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HAZARD SIGN What does the ﬁ rst downgrade of a subprime auto securitization since the credit crisis say about the state of lending? KBRA LEADS THE STRUCTURED FINANCE MARKET WITH TIMELY & TRANSPARENT CREDIT ANALYSIS

NEW YORK • PENNSYLVANIA • MARYLAND • DUBLIN

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002_ASR0918 2 9/4/2018 5:38:15 PM Editor’s Letter

Dubious Honor

Honor Finance raised some eyebrows late in 2016 when it sold double B rated securities as a first-time issuer. This summer it earned a different kind of notoriety when both S&P and Kroll downgraded these notes, warning that investors were at risk of not being repaid. But this has hardly soured investors on speculative grade bonds backed by subprime auto loans. To the contrary, demand for higher yield is fueling issuance of securities rated as low as single B. Until this year, no subprime auto lender had ever issued an asset-backed with such a low credit rating; as of June, three issuers had printed a total of $141 million. Westlake, the most prolific issuer, subsequently issued a third deal with a single B tranche in August. We’ve been down this road before. A new crop of subprime auto lenders raised private equity money, ramps up lending, and taps the securitization market. Credit continues to expand until too many loans go bad and the lending industry contracts. Before the financial crisis, expansion of credit into double B securities was accomplished with the help of bond insurance. This time, however, investors are relying more heavily on overcollateralization to cushion against loan losses. While rating agencies have given their blessing, using addition collateral does not cure all ills, as I explain in my cover story. In fact, it may be encouraging credit drift. S&P itself has warned that there’s no telling how single B securities will perform in a credit or business downturn. Investors, who may have been lulled by the wave of subprime auto ABS upgrades in recent years, should prepare for more “ratings volatility” among single B securities.

— Allison Bisbey

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4 Asset Securitization Report September 2018

004_ASR0918 4 9/4/2018 5:11:37 PM Contents

10 Hazard Sign What does the first downgrade of a subprime auto securitization since the financial crisis say about the state of lending?

Observation ABS MBS 6 Let States Oversee Fintech 14 Wells Eyes Refi Loans 22 CleanFund Cleans Up The OCC’s proposed national charter for As the No. 2 lender to in-school students, it The commercial PACE provider was willing online lenders would produce new risks and has the potential to shake up the market for to go to the extra mile in order to earn the market distortions, writes John W. Ryan of loans to grads with high paying jobs first AAA in this sector the Conference of Bank State Supervisors

16 Preparing for the End 31 Race to the Bottom? 7 What OCC is Missing on Fintech Two closed-end funds that invest in CLOs More nonbanks are competing to make Karen Shaw Petrou of Federal Financial think the corporate credit cycle is turning, ‘super jumbo’ mortgages, often with weaker Analytics argues these firms aren’t subject to and they see a way to profit credit standards than banks the capital and operational norms of FDIC- insured banks. Will fed regulators take that into account? 17 Pound for Pound 33 Spotlight on the FHFA European CLOs managers are starting to How will recent scandals involving director issue sterling-denominated notes, which Mel Watt and the agency’s inspector general 8 Credit-Scoring Changes Needed makes it easier to hedge currency risk affect GSE reform efforts? Having no credit history can be as worse as having bad credit in one’s file, proving the need for utility and rent payments to be in- 34 GSEs Scratch Rental Pilots 18 OCC Opens Door to Fintechs Investors in single-family homes have suf- cluded in reports, according to Dara Duguay ficient liquidity without involvement from of the Credit Builders Alliance 20 High Ambitions for State AGs Fannie and Freddie, the FHFA concluded

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005_ASR0918 5 9/4/2018 5:11:37 PM Observation

of predatory mortgage lending. Keep Fintech Changes at The OCC acted to preempt those What’s Missing from OCC’s laws, which contributed to the the State Level mortgage crisis and the largest Fintech Charter number of home foreclosures since the Great Depression. State regulations are the best laboratory for financial services in- Because the OCC did not novation, not federally derived oversight listen to the states on predatory lending, Congress had to step in By John Ryan to reaffirm the need for state and federal collaboration. In 2008, Congress codified a regulatory The national fintech charter announced by the system is accessible to all types and sizes of The Office of the Comptroller of the Currency Office of the Comptroller of the Currency has fintech firms. It plays a significant role in the [State regulation] is a recently finalized its controversial decision to been positioned by its supporters as a means economy and serves as a source of diversity system that works well and authorize a special-purpose fintech charter. of encouraging innovation and growth, but and innovation that leads to the world’s most is improving as states work Although the OCC emphasizes that it’s together to harmonize instead it brings new risks and market competitive financial system. States have holding these special-purpose charters to licensing and oversight. distortions to the U.S. economy. been and should be the laboratory of innova- standards equivalent to those demanded of If facilitating fintech innovation and tion for financial services. technology platform created by national banks, this is only sort of true with protecting consumers is the goal, preempt- Here’s why. In addition to overseeing 79% the states to coordinate licens- regard to the named prudential require- ing state licensing and consumer laws with a of the nation’s banks, state regulators are ing and supervision of mortgage ments, and it looks to be completely incorrect federal charter is not the answer. The OCC’s the primary regulatory authority of the tens market participants nationwide. on critical restrictions on competitive and charter creates a new class of institutions that of thousands of nonbank entities that range Congress further responded to financial risk. These omissions have significant benefits large, established fintech firms and from mortgage companies to fintech firms. It the crisis by reaffirming the state consumer protection, safety and soundness harms the very innovation and choice that is a system that works well and is improving as regulatory role for nonbank enti- and structural impacts. Absent egregious vio- U.S. Treasury Secretary Steven Mnuchin and states work together to harmonize the licens- ties and narrowing the scope of lations, a charter granted cannot be revoked. the Comptroller of the Currency Joseph Ot- ing and oversight system. national bank preemption in the The OCC should be sure it isn’t a shadow- ting say it would provide. Our system allows for a diverse pool of Dodd-Frank Act. bank enabler before it hands out these high- As CSBS made clear in our lawsuit against firms, encouraging small startups and in- State financial regulators will powered charters. the OCC last year, we believe a federal fintech novation. A state system is a de facto sand- continue to fight to stop preemp- If other U.S. regulators follow the OCC’s charter will have harmful consequences for box where successful innovations can gain tion efforts and preserve the example and grant charters or authorize our nation’s financial system. The American broader scale. From the state system emerged state financial regulatory system. ground-breaking activities before these policy history of building successful economies has interest-bearing checking accounts, ATMs, And all options are on the questions are fully considered, a lot of embed- not been driven by top-down industrial policy mobile wallets, prepaid cards, mobile points of table. ded risk could quickly confront both consum- that picks winners and losers. sale and phone-based international remit- We want states to continue ers and the overall financial system. Instead, it has been one that encourages tances. to be the laboratory of innova- The first structural problem we’ve spotted innovation and competition from the bottom At the same time, state regulators are in tion and encourage competition. is that bank capital and liquidity standards up. close proximity to consumers and the commu- We want a system that remains (let alone most other structurally significant Based on our experience, a federal char- nities they are charged with protecting, mak- responsive to, and protective of, prudential ones) cannot be applied in like-kind ter has been most successful at enabling a ing them uniquely situated to recognize and our citizens. fashion to fintech, because most fintech char- handful of large, dominant players, as seen act upon consumer financial protection issues. It’s time again to listen to the ters will not be anything like most national in the national banking system. To believe Federal preemption in financial services states. banks. For all the work around fintech’s edges, that a federal fintech charter will encourage regulation should be the exception, not the national banks are first and foremost finan- innovation, as has been argued, is misguided. rule. If misapplied, preemption can undermine John W. Ryan is president & CEO of cial intermediaries. This means that most risk That overlooks where financial innovation and financial market competition, innovation and the Conference of State Bank Super- comes from extensions of credit or, for larger competition originate in this country. These consumer protections. visors, the nationwide organization ones, trading exposures, and most funding come from a system fostered by the states. Case in point: We need to only look back to of state banking and financial regu- comes from the deposit or debt market. State regulators have been the primary the early 2000s, when states enacted laws to lators from all 50 states, the District Yet fintech risk is different. Very few fintechs regulator of fintech companies. The state protect consumers when they became aware of Columbia and the U.S. territories are capital intensive. Instead, they handle

