BlackRock's Mortgage Solution: Q&A
NEW YORK (
) --
BlackRock
(BLK) - Get Report
sees an opportunity to connect supply and demand in the mortgage market with a new funding mechanism.
It's unclear, however, whether BlackRock's über-conservative model will be able to maintain the cost efficiencies needed to become a standard-setter.
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Since the fall of 2008, nearly all mortgage deals have been routed through
Fannie Mae
(FNMA.OB)
,
Freddie Mac
(FMCC.OB)
, Ginnie Mae or other government entities.
The one deal that squeaked by without taxpayer backing in April was a $222 million package of "jumbo" loans from
Citigroup,
(C) - Get Report
offered by Redwood Trust. The 255 underlying loans had much higher loan-to-value ratios and its borrowers had much higher credit scores than bubble-era deals for residential mortgage-backed securitizations (RMBS) in the private market. Redwood also provided investors with detailed information about all of the loans, had "skin in the game" by taking the riskiest 5% slice of debt.
In a move that foretold big servicers' current buyback woes, Citi and Redwood also promised to resolve such disputes in binding arbitration.
The transaction got plenty of support from investors searching for safety and yield at the same time. It was heralded as a new awakening in the private market - but it hasn't been followed up by another in the intervening seven months.
What has happened, though, is an even greater thirst for return as interest rates have hit rock-bottom lows. At the same time, the jumbo-loan market has shown greater signs of life.
Those mortgages aren't within "conforming" limits set by Fannie and Freddie, of over $417,000 in most housing markets or $729,000 in pricier ones. Major lenders like
Wells Fargo
(WFC) - Get Report
and
JPMorgan Chase
(JPM) - Get Report
have expanded more credit to such borrowers in recent quarters. The borrowers who can meet their stricter underwriting standards and afford such expensive homes tend to be high-quality borrowers.
But, because the loans aren't backed by the government, they must either stay on an originating bank's balance sheet or get bundled and shipped off to private investors.
That's where BlackRock comes in.
The asset-management firm aims to set a new standard for private-label issuance via its $1 billion BlackRock Mortgage Investors Fund. The fund invests in "distressed" mortgage debt - a term that usually applies to problem loans that are going bad. But, in this case, BlackRock is using "distress" to mean a lack of liquidity rather than a lack of credit quality. In fact, the standards for mortgages accepted by the fund may be too restrictive and costly to provide an effective funding model when the market eventually regains its footing.
For instance, all the mortgages will have to be underwritten not once, but twice, separately, by both the originator and a third-party independent underwriter. That could mean "as many as three or four appraisals," according to Randy Robertson, a managing director who is co-head of BlackRock's securitized asset investment team.
BlackRock will then compare notes on both underwriters' documentation and decide whether it's a loan worthy of funding. There's also a quality control function to monitor underwriters' performance to prevent any kind of sloppy "robosigner"-like issues.
Additionally, the mortgage servicer will have to be a separate, independent third-party not housed within the lending institution. The separation aims to reduce conflicts of interest when it comes to reps and warranties and ease worries about "prepayment risk," which occurs more frequently when servicers can offer refinancing deals to borrowers. (Prepayment spooks investors who rely on interest income.)
Finally, BlackRock will be providing detailed, granular information about loans and processes to investors in its offering letters for the new mortgage debt.
With such a high level of caution and transparency, there's little doubt that investors' minds can be put at ease. But that piece of mind will also come at a price, borne by BlackRock as the issuer, which could trickle down in several ways: First, to investors in the fund, and also to the lending institutions originating the debt more carefully, to the servicing entities and cross-check underwriters, and to the consumers who pay fees for those services.
According to Robertson, the model is exactly what investors are demanding. Yet the cost-benefit scenario would seem to raise questions about the model's viability and whether it can be extended to the broader mortgage market, for borrowers who are seeking smaller loans. It's an important question as the Obama administration and Congress start addressing the future of housing-finance in upcoming months.
Robertson, who has spent 28 years in the mortgage market, fielded some questions in an interview with
TheStreet
on Wednesday. Before joining BlackRock in 2009, he headed origination and loss-mitigation departments, among other things, during a long tenure at Wachovia.
What follows is a transcript, condensed and edited for clarity:
TheStreet:
The new BlackRock initiative is getting a lot of attention, but I'm wondering how you would characterize it. Is it a first step toward getting the private securitization market up and running again or is it a game-changing platform that BlackRock would like to oversee?
Robertson:
Well, demand for quality originated product that's well-structured and provides reasonable investor transparency is there already. If you look at well-structured re-securitizations taking place and the few new transactions that have actually been issued, the investor response has been quite robust.
A lot of investor dollars want to find their way into well-structured real-estate-related paper.
With respect to starting the market, I don't think anybody has a great crystal ball in terms of when the residential market will turn around, what will happen to interest rates and all that. What experience tells me is that when it happens, you won't have time to set up for it. You need to be pro-active in designing a program that's flexible enough to meet the demand.
TheStreet:
How would you characterize the role of BlackRock Mortgage Investors Fund?
