As Insurance Falls, Assurances Rise with Smarter Securitization

Having just come back from the American Securitization Forum‘s (ASF) 2010 conference, relocated from Las Vegas to Washington DC (actually Maryland), I was stuck by the multitudinous nuances to it all. There was an underlying uneasiness that was remarkably comforting. Noticeably absent, of course, were the monolines, as I only saw Assured Guaranty [stock AGO][/stock] with a booth. Noticeably present, however, were the front-end vendors of loan performance tracking and due diligence. In the midst of it of course, regulators continued to drone about their efforts to repair the market, joined by a smattering of press members who somehow still manage to miss the point. Though I am pleased to report, these writers made up the minority of coverage, which is to be expected as more people care to read about securitization (where were you hacks in early 2007?)… And this is all important, because above all else accuracy in reporting will be key to repairing securitization. The industry itself, on the other hand, would do better without any government help in this regard, but that is a naïve hope. Truth is, investors are demanding more. And they will not pay until they get it, insurance or not. But, it seems, they are willing to pay for greater assurance. Enter into that a number of vendors looking to get that necessary edge. Let’s start with the opportunistic pitches of the power players. The session titled “Securitization Pricing and Valuation Tools” contained only one speaker: Kyle Beauchamp a director at Markit, the financial information provider. The session was early in the conference and it was packed. And no one seemed to care that it was an hour-long commercial for Kyle’s firm. He told the audience that his products tend to be the priciest, any doubt was dispelled when he started going over innovations in analytic tools and claimed the power of such tools will soon grow to predict strategic default risk by two years. Impressive. Especially if you invest in mortgage-backed securities, or are thinking of doing so. Sue Allon, perhaps the best personification of the new order of securitization to come, was there, having just launched her firm’s new due diligence platform. I discussed some particularly sensitive topics with her, as well as with her competitors, and appreciated their forthright nature in answering my questions. It’s a new way to do business and HousingWire seems to be fitting right in to this new kinder, gentler securitization market. Plus – and this is not getting any airtime – securitization is getting a whole lot smarter. I suppose it would be more reader-worthy if I could sit here and declare that all of these mortgage “bankers” (though I didn’t see many bankers) were turning several shades of socialist or I can ask questions that lead my sources in a certain way (another complaint I heard)… but I simply can’t do it. I’ve been covering this market for years and ranting or inventing news seems somewhat counterproductive at this point moreso than others, so it’s great to work with a firm that does not make me write down to anyone. As a journalist who is looking at a market, I keep in mind the market is looking at me, though upon further thought it is likely counterproductive for a journalist to rail against journalism. Still the point remains that, on the front end, securitization is getting a whole lot smarter. Case in point, FICO and Equifax teamed up to offer real-time credit score update to risk modeling for mortgage-bonds. The tool, called Credit Risk Insight, is meant to provide a prediction of distressed borrower behaviour. This is truly important because it shows both firms must have a crystal ball hidden somewhere considering the second-liens, especially home equity lines of credit (HELOCs) represent a significant portion of borrowers’ revolving debt and, thus, a huge driver of default (see below chart from Equifax). Steve Albert of Equifax Capital Markets said that in years past, investors were maybe notified of a second-lien, but not much beyond that. So if a borrower had a huge amount of revolving debt and wasn’t paying it back, that didn’t effect the bond’s status. It today’s housing market, that won’t fly with the private investors who need to support the market when the government bails. “As home prices moderate, information on second liens, including whether they exist as well as their balance and payment status, will become critical for investors to know in order to accurately value non-agency mortgage-backed loans,” said Albert. Add to that the FICO aspect. Before, the credit score at origination was the only credit score reported, even though 27% of new home buyers see their score migrate by plus or minus 20 points or more in as little as three months after signing (7% will see their score drop by more than 100 points, pushing their “bad rates” on outstanding debts to four times greater). “If you are an investor looking at FICO score at origination, it may not be reflective of the risk in the pool,” Thomas Quinn of FICO told me yesterday. No longer is insurance a big driver of confidence in the market, this tells us. Investors won’t be happy with the back stop that an insurer will pay them back in the case of huge defaults. That just isn’t smart enough for them. Besides what good is it when the insurer goes out of business? Investors want smarter front end assurance and they’ll get it. If they’re willing to invest in it. Though, I’m sure we’d all be hard pressed to turn down those ever-friendly phone calls from Sue Allon, demanding payment for some assurance.