6 Asset Securitization Report September 2018

006_ASR0918 6 9/4/2018 5:11:38 PM Observation

of predatory mortgage lending. wolves under stress? Bank hold- The OCC acted to preempt those What’s Missing from OCC’s ing companies can’t do so and laws, which contributed to the the Dodd-Frank Act extended mortgage crisis and the largest Fintech Charter this source-of-strength require- number of home foreclosures ment to nontraditional charters. since the Great Depression. The general theory here is that Because the OCC did not Online lenders aren’t subject to the capital and operational norms there is a need to ensure parent- listen to the states on predatory of regulated banks. Will regulators take this into account? company shareholders take the lending, Congress had to step in pain as well as gain from owner- to reaffirm the need for state and By Karen Shaw Petrou ship of an insured depository, federal collaboration. In 2008, a theory that doesn’t apply to Congress codified a regulatory fintech special charters. The Office of the Comptroller of the Currency transactions or interfaces, making money [State regulation] is a recently finalized its controversial decision to through cross-selling, advertising, add-on fees The OCC should be sure system that works well and authorize a special-purpose fintech charter. or other strategies. As a result, the most im- it isn’t a shadow-bank is improving as states work Although the OCC emphasizes that it’s portant risk for many fintechs is operational. enabler before it hands together to harmonize out these high-powered holding these special-purpose charters to Would the big-bank operational risk-based licensing and oversight. charters. standards equivalent to those demanded of capital framework work here? It doesn’t even technology platform created by national banks, this is only sort of true with work for the banks for which it was designed. What about the competi- the states to coordinate licens- regard to the named prudential require- The Basel brush-up — which is retrospective tive power of fintech parents ing and supervision of mortgage ments, and it looks to be completely incorrect — is even worse-designed for fintech ventures. not forced to bear any capital market participants nationwide. on critical restrictions on competitive and Is capital even the right way to ensure fintech or liquidity costs for the activi- Congress further responded to financial risk. These omissions have significant operational resilience? It would be good to ties that otherwise consolidate the crisis by reaffirming the state consumer protection, safety and soundness know before there are a lot of special-purpose into their earnings? When can regulatory role for nonbank enti- and structural impacts. Absent egregious vio- banks. . fintechs upstream earnings given ties and narrowing the scope of lations, a charter granted cannot be revoked. Secondly, what exactly will these fintechs that they are not to be covered national bank preemption in the The OCC should be sure it isn’t a shadow- do in relation to parent companies and/ by stress tests even though the Dodd-Frank Act. bank enabler before it hands out these high- or partner institutions? Banks are under a OCC says its standards are State financial regulators will powered charters. lot of restrictions here, starting with all the banklike? Who loses and what continue to fight to stop preemp- If other U.S. regulators follow the OCC’s disclosures customers have to get to be sure financial-stability risk might tion efforts and preserve the example and grant charters or authorize that they know a nontraditional product isn’t result from fintech operations of state financial regulatory system. ground-breaking activities before these policy backed by the Federal Deposit Insurance different sizes, business models And all options are on the questions are fully considered, a lot of embed- Corp. I know fintechs aren’t allowed to take in- or interconnectedness? table. ded risk could quickly confront both consum- sured deposits, but any company with “bank” These questions are critical We want states to continue ers and the overall financial system. in its name could be easily understood to do not only to fintech special-pur- to be the laboratory of innova- The first structural problem we’ve spotted so. Bank holding companies are also barred pose charters but to the OCC’s tion and encourage competition. is that bank capital and liquidity standards from tying products so that customers are broader principle that it can We want a system that remains (let alone most other structurally significant forced to get something they don’t want Bank establish a category of special- responsive to, and protective of, prudential ones) cannot be applied in like-kind holding companies also cannot offer a deeply purpose national banks when it our citizens. fashion to fintech, because most fintech char- subsidized price on one product to encourage thinks a policy or market benefit It’s time again to listen to the ters will not be anything like most national customers to get others. would ensue. If the OCC doesn’t states. banks. For all the work around fintech’s edges, Since fintech parents are unlikely to be build out its special-purpose national banks are first and foremost finan- bank holding companies, no such anti-tying charter policy, we’ll get a lot John W. Ryan is president & CEO of cial intermediaries. This means that most risk prohibitions apply. Given the tied offerings more innovation at the cost of a the Conference of State Bank Super- comes from extensions of credit or, for larger already evident by fintechs seeking nonbank lot less responsibility. visors, the nationwide organization ones, trading exposures, and most funding bank charters, this market power is clearly of state banking and financial regu- comes from the deposit or debt market. desired. Should it be allowed? Karen Shaw Petrou is a managing lators from all 50 states, the District Yet fintech risk is different. Very few fintechs Finally, will fintech parents stand by their partner at Federal Financial of Columbia and the U.S. territories are capital intensive. Instead, they handle special-purpose banks or throw them to the Analytics

asreport.com September 2018 Asset Securitization Report 7

007_ASR0918 7 9/4/2018 5:11:39 PM Observation

that “no score” is better than a Risks of Credit-Scoring Bill “low score.” In fact, if anything, this data (table 2) suggests the Are Overstated opposite — AFSPs are congre- gating in higher numbers in “no score” neighborhoods than in Including rental and utility payment history, in a proposed amend- “low score” neighborhoods. The ment to the Fair Credit Report Act, can benefit thin credit files proliferation of these types of alternative lenders in majority By Dara Duguay “bad” and no-credit neighborhoods suggests that they simply locate where the demand for Current legislation designed to enhance a gap. If regular bills can be reported to the consumer credit scores is a win-win for all credit bureaus, then positive behaviors such as Having bad credit history is concerned. paying on-time can be rewarded. Since most worse than having no credit On June 25, the House unanimously passed consumers have utility, telecom and rental history whatsover? The CBA has not found this to be The Credit Access and Inclusion Act, spon- payments, they would immediately benefit. true. sored by Reps. Keith Ellison, D-Minn., and Experian has found that including on-time Robert Pittenger, R-N.C., which would amend utility payments has reduced the number of their services is greatest, because the Fair Credit Reporting Act to clarify Federal consumers marred with a subprime credit a significant portion of the popu- law with respect to the reporting of certain history by 50%. Similarly, LexisNexis has ana- lation does not qualify for more positive consumer credit information to con- lyzed using a more expansive alternative data mainstream forms of credit. sumer reporting agencies (i.e. rent, utilities and set, including such things as asset ownership A very important point to telecommunications). and occupational licenses. Their results reveal remember is that negative data A Senate companion bill by Sens. Tim 33% more minorities scorable and 31% more is currently being reported on Scott, R-S.C., and Joe Manchin, D-W.V., has renters approved for credit products when utility and telecom payments, if also been introduced. alternative data is factored in. the past-due account is reported Whether we like it or not, a good credit Credit Builders Alliance is aware of the to the collection agencies. The history is crucial in today’s economy. Far more main objection to the pending legislation: the fact remains that consumers are than just a number, a good credit score is a concern that this bill would damage the credit already experiencing negative in- prerequisite for accessing everyday financial scores of millions of Americans. The worry is formation on their credit reports. products like a credit card, a personal loan or that late payments would result in a negative This bill attempts to level the auto financing. It has also become a hugely credit history. The contention is that “having playing field by having positive influential factor in the tenant and employ- a bad credit history is worse than having no payment history reported. ment screening process. However, those with credit history whatsoever.” As a case in point, CBA led no credit score or a poor credit score have But CBA has not found this to be true. a successful rent reporting pilot limited prospects. These consumers often turn Our experience with our more than 500 with affordable housing provid- to high-cost payday lenders to obtain credit non-profit members located throughout the ers. The act of reporting ontime and are unable to access rental housing or U.S. has been that the absence of a credit payments for more than 1,200 jobs. history remains a significant barrier to access- residents resulted in 100% of According to Experian, 64 million Ameri- ing credit products, rental housing and jobs the residents, who were previ- cans have no credit or a thin file. For these among the 50% of employers who conduct a ously credit invisible, now having Americans, the need to build a positive credit credit history check during their job applica- a credit score. Additionally, the history is paramount. However, building credit tion process. average VantageScore was 670, is often a vicious circle. If you don’t have Adding to CBA’s anecdotal evidence is which brought them out of the credit, it is hard to get credit. But, if you can’t research conducted by the Federal Reserve. In subprime category. get access to credit, how are you ever able to a study on alternative financial service provid- build credit? ers, including payday lenders and pawn shops, Dara Duguay is the executive This is where the current legislation fills the Fed found that there is no clear evidence director of Credit Builders Alliance

8 Asset Securitization Report September 2018

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009_ASR0918 9 9/4/2018 5:38:15 PM HAZARD SIGN

What does the first downgrade of a subprime auto securitization since the financial crisis say about the state of lending?

By Allison Bisbey

Over the past couple of years, subprime auto lenders have been able to offload more and more of the risk in their loans to investors desperate for higher yields. Despite the high rate of default among borrowers with poor credit, investors are snapping up billions of dollars of auto loan-backed securities with below investment grade ratings – in some cases as low as single-B. They are willing to do so in large part because lenders are putting up additional loans as collateral for the bonds, and because credit rating agencies believe that this overcollateralization will insulate investors from expected losses. Problems at Honor Finance, an Evanston, Ill. lender backed by CIVC Partners, show that this form of credit enhancement can’t cure all ills. In July, both S&P Global Ratings and Kroll Bond Rating Agency downgraded the most subordinate securities issued in a 2016 transaction after Honor lost much of its senior management, stopped originating loans, and resigned as servicer. Losses on collateral for the deal are so high that both rating agencies believe investors are at substantial risk of not being CREDIT LINE HERE LINE CREDIT

