What is the private-label securitization market ?

Question

I have the idea that it is where private investors hold bonds backed by subprime mortgages (in the past, now); I want to know, what is the expanse of the private label sec market? That is to say, what other assets and such can be included in this beyond subprime loans (if any)?

Thanks in advance- I really appreciate all the people who devote time to educate others on Yahoo! Answers.

Answer 1

Secretary Henry M. Paulson, Jr.

Statement on Covered Bond Best Practices

Washington - Good afternoon. Thank you all for coming today. Joining me on stage are FDIC Chairman Sheila Bair, Federal Reserve Governor Kevin Warsh, OCC Comptroller John Dugan and OTS Director John Reich. We also welcome representatives from Bank of America, Citigroup, JP Morgan Chase, and Wells Fargo. I will make a few remarks, my colleagues will also address you and then Jeff Brown with Bank of America will speak.

As we are all aware, the availability of affordable mortgage financing is essential to turning the corner on the current housing correction. And so we have been looking broadly for ways to increase the availability and lower the cost of mortgage financing to accelerate the return of normal home buying and refinancing activity.

The housing government-sponsored enterprises, Fannie Mae, Freddie Mac and the Federal Home Loan Banks, and the Federal Housing Administration are funding more than 70 percent of residential mortgages during these months of market stress. They must continue to be active here.

At the same time, private-label securitization, another important source of mortgage finance, has become severely strained and credit conditions have tightened. In addition to securitization done by housing GSEs, private mortgage-backed securitization benefits the American consumer and our markets. The private-label market will evolve in response to current challenges, and I expect it to return with greater risk-awareness and investor discipline. We also believe it is useful to explore additional mortgage financing options to complement more traditional funding models.

One option we have looked at extensively is covered bonds, which are a $3 trillion market used widely in Europe for mortgage funding. I believe covered bonds have the potential to increase mortgage financing, improve underwriting standards, and strengthen U.S. financial institutions by providing a new funding source that will diversify their overall portfolio.

Treasury has been working with our regulatory counterparts to look at ways to support the emergence of the covered bond market in the United States. We consulted with our European counterparts, including the UK Treasury. We also spoke with potential U.S. market participants, including issuers, investors, underwriters and ratings agencies. While many European countries have dedicated covered bond legislation, the U.S. regulatory environment is different. Covered bonds are a promising financing vehicle and we believe this market can grow in the United States absent federal legislative action.

To help achieve our goal of broader choices in mortgage finance, today Treasury is publishing a Best Practices guide for U.S. residential covered bonds. This document is intended to outline practices that will promote covered bond market simplicity and homogeneity, using high quality mortgages as collateral. It is a starting point and complements the FDIC final policy statement of July 15th.

I appreciate the FDIC's strong leadership in advocating covered bonds and providing clarity to potential investors. Together, the FDIC final policy statement and a Treasury Best Practices guide should give market participants the tools to build a market that will benefit U.S. families and the U.S. economy. A U.S. covered bond market also will present new opportunities for further international investment in the United States.

We knew that this initiative would be successful only if the largest banks paved the way. And so I welcome the announcement by America's four largest banks, Bank of America, Citigroup, JPMorgan Chase and Wells Fargo, that they intend to establish covered bond programs and kick-start this market in the United States. And, I am also pleased to know that the two existing domestic issuers of covered bonds intend to align their programs with these new practices.

We applaud these banks for their leadership and for recognizing an opportunity to help increase mortgage funding availability and strengthen our financial system. We are at the early stages of what should be a promising path, where the nascent U.S. covered bond market can grow and provide a new source of mortgage financing.

Covered bonds are simply one tool for mortgage financing and will not, alone, complete the housing correction. We will continue to pursue our efforts to avoid preventable foreclosures and to speed, without impeding, the necessary course of this housing correction. Thank you and now

B a c k g r o u n d

The earliest securitized transactions date back to the early

1970s and were the sales of pooled mortgage loans by the

Government National Mortgage Association ( Ginnie Mae).

