M&A Pressure, Speculation, and Fuel – the Non-Agency MBS “Currency” -- January 4, 2007 (Also appearing in the MBA NewsLink)
In the late 1970’s when Bank of America issued the first non-agency (also referred to as “private label”) mortgage backed securities (MBS), who would have predicted that nearly 30 years later this irregular and small issuance would grow to over $1 trillion annually. This volume represents an estimated market share of over 50% of all MBS issued in 2005. Since 2000 when the MBS market volume exploded from approximately $600 billion, we’ve witnessed the GSE’s market share shrink from over 80% to less than 40% of an aggregated annualized MBS market valued at well over $2 trillion. Furthermore, with the total MBS markets representing just over 1/3 of the approximate $26 trillion in all US domestic debt outstanding (per the Federal Reserve), any material impact on MBS securitization, pipeline, and quality will result in global anxieties.
The exceptional growth in non-agency MBS has been in part due to the rapid securitization of non-traditional mortgage products fed by a demand for higher performing asset classes with wider spreads. However, with a rush to increase non-agency MBS offerings, is the credit quality being upheld? What levels of implicit investor and issuance risks are being accepted as defaults rise and credit standards stagnate? How will the “changing face” of non-agency MBS affect the “currency” of M&A deals, liabilities, synergies, and write-offs?
During the last five years, this investor enthusiasm for increased risk and performance helped propel a belief that “no loan was a bad loan” if the origination paperwork could be “certified” as part of the underwriting process. While this idea pushed home ownership to record high national levels (i.e., exceeding 70%), it also unwittingly created an expectation among some investors and lenders that the cycle had few non-elastic limitations. With the obvious confirmation from many rating agencies that we indeed experienced a housing correction in 2006, the securitization efforts and processes may have become the catalyst for potential industry and cross-industry M&A transactions even as MBS downgrades continue to mount.
Although not a prevalent belief, it can be debated that the widespread adoption of non-agency MBS has in part fueled the increased M&A activity that the industry is currently experiencing. If examined holistically, it is the demand for a constant and growing base of higher-performing pooled loans (e.g., Alt-A, Jumbo, Sub-prime), which perform above the estimated 100 basis point spread between GSE MBS’s and treasuries that has fueled Wall Street and industry acquisitions.
Conversely and heightened by non-traditional mortgage offerings, established traditional prime lenders and retail banks have sought to rein in their exposure. This revelation has taken the shape of non-performing buy-back obligations, and credit quality set-asides by placing their key divisions specializing in these debt instruments up-for-sale. Moreover, industry leaders are seeking a rebalancing of risks not only within the securitization process, but also within their corporate offices. This reassessment has been triggered by a need to lock in market appreciation and growth, while removing potential short-term and long-term operating profit hazards.
Nearly every industry watcher can point to real and perceived examples of the aforementioned trends and transactions. However, what does this mean in 2007 for an industry already jolted by major restructurings, declining volumes, and layoffs? What about any compliance and regulatory pressures? How will the adoption of “e” channels begin a value chain disintermediation of the securitization process, thereby displacing established incumbents and vertical delivery processes?
The net is that the historical demand for non-agency MBS may be the currency driving “retraunching” of industry players and offerings in 2007. Regardless, we are likely to see increased real and speculative demands being placed on the MBS securitization processes, agencies, and even interim servicers this coming year. As the famous industrialist Andrew Carnegie once said, “The first man gets the oyster, the second man gets the shell.” It appears 2007 could be the turning point for M&A riches, or just an acquisition of an expensive decoration.
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