10 Asset Securitization Report September 2018

010_ASR0918 10 9/4/2018 5:11:41 PM CREDIT LINE HERE LINE CREDIT

asreport.com September 2018 Asset Securitization Report 11

011_ASR0918 11 9/4/2018 5:11:42 PM repaid. another lender, Mercury Finance, where bonds better insulated from losses. Honor wasn’t the first subprime auto Collins was brought in as COO to lead a That’s not how things turned out. lender to run into problems since the restructuring and DiMeo was the vice According to both S&P and Kroll, financial crisis. At least two others, president of credit. Honor had a policy of offering borrowers Summit Financial Corp. and Spring Tree Moreover, the company had been prof- additional time to make payments that Lending, have folded this year after itable since 2012. was unusually lenient. After this policy allegations of fraud or misreported losses And investors were desperate for yield was revised, delinquencies and losses caused their banks to withdraw funding. and were becoming more comfortable started to pile up faster. That meant there But none of these other lenders had taking on additional risk, thanks to the wasn’t as much additional cash available tapped the securitization market for fund- increased credit enhancements. to pay down the principal of the bonds. ing, so investors didn’t feel it. “Beginning in late 2016, across all By July, losses had already reached 20%, “Pre-crisis, many subprime bonds structured products, spreads compressed and overcollateralization had fallen to came with a financial guarantee; they significantly and issuers began increasing 13.36%, prompting both S&P and Kroll to were wrapped with insurance, in addition leverage within securitizations by issuing downgrade the $8.9 million of BB-rated to overcollateralization,” said Joseph further and further down the capital bonds, Cioffi, chair of the insolvency, creditors’ stack. I don’t think subprime auto was any It was the first time S&P had down- rights & financial products practice group different,” said Neil Aggarwal, a senior graded a subprime auto loan asset- at Davis & Gilbert. “Today, there is more portfolio manager at Semper Capital. backed since 2002, and the first down- reliance on excess collateral.” While there was some market turmoil grade of any kind of auto loan ABS since He said this is often accompanied by a early in 2016, by the time the Honor 2011. drift in credit standards. securitization was issued in December, Things could get even worse. Honor’s Certainly, Honor played at the deep the markets had recovered and “a full-on two co-founders and chief financial end of the subprime auto market, lending grab for yield was taking place,” Aggar- officer have left the company and Wells to borrowers with FICO scores ranging wal said. “Much of the ABS sector had Fargo has withdrawn a line of credit from 475-650, according to S&P. And rallied back in spread terms, and interest Honor relied on to warehouse loans until nearly a quarter had no FICO score. But rates were still very low. So a lot of deals they could be securitized. This brought many of its lending practices, such as that could get done were getting done.” new originations to a halt. On July 13, high loan to value ratios (the initial Both S&P Global Ratings and Kroll Honor notified the indenture trustee weighted average LTV of the loans Honor Bond Ratings believed that investors in (which is also Wells Fargo) that it securitized was 135.12%) are common in Honor’s auto asset-backeds would intended to resign as servicer. In August, the industry. And it appeared to avoid continue to receive interest and principal senior noteholders approved the appoint- one of the industry’s riskiest practices, so long as losses stayed within their ment of a successor servicer, a unit of extending the terms of loans in order to expectations for 20.5% to 21.5% of the Westlake Financial Services, a subprime lower monthly payments. None of the original balance of the collateral over the lender based in Los Angeles. loans in the 2016 securitization had terms life of the transaction. A servicing transfer comes with its own beyond five years, according to rating The rating agencies based their views risk: A potential disruption in payment agency research. on the fact that the initial overcollateral- collections. Kroll said in July it was Nevertheless, the transaction raised ization of Honor’s transaction was 11%: it concerned that this could result in a some eyebrows because, at that time, was issuing $100 million of bonds backed majority of borrowers who were currently only more seasoned issuers had been by $111 million of loans. This meant there behind on payments or had obtained an able to issue bonds with such low ratings. would be more interest payment rolling in extension to eventually default. When the “It was a very bold move,” Cioffi said. each month than were needed to pay servicing transfer was approved, the Honor was able to pull this off in part interest and principal payments on the rating agency issued a report saying it because its management team had bonds. These extra funds could be used was closely monitoring the situation. individual experience in the subprime to pay down additional bond principal, S&P has said it expects that losses on auto lending industry and so were not quickly building the overcollateralization the collateral for Honor’s deal could unknown. Co-founders James Collins and to 20.5% of the outstanding bonds. In eventually reach 30%. Robert DiMeo had worked together for other words, there would be fewer bonds Problems at Honor have had little over 20 years, including their stints at left outstanding, leaving the remaining impact on demand for subordinated

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012_ASR0918 12 9/4/2018 5:11:43 PM asset-backeds issued by other lenders. They have continued 'B' is the new 'BB' to tap the securitization market for bonds rated both double B Subprime auto lenders issued $141 million of single B rated and single B. In fact, issuance securities through June, compared with none in 2017 of single B notes, which were unheard of until this year, had reached some $141 million • WLAKE 2018-1 Class F: $56.7M through June, according to S&P. • WLAKE 2018-2 Class F: $56.7M Most recently, Westlake completed a $1.1 billion securitization in August that • UACST 2018-1 Class F: $6.1M included $62.2 million of single B notes. It was the lender’s third deal of the year, and was • ACAR 2018-1 Class F: $14M upsized from $800 million initially. • FIAOT 2018-1 Class F: $7.5M In a report published in June, S&P noted that this follows a similar pattern in Source: S&P Global Ratings which demand for higher yield spurs increased issuance of riskier securities, just as the credit propensity to roll over the unpaid balance little information available about the cycle is turning. of old loans “is a recipe for trouble payment history and creditworthiness of “This is reminiscent of the mid-1990s ahead,” and not just for subprime loans, borrowers when compared to other when BB rated classes first become but for loans to prime borrowers as well. sectors within structured products,” he popular,” the report states. Issuance of BB Another factor that is tough on Aggarwal said. “So investors have to base rated auto asset-backeds grew from $5.2 borrowers, but good for asset-backed their assessment of risk more heavily on million in 1995 to $26.2 million in 1996, investors is that used car prices have held the lender and servicer. And there’s a and approximately $60 million in 1997, firm, and in some cases are still rising. significant amount of inherent risk in just as the subprime auto loan industry “This is largely coming from the leasing originating and servicing subprime auto was beginning to unravel. phenomena,” Acevedo said. “It’s causing loans.” That’s why there is often tiering of The rating agency warned that there is a tidal wave of near-new vehicles to hit these operators that determines how no rating history of single B auto bonds, the market, bringing prices up significant- easy it is to sell the securities when so its unclear how they might perform in ly We’ve never seen this many near-new something goes wrong. an economic or business downturn. used cars. Older cars are in shorter “Something like the events at Honor Lenders aren’t just offloading more of supply, and demand is really heavy.” definitely creates more caution” for other the risk in their deals, they are also High used car prices encourage third and fourth tier operators. However, loosening underwriting – so there is more borrowers to stretch their budgets, though it’s not impacting prices of the top tier of risk to unload. Prime and subprime it also reduces losses for investors when a subprime issuers,” he said. lenders alike are increasingly using borrower defaults and the vehicle is “The structure of subprime auto features such as longer terms, which repossessed. securities is fantastic; there’s a lot of lower monthly payments, and high LTVs, Aggarwal acknowledged that prob- excess spread to turbo [pay down] bonds, which allow borrowers to roll the balance lems at Honor “highlight some of the it’s short-dated, and there are a lot of of existing loans into new loans. embedded risks” in the subprime auto structural protections.” However, liquidity Jeremy Acevedo, manager of industry sector, even if he it did not impact is not always there. “As an investor, you analysis at Edmunds.com, said the demand for the broader market.. have to evaluate how much spread you extension of loan terms, combined with a “With subprime auto ABS, there’s very require to take at that level of risk.”

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excludes whole loans that were financed by being sold to inves- It's academic tors or held on balance sheet. Private student loans are only a tiny portion of the $944B “It feels like a lot of the low- loan portfolio at Wells Fargo. It has the heft to conquer the hanging fruit has already been student refi market, but would it be worth it? taken out of the refi market,” said Robert Kelchen, assistant profes- sor of higher education at Seton Student loans, 1% Hall University. Breakdown of loan portfolio at Other consumer, 45% Wells Fargo Commercial loans, 53% Kelchen noted that SoFi, for “My guess is they’ve had requests from existing [student loan] customers to refinance, and they want to have that capacity.”

example, started out targeting students in certain programs at Source: The company (Data as of June 30) a small number of elite universi- ties. SoFi has since expanded the number of schools and programs, but that means it is reaching students with somewhat more risk Wells Fargo Can Upend of not repaying their loans. And as this market broadens, the in- Student Loan Refis; Will It? terest rate on refinance loans has begun to approach the rates for Cheap funding and marketing muscle could give it an advantage, many existing private loans as but the market may not move the needle for the bank well as federal loans for graduate students. This makes refinancing By Allison Bisbey less attractive to many students in this broader pool. Another reason the refinance With cheap funding and plenty of marketing who have obtained advanced degrees and market is so modest is that, even muscle, Wells Fargo has the potential to shake high-paying jobs. These borrowers are highly for the best borrowers, it gener- up the student loan refinance business. coveted, but they represent a small corner of ally only makes sense to use But does it really want to? the $1.4 trillion student loan market, and the these loans to repay federally Wells is the second biggest underwriter competition is growing. guaranteed loans to graduate of private student loans, which are used to In addition to fintech lenders such as Social students or parents, which pay finance the cost of higher education over and Finance and CommonBond, a number of rates of over 7%. Federally guar- above what federal student loans cover. It smaller banks, including Citizens Financial, anteed undergraduate loans only is now looking at offering loans that will not Laurel Road and SouthEast Bank, as well as pay around 5.5%. just consolidate private student debt, but also many state student loan agencies, also offer “So the question is,” Kelchen repay federal loans. refinance loans. said, “can Wells Fargo potentially Refinance loans take advantage of the Since 2013, SoFi and others have bundled poach some of the low-hanging lack of underwriting done by the federal some $18 billion of refinance loans into collat- fruit, or is the goal to get people government, offering better rates to borrowers eral for bonds, according to DBRS. This figure who have some private loans