Randy Robertson:
There's a gap being left in an underserved market.
The securitization outlets have been severely reduced for a whole host of reasons - regulatory, ratings agency, investor, the list goes on and on. For another host of reasons, banks haven't been taking on additional real-estate exposure either.
The combination of those two and Freddie and Fannie not accepting larger balance loans, the market's underserved. We want to serve that market.
If we can simultaneously engineer kind of the prototypical, bellwether security through an investor's eyes while helping to open up that market again, well then, that would be fantastic.
TheStreet:
Jumbo mortgages seem to be coming back after a long period where borrowers couldn't get that type of credit. It seems like you're setting up a framework for something that already has some percolation and you're hoping for it to expand. Is that fair to say?
Robertson:
We will do loans as long as they're loans that make sense, both in terms of the underlying credit and the price that can be extracted. And if we can't, we can't.
We're not in the mortgage origination business, per se. We're there as a facilitator of credit. To the extent that that makes sense for all parties concerned, we'll be active and to the extent it doesn't, we won't.
TheStreet:
What's the difference between your model and the 'olden days' version of private-label RMBS?
Robertson:
From the origination perspective, back in the day loans didn't carry much in terms of documentation. It was "a rising tide floats all boats" mentality, so the majority of people were feeling pretty comfortable that housing prices were going to keep going up so it would cure all evils.
Less and less was done around documentation verifications and all of the wonderful things that should make you feel more comfortable about taking a credit out on a borrower. The process of purchasing loans revolved around sampling as opposed to a full underwrite. Then, as originators' product saw heightened demand, people buying the pools did less and less sampling. So, you started at 25%, then it went to 15, then to 10 and in the end some people were doing 5% sampling due diligence on the loans when they securitized them.
Compare that to what we're talking about here - a loan that's fully documented; a loan that is not only underwritten by the originator, it's also underwritten by a third-party independent that underwrites it not off of their documents, but as though it's a brand new loan.
Then those underwrites are sent to BlackRock, when we compare the results of the two and ultimately decide if it's a loan we want to make, on every single loan. There's no sampling, and there's not one level of underwrite, there's two levels of underwrite, which could mean there are as many as three or four appraisals being done on the property. There's also a quality-control function to maintain the quality of the underwrite.
Generally in the past, the originator and the servicer were one in the same. Since they're related parties, we certainly feel, as investors, that can potentially present conflicts of interest. So we have split that all off to an independent third-party servicer who's in the business to service, not in the business of originating loans.
That's useful in a couple of respects. Number one, you don't have to worry about the servicer soliciting the customer for refinance, so as an investor I can get more comfortable around the prepays. And then I don't have the same issues I potentially have between conflicts of interest when there's something wrong with the loan - perhaps a violation of a rep or warrant, which could create a financial burden for the originator.
There's also a great amount of transparency in the offering document. If we do decide to securitize the loans, it will be quite comprehensive vs. the amount of data that was typically available back in the day.
TheStreet:
It sounds very thorough. As a big investor itself, I suppose BlackRock had its finger on the pulse of what the market really needed to trust mortgage-backed securities again?
Robertson:
That's right, we look at it from our view as an investor: What would be attractive as us as an investor? As a fiduciary for accounts that we manage money that invest in the residential real-estate space? What features would be attractive to us?
TheStreet:
What about the extra costs of these checks and balances? Whom do they get passed onto - the borrowers, the investors?
Robertson:
That's a very interesting question. Explicitly it's going to get passed along to the issuer, so effectively it's going to be the fund.
It would buy the loans at a price - at a market price - and then package them and put them in a security and those would be part of the deal transaction cost. But, ultimately, the expectation would be that those costs would be more than offset by the fact that, because the security is of higher grade and more predictable, the price it would bear in the marketplace would be better than the average transaction that didn't have those features. And as a consequence, nobody really bears the cost.
Hopefully it would translate into a better rate for the borrower because the quality that they bring to the table is warranted, the transparency and efficiency of the operating structure of the securitization is such that the investor can get comfort around that. The investor should be willing to pay a higher price vs. alternatives that don't have it.
TheStreet:
Is there any kind of estimate of the differential?
Robertson:
It's hard to say because everything is relative at a point in time.
When things are at their wides, it might different than when they're closer to their tights. The premise we're going on is, without
that protection, it's almost to the point where the offering probably wouldn't be accepted. So, I think that's the risk that the fund is willing to bear and that's ultimately what it will earn off of. If it's successful, it will earn a reasonable return for that investment in the structure itself.
TheStreet:
As the whole debate about the future of housing-finance reform is coming up, I'm sure a lot of people will be paying close attention to this. Do you have a view of how this plays into the broader framework?
Robertson:
In consideration that the private markets are certainly willing to look at and take on risk in the housing space, properly structured. As opposed to the alternative, if there's not a government outcome, that spells disaster for the housing. This is one of other programs that will likely be introduced if the markets are free to trade that will provide credit to the sector. So, we'll see.
-- Written by Lauren Tara LaCapra in New York
.
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