These transactions were followed by the Federal Home Loan

Mortgage Corporation (Freddie Mac) and Federal National

Mortgage Association (Fannie Mae) in the early 1980s. These

new securities were backed by full faith and credit of the

respective agencies which were either government agencies

(Ginnie Mae) or quasi-government agencies (Fannie Mae and

Freddie Mac). Because of such backing and guaranties, these

securities (also known as single-class mortgage pass-throughs)

carried an implied “AAA” credit rating. However, the capital

markets were looking for more technological innovations to

satisfy their investors. They were looking for diverse “maturity

” mortgage product which gave rise to the concept of

collateralized mortgage obligations (multiclass mortgage pass

throughs, CMOs or MBS) soon to be followed by asset-backed

securities (ABS). Some of these securities have managed to

become among the most exotic securities on the street.

Today, the total outstanding issuance of CMOs, MBS and ABS

has reached a staggering level of over two trillion dollars. The

non-agency or private label multiclass mortgage-backed passthrough

market originated in response to an increased

demand for low credit risk mortgage-backed securities with

diverse cashflow and maturity characteristics. The difference

between agency and private label transactions is as follows: in

the case of agency transactions, the underlying single-class

mortgage pass-through pools are government or quasigovernment

obligations and, therefore, the credit risk of such

pools is retained by these agencies and is negligible to the

investors, and in the case of private label transactions, the risk

of the underlying mortgage loans is fully transferred to the

“willing” investors as described below.

Ginnie Mae

The primary purpose of establishing Ginnie Mae was to

fund the government-sponsored residential mortgages

originated by various lenders by creating an active

secondary mortgage market. Unlike Fannie Mae and

Freddie Mac, Ginnie Mae does not purchase mortgages

from lenders.

The credit risk is relatively higher in the private label market

because the losses on the mortgage loans must be absorbed

directly by the investors. Unlike agency transactions, there is

no guarantee of timely or eventual payment of either principal

or interest to such investors. For investors, analysis of relative

priority of cashflows as well as the credit risk of the underlying

mortgage loans take a significant role in the private label

market.

The success of securitization in the mortgage market and the

acceptance of new securities by the investors has lent application

of this concept to other assets such as credit cards, auto

loans, leases and many others. The primary focus here is to

deal with the concept of securitization in the context of some of

the other commonly securitized assets. We will assess the

needs of financial institutions and industrial firms to apply this

technology to create a source of funding for themselves.

Fixed income or derivative?

MBS/ABS are considered “fixed-income” securities as well as

“derivative” securities. “Fixed-income” pertains to the fact that

MBS/ABS generate a coupon income (not necessarily a fixed

dollar amount) periodically whereas “derivative” refers to

MBS/ABS being “carved or derived” out of an underlying pool

of assets. Unlike other fixed income securities such as corporate

bonds, MBS/ABS are fairly complex instruments to

analyze. As mentioned above, MBS/ABS are structured to

satisfy the “risk,” “return” and “maturity” characteristics of

different investors. Imagine an upward-sloping yield curve

vertically cut out into small slices where each slice represents a

“tranche” or a “class” in an MBS/ABS. Each “tranche” has a

different priority of payment of interest and principal. This

priority of payment is what makes MBS/ABS somewhat difficult

to analyze.

All “agency” securitizations are implicitly “AAA” rated and

therefore carry negligible credit risk, whereas, the privatelabel

market has produced multiclass mortgage pass-throughs

with ratings ranging from “AAA” to below investment grade.

Basic Analysis

In view of the fact that securitization technology has grown

tremendously not only domestically but also globally calls

for a better understanding of this technology. The basic

rule of thumb to understanding this innovative process is to

stick to the “basics!” “Information overload” can prevent

people from learning and understanding the benefits and

attributes of such technology. We will study some of the

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attributes from both an issuer’s and investor’s perspective. We

will approach this process in two parts. First, we will determine

why securitization may be beneficial to some issuers; and

second, why investors may want to buy these securities.

• Why securitize? Issuer’s perspective.

• Why buy? Investor’s perspective.

Why Securitize? Issuer’s perspective.

Securitization offers several benefits to an issuer. Instead of

simply listing out the benefits, let’s take a methodical

approach to finding out