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and some federal loans to refinance their and potentially get into trouble down the On the other hand, Riber said, “the refi- federal loans with the company they road.” nance market could shrink if interest rates already have private loans with?” Even if the refinance market is too rise more than expected, because the Michael Tarkan, an equity analyst at small to make a big impact on Wells incentive for a student loan borrower to Compass Point, thinks the bank’s goal Fargo’s balance sheet, the bank could refi goes down as the difference between is relatively modest. “My guess is they’ve have a big impact on existing lenders. their current loan rate and the new refi had requests from existing [student loan] Certainly, Earnest has picked up the pace loan rate gets smaller.” customers to refinance [federal student of origination since being acquired by the Of Wells Fargo’s two biggest competi- loans] and they want to have that capa- student loan servicing behemoth Navient tors in in-school lending, only Discover bility,” Tarkan said. in the fourth quarter of 2017; so far this offers refinances loans, and the company “Wells Fargo has a lot experience in year, it has completed three securitiza- declined to provide origination volume student lending, so this is a logical step, tions totaling over $1.2 billion, more than for the product, which has been available but I don’t get the sense it’s intended to it did for all of 2016 and 2017. Navient’s to all of its customers since March 2017. really drive a lot of volume or that it will bigger balance sheet and strong servicing SLM Corp., better known as Sallie Mae, “My guess is they’ve had significantly move the needle for Wells record also earned a higher credit rating has repeatedly downplayed the threat of requests from existing Fargo,” he added. on the deals, lowering its funding costs. refinance lenders, despite the fact that [student loan] customers to A Wells spokesman would not com- “It’s a little too early to tell if Wells can student lending is by far its biggest line refinance, and they want to ment on Wells’ plans or analysts’ specula- be more competitive in the refi market, of business — and refinance lenders are have that capacity.” tion but wrote in an email that the bank but presumably it could drive higher con- cherry-picking some of its best borrowers. “is continuously evaluating the market- solidation for lenders,” Tarkan said. Sallie Mae executives reiterated on place to better serve customers.” “A new product with name recognition the company’s second-quarter earnings is certainly a concern” for existing refi call that margins on refinance lending Potential to drive consolidation lenders, “but at least some of the bigger are thin and eroding, noting that lenders among lenders refi lenders already out there have pretty have started to raise their interest rates. Unlike SoFi, CommonBond and some good name recognition and relation- The amount of loans originated or ser- other refi lenders that rely on securitiza- ships with colleges,” Kelchen said. While viced by Sallie Mae that were refinanced tion and whole loan sales for funding, relationships with colleges are not quite by other lenders fell by $3 million, or 1%, Wells Fargo holds the student loans it as important for refinance lenders as for in the second quarter to $221 million. makes on balance sheet. Its student loan undergraduate in-school lenders, “refi portfolio was $11.9 billion at the end of lenders want to get students fairly soon Cherry picking the best borrowers the second quarter. That was just a frac- after graduation.” Refinance lenders are cherry picking the tion of the bank’s $441 billion consumer Another potential advantage for Wells, best borrowers from in-school lenders loan portfolio and an even smaller frac- according to Kelchen, is the bank’s exist- and the federal government. Monthly tion of its total $944 billion portfolio of ing relationships with borrowers through charge-offs for all securitized refi student consumer and commercial loans. its in-school lending program, though he loans tracked by DBRS averaged 0.02% Wells Fargo may be losing existing said this advantage seems to be fairly of the outstanding principal balance in borrowers to refinance lenders “at the modest. “Wells Fargo is a large bank, and the second quarter. That was unchanged margin,” Tarkan said, but not nearly as their cost of funds is probably lower than from the first quarter, but up from 0.01% much as it likely lost during a big refi- everyone else, and that could be an issue, a year earlier. nancing wave in 2017. as the other lenders won’t be happy if Loans at least one month behind on Jon Riber, senior vice president of U.S. Wells offers a lower rate,” Riber said. payments averaged 0.19% in the second asset-backed securities at DBRS, is skep- He said the bank’s marketing muscle is quarter, while loans at least two months tical that Wells Fargo would try to com- also a potential advantage. “Acquisition behind on payments averaged 0.09% . pete by going down the credit spectrum. costs in the refi space — meaning the Refi delinquencies are significantly “I’d assume they’d go after the same marketing cost to acquire borrowers — lower than delinquencies on traditional types of borrowers” as refi lenders like have increased because of the competi- private student loans or federally funded SoFi and CommonBond “because they tive nature of the refi market. SoFi has student loans. For example, 3% of private are a bank that will most likely hold their spent a lot on expensive Super Bowl ads, student loans and 6.9% of FFELP loans loans on balance sheet,” he said. “They which Wells could easily do. For the other were at least two months behind on pay- won’t lend to non-super-prime borrowers, lenders, this is not an option.“ ments in the second quarter. ASR

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CLO securities were backed by Pick Up in Demand for euro-denominated loans and CLO Investors Gear Up for bonds. Sterling Tranches of CLOs That’s the strategy Barclays is Turn in Credit Cycle using with Sirius, which is issuing New deals from PGIM and Barclays are the first GBP-denominat- three tranches of notes in three ed CLOs in five years, giving investors currency diversity options difference currencies that all carry the same Aaa credit ratings. The pound notes are backed by By Glen Fest pound assets, the euro notes are backed by euro assets, and the dollar notes are backed by dollar Until recently, collateralized loan obligations Asian investors are the largest purchasers denominated in pounds sterling were a tough of CLO paper in the European market, and These strategies could be sell. Canny said that many of them are looking based on a long-term view European CLO managers have long ex- to diversify their portfolios by buying assets of U.K. macroeconomic fundamentsl or potential pressed an interest in issuing sterling tranches denominated in different currencies. “There concerns over Brexit of notes, if only because this would make it is obviously a significant amount of pension easier to find enough assets for deals. The funds, insurance companies and banks that assets. However, should one or alternative – issuing euro denominated notes purchase this type of paper, and I think it’s just two tranches of the tranches be backed by assets denominated in pounds – currency diversification strategies,” he said. redeemed early, the principal requires hedging against changes in exchange These strategies could be based on a long- and interest proceeds from the rates, which is expensive. But there just weren’t term view of U.K. macroeconomic fundamen- corresponding currency will be enough buyers for sterling notes to make is- tal or potential concerns over how Brexit may converted to pay off the remain- suing them, and saving on hedging expenses, impact pound- or euro-denominated securi- ing tranches. worthwhile. ties, according to Canny. The euro and dollar tranches That appears to be changing. In July, PGIM Of course, pound-denominated CLO notes issued by Sirius were sized to priced a £325 million deal, dubbed Dryden could also appeal to U.K. investors, who would match the equivalent of £1.125 63 GBP CLO that is the first pound-sterling not need to worry about foreign exchange billion and pays 140 basis points CLO that S&P Global Ratings has rated in risk, as the do with euro-denominated CLOs. over the appropriate interbank five years. All of the notes being offered are However, it seems that this natural buyer base lending benchmark; there is also denominated in pounds, as are the loans and was not large enough to justify issuing sterling a subordinate tranche of notes bonds used as collateral. (Assets denomi- notes. denominated in pounds that will nated in other currencies may be added in the be retained by Barclays. future, however.) Multicurrency deals rare For now, Dryden 63 GBP CLO Also in August, Barclays priced Sirius Multicurrency deals themselves are unusual, does not need to be hedged, Funding, a CLO that will issue securities those with a pound tranche even more so. The since both assets and liabilities denominated in three different currencies, vast majority of outstanding deals have notes are denominated in pounds. pounds and euros and dollars, totaling £4.5 denominated in either dollars or euros, and But the deal permits PGIM to billion. The notes are backed by assets in all the circa 160 CLOs totaling $87.9 billion are add future assets in non-pound three currencies. It is the first pound CLO that nearly six times the size of the 45 euro CLOS sterling denomination - presum- Moody’s Investors Service has rated since totaling €22.56 billion. ably euros - which can make up 2014. Multicurrency CLOs were more common to 80% of the pool of loans. Ac- Interestingly, demand for the pound CLO before the financial crisis, and were commonly cording to an S&P presale report, securities comes primarily from Asian inves- backed by loans and bonds denominated in no more than 5% of those assets tors, not U.K. investors, according to Aidan both pounds and euros. Hedging was unnec- can remain unhedged. Canny, a managing director in BNY Mel- essary since pound-denominated CLO securi- The AAA rated tranche on lon’s corporate trust business for Europe, the ties were backed by pound-denominated Dryden 63 pays Libor plus 125 Middle East and Asia. loans and bonds, while euro-denominated basis points. ASR

