted at less than 350 percent), and a junk tranche. The bank would hold the senior tranche and dispose of the rest into the private investor marketplace.
"An investment bank will take an existing security that's worth 50 cents or 60 cents on the dollar," explains Skip Curth, a partner in the financial services offices of Ernst & Young. "Perhaps half of that security is worth 90 cents on the dollar; the rest is worth far less. That's the way you retranche it."
Re-REMICs are similar to the good-bank/bad-bank scenario many have proposed to improve banks' balance sheets: remove the toxic assets so they don't overwhelm the healthy ones. Banks, insurance companies, and hedge funds have been the biggest buyers of Re-REMICs this year. Doug Williams, an advisory partner in KPMG's building, construction, and real estate practice, says the products have become particularly popular among banks. "They are using Re-REMICs to clean up their balance sheets and improve regulatory treatment," according to Williams. "It's a good bank/bad bank - good bond/bad bond scenario."
Bank regulators have been drivers of the resurgence, he says. "Regulators are trying to help, not hurt. They've been very understanding." Regulatory agencies have given the green light to banks planning Re-REMIC deals as way to improve their capital ratios.
The IMF acknowledges there's some wariness in looking for resecuritization - with overall lowered capital backing - as a means to deal with poorly rated assets, according to an IMF paper published in October. IMF senior financial sector expert John Kiff writes that "the potential for this market to grow is substantial," but Re-REMICs are vulnerable to future downgrades if there's future deterioration in the housing market, he cautions. He also worries that the market is "partly driven by rating/regulatory arbitrage," which is more about gaming the ratings process than improving risk exposure. However, he lauds the robustness of the underlying structure of Re-REMICs and their ratings.
Many of the Re-REMICs done this year have been two-bond deals, say banking sources, comprised of senior securities sold to banks and insurance companies, and unrated bonds sold to hedge funds. Broker-dealers, who sometimes hold the senior paper but always try to find a home for the junk, generally create the instruments. Hedge funds are attracted to unrated pieces of the Re-REMICs because they can buy them at fire-sale prices for long-term holds.
"The resurgence is creating more liquidity," Curth notes. This has implications for the greater securitization market. "Twelve months ago there was nothing, no exit. Now people look at the Re-REMICs market and say 'look, they can do this.' Re-REMIC deals imply a certain base-line price," says Curth.
Privately based new originations are trickling back into the securitization market, observers say. Almost all of these deals have been in the form of single-transaction, commercial mortgage-backed securities. But most new business is backstopped by TALF, Fannie Mae, Freddie Mac or Ginnie Mae.
"You can't confuse movement with progress," says Jon Van Gorp, a partner at Mayer Brown. "The new residential mortgage securitization market remains frozen, except for the RMBS backed by Fannie Mae, Freddie Mac, and Ginnie Mae." Van Gorp thinks the pace of the Re-REMICs business will slow because the underlying prices have risen and are not as attractive as they were earlier this year. Many banks have now worked through assets suitable for Re-REMICs-ing he believes. Curth agrees that as pricing has improved, there have been fewer arbitrage opportunities.
But Curth and other sources say bank demand is holding up well, with some super-regional and regional institutions getting involved. "Banks are looking at their capital requirements and re-securitizing," says Curth. "They're holding onto the triple A and selling the lower bonds."