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CLO securities were backed by volume in the first half of the euro-denominated loans and CLO Investors Gear Up for year matched the estimated $74 bonds. billion in new CLO issuance, Ma- That’s the strategy Barclays is Turn in Credit Cycle jewski said. “CLO equity remains using with Sirius, which is issuing reasonably well-bid despite three tranches of notes in three the liability widening as spread difference currencies that all car- Execs at two firms say expectations for an eventual rise in defaults compression has subsided,” he ry the same Aaa credit ratings. are driving their strategy to extend reinvestment periods said. “We continue to have a The pound notes are backed by robust reset pipeline and expect pound assets, the euro notes are By Glen Fest to direct additional resets in the backed by euro assets, and the second half of 2018.” dollar notes are backed by dollar In addition to resets, Eagle Corporate defaults are still near historic lows, Investors Service. That was down from 2.4% in These strategies could be but some investors in collateralized loan June but up from 1.5% in July 2017. “When credit dislocation based on a long-term view obligations are preparing for the inevitable. Still, there are some signs that the credit occurs, “there will be a of U.K. macroeconomic Eagle Point Credit Co. and Oxford Lane cycle is turning. For a long time, strong de- commensurate amount, and fundamentsl or potential hopefully an even greater Capital are both closed-end investment funds mand llowed speculative-grade companies concerns over Brexit amount, of price volatility.” that focus on the riskiest securities issued by to reprice outstanding debt at lower interest assets. However, should one or collateralized loan obligations, and so are rates, lowering their funding costs. But repric- Point has stepped up investments two tranches of the tranches be highly exposed to potential defaults on lever- ings in the $1 trillion-plus leveraged loan mar- in new-issue CLOs and ware- redeemed early, the principal aged loans. And both are gearing up for an ket have all but dried up, with none occurring house accumulation facilities; and interest proceeds from the eventual turn in the corporate credit cycle. during July, Majewski noted on Eagle Point’s this activity reduced the firm’s corresponding currency will be “We do agree it’s a when not an if,” Eagle conference call. capital reserves to $2.8 million converted to pay off the remain- Point CEO Thomas Majewski told analysts on In addition, the percentage of loans trading as of June 30 from $8.3 million ing tranches. an Aug. 14 conference call. The firm has over above par, or face value, on the JPMorgan at the beginning of the second The euro and dollar tranches $2.3 billion in assets under management in 70 Leveraged Loan Index had fallen to 46% in quarter. issued by Sirius were sized to CLOs, primarily in the “equity,” or most subor- mid-August from 70% in May. Oxford Lane boosted its match the equivalent of £1.125 dinate tranches of these deals. In the second quarter, Eagle Point reset the investments in CLO equity by billion and pays 140 basis points Oxford Lane Capital CEO Jonathan Cohen terms of eight CLOs for which it has control- $45.8 million (new investments over the appropriate interbank expressed a similar view on a conference call ling interest. (Unlike refinancings, in which new net of sales and repayments of lending benchmark; there is also held the previous week. “I’m not sure we’re at notes with lower interest rates are issued and existing CLO holdings) in the sec- a subordinate tranche of notes the beginning of the end or the end of the be- proceeds are used to repay existing notes, ond quarter. It also extended a denominated in pounds that will ginning,” he said. “But we are certainly closer resets typically are undertaken to extend rein- sale-and-repurchase agreement be retained by Barclays. to the end.” vestment and non-call periods of deals about with Nomura Securities, provid- For now, Dryden 63 GBP CLO Eagle Point and Oxford Lane have some- to start amortizing.) ing it additional capital to fund does not need to be hedged, thing else in common: Rather than take a In July and August, Eagle Point reset two opportunistic CLO purchases, the since both assets and liabilities defensive stance, both are taking steps to stay further deals, bringing the total number of company announced. are denominated in pounds. invested in the leveraged loan market for as resets to 18 since January 2017. Cohen said Oxford Lane will But the deal permits PGIM to long as possible. They are either buying stakes “The No. 1 thing we’re working on in our focus on building out longer add future assets in non-pound in CLOs with extended reinvestment periods portfolio is to buy as much reinvestment pe- reinvestment periods for its CLO sterling denomination - presum- or, in the case of CLOs in which they have a riod as possible,” Majewski said. equity holdings. Because of the ably euros - which can make up controlling interest, are voting to extend the By extending the period during which deals “long-term, relatively low-cost to 80% of the pool of loans. Ac- reinvestment periods. The idea is that manag- can be actively managed, Eagle Point is hop- leverage facilities” the firm has cording to an S&P presale report, ers of deals that can be actively managed for ing that when “that day of credit dislocation in place to acquire the posi- no more than 5% of those assets longer will be in the best position to pick up occurs, there will be a commensurate amount, tions, he said, Oxford Lane’s CLO can remain unhedged. troubled loans on the cheap. or hopefully even greater amount, of price stakes will be “well positioned The AAA rated tranche on This is unlikely to happen soon. The trailing volatility,” Majewski said. This would allow to perform during an economic Dryden 63 pays Libor plus 125 12-month U.S. leveraged loan default rate managers to pick up loans on the cheap. dislocation or a widening spread basis points. ASR finished July at 2.2%, according to Moody’s Marketwide, the $74 billion in reset CLO environment.” ASR

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Financial Group LLC. “The OCC OCC’s Door Officially Open, very much reaffirmed they will be looking at applying all of the But Fintechs Not Rushing In safety and soundness expectations they would apply to a Fintech firms have the federal option they have long sought, but traditional bank.” Still, fintech firms reacted to meeting the agency’s application requirements will not be easy the news positively, and indicat- ed some may test the waters. By Rachel Witkowski David Klein, CEO and co- founder of CommonBond, said companies would be seeking ad- Fintech companies now have the federal also prompted a slew of additional questions, ditional “clarity” from the agency, option they have long sought after the Office including whether firms would be able to meet but he added that the more fi- of the Comptroller of the Currency green- the regulator’s tough criteria, and whether nancially sound fintech firms will lighted firms to apply for a special-purpose state regulators would continue to fight the likely consider applying despite bank charter. But winning OCC approval on charter concept in court. having remaining questions. charter bids will not be a walk in the park. “There are no short cuts here for prospec- “For many capital-intensive One day after the OCC’s July 31 announce- tive fintech charter applicants,” said Julie fintech firms, it’s probably less ment, some fintech firms signaled clear inter- Williams, managing director and the director a question of whether to get a est in the charter. But the agency’s decision of domestic advisory practice at Promontory charter and more about when to

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Financial Group LLC. “The OCC apply for one,” he said. “This is a conver- of planned products, services, and activi- signs that firms’ enthusiasm about the very much reaffirmed they will sation I’m sure many capital-intensive ties,” the OCC said in its press release. idea may have dwindled since the agency be looking at applying all of the fintech companies are having right now.” The OCC also appeared to provide some first proposed it under former Comptroller safety and soundness expec- The OCC’s statement, along with flexibility in how an applicant would craft Thomas Curry. tations they would apply to a an accompanying supplement to the its “contingency plan,” which is akin to the Speaking to reporters in May, the traditional bank.” agency’s licensing manual for fintech stress tests conducted by large banks. current comptroller, Joseph Otting, said Still, fintech firms reacted to applicants, did address some questions The OCC “left the financial inclusion some companies are less interested after the news positively, and indicat- the industry had about what would be part pretty open,” Klein said. discussing the process with the OCC and ed some may test the waters. required to get a charter. But Williams pointed out that both learning what is involved. “They began to David Klein, CEO and co- For example, the OCC said applicants requirements go beyond what regulators learn about national banking versus state founder of CommonBond, said would have to meet similar capital, liquid- typically expect from a de novo bank banking and operating across state lines companies would be seeking ad- ity, stress testing and financial inclusion applicant. The contingency plan and and then they come talk to us, and we ditional “clarity” from the agency, requirements as traditional banks. financial inclusion “are additional to the explained the issue … of capital, liquidity but he added that the more fi- However, the OCC also left some requirements that we see in the standards and serving your community,” Otting said. nancially sound fintech firms will wiggle room by not explicitly defining the and application processes for a tradition- Sam Taussig, head of global policy likely consider applying despite needed capital ratios or what “financial al bank charter,” said Williams, who was at Kabbage, said the OCC appeared to having remaining questions. inclusion” requirements with which char- a former senior deputy comptroller and communicate that it will tailor the charter “For many capital-intensive ter recipients must comply. chief counsel at the OCC. to how each firm operates. fintech firms, it’s probably less “The expectations for promoting The overall level of interest in an OCC “The charter is certainly on the table as a question of whether to get a financial inclusion will depend on the charter among the fintech industry is one of many options and we’re certainly charter and more about when to company’s business model and the types somewhat of an open question amid excited about it,” he said. ASR

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ber warning the Trump administration appointee that they stood ready to ramp up efforts if the CFPB let down its guard. “If incoming CFPB leadership prevents the agency’s professional staff from aggressively pursuing consumer abuse and financial misconduct, we will redouble our efforts at the state level to root out such misconduct and hold those responsible to account,” they said. In the time since, the agency has certainly shown signs of a less aggressive approach. After Mulvaney decried the agency’s enforcement apparatus as overaggressive, it took months before the agency revived public actions against companies. But since mid-June, enforcement ac- Gary Gensler, chair of Maryland’s Financial Consumer Protection Commission Bloomberg News tions have accelerated. Observers say state AG offices that had participated most will- Can State AGs Really Serve ingly in Cordray-led investiga- tions have continued to operate as ‘Mini-CFBPs’? at full tilt in the Mulvaney era, pursuing fraud allegations and Several pledged to compensate for a slowdown in enforcement at other claims. the Consumer Financial Protection Bureau under Mick Mulvaney But with no general drop- off in investigatory activities, By Kate Berry state budgets in some cases are too tight to establish mini- CFPBs around the country more broadly. “All the states were Late last year, 17 state attorneys general under former Director Richard Cordray. already at capacity in terms of pledged to fill the gap if the Consumer Meanwhile, with the CFPB actually ac- their ability to ramp up their Financial Protection Bureau slowed its celerating enforcement actions of late, some enforcement activity,” said Chris- enforcement activity under acting Director argue that the void left for states to fill may topher Willis, a consumer finance Mick Mulvaney. But their efforts to compen- not be that big. Indeed, many observers say practice leader at the law firm sate for a less aggressive CFPB have so far not much has changed in how states and the Ballard Spahr. “The states are been a mixed bag. CFPB investigate financial firms for potential doing as much as they can with Only a handful of states, such as Pennsyl- wrongdoing. constrained budgets and staff, vania and New Jersey, have announced plans The creation of mini-CFPBs “hasn’t been as and those constraints have not to create so-called “mini-CFPBs”. In other necessary as some would have thought,” said changed.” states, budgets have been too constrained to Richard Gottlieb, a partner at Manatt, Phelps However, in some states, the expand enforcement operations beyond what & Phillips. Trump administration’s pro- AGs were already doing to assist the CFPB The AGs sent Mulvaney a letter in Decem- business, deregulatory posture

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has been seen as an opportunity for AGs Some states also are reassessing how going after big pots of money or provid- to cast themselves as more aggressive best to deploy their resources in reaction ing restitution to borrowers. consumer watchdogs. to what the CFPB does. The added funds But the states also are less likely to “The states are asking, how do I maxi- allow states to conduct more investiga- take action against companies for viola- mize my deterrence effect, if I’m a state tions against bad actors, typically involv- tions of fair-lending laws or disparate AG with limited resources?“ said Allyson ing fraud. Attorneys generally also hope impact, which are resource-intensive, Baker, a partner at Venable and a former to get a political boost by broadcasting require expensive statistical analysis and CFPB enforcement attorney. “Since this their aggressive stance to fill in the void. could lead to more litigation. administration came into power there “Prior to the election of Trump, it was a Many observers say the dynamic has been a collective concern among way for the states to follow on with what between states and the CFPB has not attorneys general across the country that the CFPB was doing,” said Catherine changed much since the agency’s new there would be receding enforcement Brennan, an attorney at Hudson Cook. leadership took the helm. “It’s not like power and one of the things the AGs have “With the election of Trump, I think those enforcement went away,” said Gottlieb. tried to do is compensate for that or ad- state mini-CFPBs have taken on more dress that.” importance at the state level — and for “All of the states were already at Pennsylvania announced its initiative those attorneys general organizing these capacity in terms of their ability before Mulvaney took the reins of the mini-CFPBs, it’s a good issue if you are to ramp up their enforcement CFPB, with state Attorney General Josh planning on running for higher office.” activity.” Shapiro creating the Consumer Finan- Brennan has specifically advised online cial Unit to field consumer complaints lenders to be cautious about doing busi- States have often argued that they and target predatory lenders. He tapped ness in Virginia, claiming that a company are a better venue for enforcement of Nicholas Smyth, a former CFPB enforce- can “do everything right and still find consumer protection laws, claiming that ment attorney, to head the new unit. [themselves] on the receiving end” of an federal preemption and regulatory au- Earlier this year, New Jersey picked inquiry or enforcement action. thority handed to agencies like the Office Paul R. Rodriguez, a lawyer in New York Other observers note that, even where of the Comptroller of the Currency and City Mayor Bill de Blasio’s office, as direc- budgets are constrained, state-backed the now-defunct Office of Thrift Supervi- tor of the division of consumer affairs. efforts in the Trump era should not be sion helped lead to industry abuses that Other states have eyed similar moves, dismissed. “We all have capacity issues were a major cause of the financial crisis. but it is unclear whether they can devote and there’s plenty for us to be doing and In addition to state AGs, banks and enough resources to compensate for any there always has been,” said John Ryan, financial firms also have to contend with perceived slowdown in CFPB activity. the president and CEO of the Conference reinvigorated state banking regulators, Maryland has created a new Finan- of State Bank Supervisors. who continue to flex their muscles. cial Consumer Protection Commission He said efforts at the federal level al- New York’s Department of Financial chaired by Gary Gensler, a former Gold- ways draw “greater attention.” But even a institutions and California’s Department man Sachs executive and head of the state like Maryland allotting $1 million for of Business Oversight have stepped into Commodity Futures Trading Commission its initiative should be applauded. the breach on several fronts, including in the Obama administration. The state On the legal front, however, little has signing a consent order against Equifax legislature is expected to set aside $1.2 changed for the states. Every AG’s office with six other states. million to create 10 positions for the unit. has a consumer protection division with New York also is creating data security Some states, meanwhile, already express statutory authority to enforce rules. California is seeking information ramped up their financial consumer federal consumer protection laws includ- from a dozen unlicensed student loan protection efforts before President Trump ing unfair, deceptive and abusive acts servicers and is cracking down on lenders came to office. In 2015, Virginia Attorney and practices, known as UDAAP. trying to avoid state interest rate caps. General Mark Herring created a special States are trying to respond to the “There’s an endless supply of real bad unit targeting predatory lenders. Virginia changes at the CFPB with Mulvaney actors for [the states] to go after,” said has doubled the number of attorneys fo- focused more on confidential supervisory Willis. “For financial institutions, in terms cused specifically on consumer protection resolutions while issuing fewer consent of the level of compliance scrutiny and to 10 from five, and added 18 additional orders and enforcement actions. risk from the changeover at the CFPB, the personnel including dispute resolution Mulvaney also has put a priority on world is not that different today than it specialists and paralegals. criminal actions and fraud, as opposed to was two years ago.” ASR

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slower to tap the securitization Why CleanFund Held Out market than residential PACE providers; in part because it for an AAA takes longer to underwrite the financing and assemble a diverse Bragging rights were a key benefit for the commercial PACE pro- pool of assets. Now that Clean- vider, which was the second to bring a deal to market Fund has completed the process, it has important feedback that can help it to price future funding By Allison Bisbey more efficiently, knowing how potential investors view the various kinds of collateral. “Eventu- Providers of property assessed clean energy inclined to accept the lower yields on these financing have tended to shoot for relatively super-safe securities as would other kinds of “Five percent modest credit ratings when they initially tap investors, such as banks or money managers. overcollateralization the securitization market, Unlike Greenworks’ $75 million deal, which seemed light to some investors on calls; 10% ... But CleanFund, a San Francisco-based firm was rated AA by Morningstar Credit Ratings was received well.” that provides PACE financing for commercial and was placed with a single investor, TIAA property, went a different route, achieving an Investments, CleanFund’s transaction was ally this will help us [as we] feed AAA from DBRS on its inaugural securitization placed with a total of four investors, three it into more precise pricing and of $115 million of PACE assessments. The firm insurers and a money manager. structuring of individual deals to did it in part because of a key benefit: Brag- CleanFund did have to make a concession credit factors that seem to mat- ging rights. to its investors, some of whom were not quite ter to investors,” Saunders said. “We were looking for a little distinction to as comfortable with the collateral as DBRS; While “it’s OK to have a golf set ourselves a bit apart,” CleanFund CEO the sponsor increased the amount of excess course or a community center Greg Saunders said in an interview. collateral available to protect noteholders in and factory as part of the col- The deal is not the first commercial PACE the event of losses or late payments, to 10% lateral pool … we can’t get car- securitization ever — that distinction belongs of the balance of the notes from 5% originally. ried away with alternative asset to Greenworks Lending, which completed a (DBRS was willing to assign an AAA based classes,” he said. Instead, they private placement in 2017. Still, “we like that on 5% overcollateralization.) Doing so meant need to be balanced with more it’s the first AAA, and not just the first 144a,” reducing the amount of notes issued to $103 traditional types of commercial Saunders said, referring to the securities law million from $109 million originally. property. rule that allows for the sale of unregistered “Five percent overcollateralization seemed Commercial PACE securitiza- offerings to certain types of investors. light to some investors on calls; now that it’s tions are somewhat analogous to Bonds backed by PACE loans are one of at 10%. It was received well for sure,” Saun- commercial mortgage securitiza- the few types of asset-backeds with long ders said. tions, where investors are used tenors — the underlying assessments, which CleanFund also opted not to squeeze the to seeing a broad diversity of finance energy efficiency upgrades, can last last dollar of borrowing in the deal, which assets. So CleanFund also fielded 20 years or longer. So these investments are closed July 31; the sponsor did not issue any questions from investors about particularly attractive to insurance companies, subordinated tranches with lower ratings and the heavy exposure to California which generally try to put their money to work fewer investors protections. and Texas and to the five largest in assets with terms as long as their policies. The deal, CleanFund Commercial PACE assessments. However investors Since insurance regulators assign the same 2018-1 refinances $115 million of PACE as- seemed to feel more comfortable risk weighting to securities with a credit rating sessments on 82 properties in six states in once they understood that the of single-A-minus or higher, there’s less of an the West Coast, Midwest and East Coast, or lien created by an assessment is economic incentive for PACE providers to pro- roughly two thirds of the financing that the senior to that of a mortgage, and vide the additional investor protections neces- CleanFund, which was founded in 2009, has moreover cannot be extinguished sary to achieve the top credit rating of AAA. arranged to date. upon default, since it does not Insurance companies may not be as Commercial PACE providers have been “travel” with the borrower. ASR

22 Asset Securitization Report September 2018

022_ASR0918 22 9/4/2018 5:11:53 PM The Role of the Trustee

PARTICIPANTS

Anna Anderson Partner, Chapman and Cutler LLP

MODERATOR

Danielle Fugazy Doneene Damon contributing editor, Executive Vice President, SourceMedia Head of Corporate Trust and Agency Services Group, Richards Layton & Finger Trustees play a critical role in any asset securitization transaction. They are there to protect the interests of the investors. However, over the years the role of the trustee Patricia Evans Schulze has in some cases grown and in other cases changed.Asset Managing Director, Global Capital Markets, Securitization Report brought together leading industry Wilmington Trust, N.A. experts to discuss the various types of trustees that can be needed for an asset securitization transaction, the different roles they can play, and why they are a crucial part of the Ryan Foss Senior Vice President, transaction process. Wilmington Trust sponsored the event. Capital Markets & Strategy, Laurel Road What follows is an excerpted version of the conversation where various scenarios were discussed. The event took place in ASR’s New York offices and included epresentativesr Benjamin Jordan from Wilmington Trust, Chapman and Cutler LLP, Richards Head of Transaction Management, Wilmington Layton & Finger, and Laurel Road. Trust, N.A.

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001_ASR0918 1 8/13/2018 5:43:09 PM Danielle: What is a full trustee and of services. However, the structure of to hold title stems from a concern why would you need one? the deal may mandate a specific type that the only way to avoid licensing of trustee. For example, if you use a requirements at the state level is to have Pat: The “full service” trustee will take Delaware statutory trust or a New York a federally or nationally chartered bank on the role of the indenture trustee, as common law trust—you may likely need hold title to the assets as trustee. well as other related roles, including the an owner trustee. paying agent, calculation/verification It used to be that the trust could hold agent, document custodian, as well Additionally, we are not always the paying title, but there has since been concern as backup servicer. These roles agent in an owner trustee structure. But that the trust itself would then have to aren’t all under the trustee umbrella, more often than not, we are asked to qualify in the states where the loans but nevertheless they are usually hold title. If there is a title requirement were originated. This would be a intertwined with the indenture trustee. within the structure, and both an owner real headache for the transaction if it Issuers and their counsel may find that and indenture trustee are engaged, it occurred post-closing. So structures it’s cost efficient for a transaction to is typically (but not always) the owner started to incorporate the requirement have one entity providing the full range trustee that takes title. The requirement to hold title at the trustee level on the

002_ASR0918 2 8/13/2018 5:43:11 PM front end of structuring the transaction. but are you also handling some of the Danielle: Can a single provider play During the financial crisis, many banks, administrative functions like paying all the roles? Are there conflicts? who were at the time holding title as agent and registrar. In some transactions, Ben: Since we are a Delaware-based trustee, were stuck with foreclosures those roles are bifurcated or separated shop, we can offer the whole plethora and were exposed to a lot of reputational among institutions. That said it certainly of trustee services. Within those trustee risks and liability, which resulted in provides efficiency when you have services there are layers of different these banks unwilling to hold title in one- stop shopping. One institution that obligations and roles. Regarding the transactions post-crisis. With strong can do the trustee plus the administrative indenture trustee role, we also offer the client relationships and with the proper functions—that’s how I think of a full calculation agent, where we will model protections in place, Wilmington Trust service trustee. And it can also include the waterfalls and we have a whole will consider holding title in its name as the various other services that can be analytics group that does that work. trustee. provided like custodian, backup servicer, etc. Anna: The baseline difference between Doneene: Full service trustee means the various types of trustees involves you are not only acting as a trustee,

003_ASR0918 3 8/13/2018 5:43:12 PM asking who the trustee is representing prohibit the same institution from and which party’s interests the trustee serving in both roles at the outset. is acting at the direction of. Another However, it if there’s ever a trigger factor to consider is the level of the in that transaction from a default trustee’s involvement in the transaction; perspective, the TIA requires that there whether the trustee has a passive role be no conflict of interest. That’s when in the beginning—prior to events of one party would need to resign. In default—or a more active role after some transactions the investors and the the occurrence of an event of default. issuers may not want to run that risk. It’s important to note that a particular In the private deal context, it’s not TIA type of trustee’s role can change covered; it’s really perceived conflicts across asset classes. Ultimately it is a of interest. In some deals the parties question that should be answered at will use affiliated entities. In deals where the beginning of the transaction and the same entity is used, different teams depends on the situation, what the will handle the different sides of the client needs, and what services the deal. We also add specific language trustee has to offer. into the deal documents disclosing Ryan: We actually prefer to have to the various parties that the same a one-stop shop. We have enough institution is serving in multiple roles, counter parties as an issuer as it is. But but that the execution of their duties The baseline difference it’s been suggested to us by counsel and responsibilities in each of those that we should bifurcate the indenture roles is in no way a hindrance to what between the various trustee and the owner trustee role, even they need to do in other capacities. though we prefer to have everything types of trustees The efficiency piece of working with a consolidated in place. single provider cannot be overlooked. involves asking who the Pat: If it’s a public deal, it’s likely It also makes a ton of sense from a fee governed under the TIA, and in that perspective as well. trustee is representing case it may make sense to have each Anna: We draft those documents trustee role (owner and indenture) and which party’s to expressly state the duties for the handled by separate entities. However, different roles such that knowledge in usually if it’s not a public deal, people interests the trustee is one role is not imputed to knowledge are comfortable with a bifurcation within in another role. There has to be actual the same institution. When we do serve acting at the direction of. knowledge of certain events and as both indenture trustee and owner notice provisions, for example, so that Anna Anderson trustee in the same transaction, we every transaction party understands Partner, Chapman and Cutler LLP have a different administrator handle that there are distinct and separate the indenture trustee and another roles even though the roles may be administrator work with the owner performed by the same institution. trustee. And from a legal perspective, we’ll have a different lawyer represent Danielle: What is the nominal us as an indenture trustee and then trustee? Why and how did this role another lawyer within the same firm come about? represent us as owner trustee. Ben: After the financial downturn there Doneene: In a public deal, the trust was a ton of litigation surrounding indenture act controls. It doesn’t securitizations, especially in the private

004_ASR0918 4 8/13/2018 5:43:14 PM market. At that point, the trustee, because they are named as the owner of the collateral within the trust, is the first one to be named in all of the litigation. This happened mainly in the mortgage industry. As a result, a lot of trustees made the decision not to be named trustee anymore. They said they will do all the other work, such as be the securities intermediary, the master servicer, the paying agent, and calculation agent, but they just don’t want to be named the trustee for the specific reason of wanting to stay clear of the litigation possibilities. So other banks—including ourselves—saw that as an opportunity. We could enter the business of a nominal trustee role. In the past three years we’ve expanded our suite of services so that we now play the full indenture trustee role—this is obviously our preference We perform the whole suite of services, roles, and in transactions—where we can be your named trustee, your securities obligations while there are still other trustees out intermediary, your paying agent, and your calculation agent. We perform there that can’t or are unwilling to perform those the whole suite of services, roles, and obligations while there are still other services due to prior litigation. trustees out there that can’t or are Benjamin Jordan unwilling to perform those services due Head of Transaction Management, Wilmington Trust, N.A. to prior litigation. Very few banks are willing to Pat: Trust’s preference to provide multiple Ryan: That sounds like a really hold title today. They would prefer to services to the transaction that provide poor risk/reward role to take. Why does take on the “securities administrator” additional revenue in support of the all of that rep and warrant risk roll up to role and bring a nominal trustee into risk that we take on. Additionally, Wilmington Trust, why are borrowers the deal to hold title. But even when borrowers are often referred to the calling Wilmington Trust about loan serving as nominal trustee, especially trustee who holds title rather than to modifications when they should be on RMBS transactions, there is still the servicer when it comes to questions calling their servicer? Where’s the risk and liability. As nominal trustee, or concerns about their mortgage. disconnect? there are rep and warrant situations Trustees will direct the borrower to the Pat: Sometimes it’s the that require trustee involvement. Even appropriate servicer, but this is another responsiveness of the servicer. In as nominal trustee, there is still plenty example of a nominal trustee with more some cases the servicers can change of risk and liability for a role that the than just a ‘nominal’ role, especially frequently and the borrowers don’t industry deems ‘nominal.’ For these in situations where the servicer is not know who to call. Meanwhile, titles to reasons, and others, it is Wilmington being responsive.

005_ASR0918 5 8/13/2018 5:43:15 PM the loans remain in Wilmington Trust’s name as trustee. Sometimes, it is just easier for the borrowers to go right to who they know ‘owns’ their loan. They don’t necessarily know that their loan has been ‘sold’ into a securitization, and they likely don’t understand the role of a servicer or the role of the trustee.

Doneene: If you think about the mortgage market crisis, a lot of the litigation was brought on by investors against trustees because they had an expectation that the trustees were going to be taking certain actions that trustees actually weren’t obligated to do. Across the board, everyone involved in these structures needed some education in terms of roles and responsibilities and who to go to in certain instances. You had many different categories of participants who really didn’t understand these structures and it created a lot of the issues. And that resulted in the decision for a lot of From my perspective, having one shop that you the banks to pull back. can go to helps deepen the relationship. Anna: There is always the deep pocket concern. Any institution named Doneene Damon in a figurehead role is likely going to Executive Vice President, Head of Corporate Trust and Agency Services Group, Richards Layton & Finger be pulled into litigation. So, from a drafting standpoint, we review and revise the indemnity provisions and can be recovered, when, and by which Pat: If Laurel Road were to hire an any related side letters as necessary. transaction party. owner trustee, a nominal trustee, and Based on relatively recent case law a securities intermediary, they would we’ve had to add language into Danielle: What are the advantages be looking to three different institutions, indemnification provisions to expressly of having a full service trustee and, potentially three different law firms state that amounts can be recovered in versus a separate account admin, as well. This all adds to the costs and a connection with any enforcement of its and paying agent and nominal lack of efficiency for the transaction. right to indemnification. Indemnification trustee? Doneene: It’s also about relationships. provisions are a critical component Ben: The main advantage is you’re not From my perspective, having one shop of a transaction document, but not dealing with multiple parties. Because that you can go to helps deepen the something that people generally like there are a lot of transactions where relationship. You know one another and to talk about at the beginning of a deal there’s a nominal trustee, a securities you know what services the trustee when they’re planning on everything intermediary, paying agent, calculation can provide. The trustee knows what going well. Regardless, the documents agent. As a full service indenture to expect from you as an issuer. It need to be clear as to what amounts trustee we can offer the whole suite of creates expectations going in and you products. do not constantly have to renegotiate

006_ASR0918 6 8/13/2018 5:43:17 PM over and over again because you have there is also a desire to have grantor the same institutions that you are trust tax treatment for federal income tax working with all the time. This builds purposes. The trust is often structured strong relationships which helps create as a common law trust, but it can also efficiencies. be a structured as a statutory trust. In essence, the grantor trust typically refers Ben: Something we recognized after to a trust treated as a grantor trust for tax the downturn and prior to offering purposes in which the trustee takes title our full service role, is there’s a lot to the assets of the trust. of back and forth between the third parties. We would play the nominal The functionality of the grantor trustee role in a mortgage transaction and is taking title at the first level. The next someone else would play the securities step of the transaction typically involves intermediary or the master servicer. the grantor trust issuing some kind of The amount of back and forth with the certificate of beneficial ownership interest paperwork and notices between us that then becomes the asset of the and that other party results in a lot of owner trust. The owner trust can also be lost time as compared to us being able either a common law trust or a Delaware to do it all in house. That’s definitely statutory trust. The owner trustee serves another advantage of having everything at the owner trust level. The owner in one place. There’s also no confusion The trust is often trust or owner trustee then enters into over who’s doing what. Sometimes the an indenture with an indenture trustee securities administrator will say we’re structured as a statutory pursuant to which notes are issued to not doing that, that’s the trustee’s investors in the transaction. role and the trustee says, no, that’s trust, but it can also be It’s really all driven by tax, regulatory, and a function that you have under the licensing issues. agreement. It eliminates issues. structured as a common Pat: It’s just the nomenclature that’s Anna: It’s important to have the law trust. used and it can add confusion to the structuring conversations early in market. the planning process and make sure Ryan Foss everybody is very clear on whom Senior Vice President, Capital Markets & Anna: The bottom line is to consider is doing what, and what are the Strategy, Laurel Road what interests the trustees are expectations of each role. This allows representing. And that differs us to then draft the initial documents depending on the role. It goes to what I Danielle: Grantor trustee, owner based on the business terms, rather said earlier—that those questions need trustee, indenture trustee, what’s than be required to react and revise to be answered at the very beginning the difference between each, and documents well into the transaction of the structuring discussions. In who represents whom? timeline. our experience, more often than not Doneene: I’ll start with the grantor trustees may be brought into the deal Ryan: I do think when you start trustee. There are lots of transactions on the back end of those structuring reducing and tearing down some of where there’s a desire for the trustee to conversations, and then transaction the ancillary legal and other fees that take title to assets for various reasons. parties have to react and the trustees don’t really drive a ton of value within And in many of those transactions, a themselves have to very quickly try the transaction structure—even if it’s grantor trust is created as the first step and react to figure out what it is the just consolidating under one counter- in the transaction. The grantor trustee parties really want and what roles the party—some of those cost savings do is the party who is brought in to take transactions parties need the trustees actually end up getting passed to our title to the assets. In many transactions, to play.  customers.

007_ASR0918 7 8/13/2018 5:43:19 PM About Wilmington Trust Wilmington Trust is a registered service mark. Wilmington Trust C orporation i s a w holly o wned s ubsidiary o f M &T Bank Corporation. Wilmington Trust Company, operating in Delaware only, Wilmington Trust, N.A., M &T Bank and certain other affiliates, provide various fiduciary and non- fiduciary services, including trustee, custodial, agency, investment management and other services. International corporate a nd i nstitutional s ervices a re o ffered t hrough Wilmington T rust Co rporation’s i nternational a ffiliates. Loans, r etail and business deposits, and other business and personal banking services and products are offered by M&T Bank, member FDIC. Trademarks and brands are the property of their respective owners.

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Disclosure: This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, investment, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.

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008_ASR0918 8 8/13/2018 5:43:19 PM MBS Report

ondary market investors that are willing to buy super jumbos for Super product both whole loan and securitized Nonbanks have widened their share of the market for super investments. The number of non- jumbo loan purchases at the expense of banks bank investors and aggregators that offer super jumbos was 60% higher in June than it was a year Banks Nonbanks Credit unions ago, Optimal Blue said. Recent loan performance has been strong for mortgages originated at $2 million to $3 Jun-18 million, said Vince Furey, senior vice president, lending solutions at OpenClose, an origination software company. That’s em- boldened the secondary market Jun-17 appetite for even higher-balance loans. 0% 10% 20% 30%40% 50%60% 70%80% 90%100% “The market to securitize those high loan balances is there Source: Optimal Blue now, where it really wasn’t before. Liquidity drives everything,” Furey said.

Small investor universe Nonbanks Ease Standards to The investor universe is still small; Optimal Blue estimates Compete for ‘Super’ Jumbos less than 50 investors and aggregators are actively purchasing Originators of these multi-million dollar loans are proliferating, super jumbos. Banks make up building a new market for high-balance mortgage securitizations the vast majority of investors, but their market share of loan pur- By Brad Finkestein chases by dollar volume slipped to 80% in June, from 85% a year ago. Nonbanks’ market share An uptick in private investor liquidity is with super jumbos. grew to 17%, from 12%, while bringing more nonbank lenders into the The total number of super jumbo origina- credit unions held roughly 3% of market for super jumbo mortgages, often with tors — nonbanks, as well as banks and credit the market, Optimal Blue said. weaker credit standards than the banks that unions — grew 15% in June 2018 over the pre- Nonconforming mortgages traditionally dominate this niche. vious year, according to estimates by Optimal accounted for about 11% of Super jumbo mortgages, loosely defined as Blue, a provider of loan product and second- loans originated using Optimal loans with an original balance of more than ary market data and technology. Blue’s product and pricing engine $1 million, are often offered by banks to build Nonbank super jumbo originators, which in June, unchanged from a year tight-knit relationships with high-net-worth Optimal Blue estimates number in the “few ago. However, super jumbos ac- customers in their private banking and wealth hundred,” grew 10% year over year and now counted for 13% of all noncon- management divisions. outnumber depositories by a 2-to-1 margin. forming lending, down from 17% But nonbanks, which in recent years have Banks that offer super jumbos tend to hold a year ago. seen their influence and market share grow the loans in portfolio. But the rise in nonbank Nonbanks originate 55% of considerably, are now starting to gain traction activity is being driven by private-label sec- the dollar volume of super jumbo

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mortgages. Despite the much lower average balance of $664,560 that had They may not have assets to qualify for number of originators, banks and credit meaningful levels of low-documentation super jumbo bank financing.” unions account for 45% of super jumbo income loans (37%). The high percentage As a result, money-center banks are What the FHFA Scandal lending by dollar volume because their of non-qualified and higher-priced quali- not Verus’ competition for these loans. average loan size tends to be higher than fied jumbo mortgages also “fell outside The growth has been all along the Means for GSE Reform nonbanks, according to Optimal Blue. the credit box,” Fitch Ratings noted in a credit spectrum. “There are a lot of The number of nonbank super jumbo presale report. common-sense loans out there, and if we lenders is in the low hundreds, Opti- And in a recent $1 billion prime jumbo can find a common-sense loan to buy in mal Blue estimates. Among them is the pool, JPMorgan increased its level of the super jumbo space, we will do that,” Denver-based direct lender Eave, which riskier third-party originations through Smith said. offers mortgages with a $20 million loan correspondent and broker channels. That Luxury Mortgage, a Stamford, Conn.- limit, and LoanStream Mortgage, which factored into a Moody’s Investors Service based subsidiary of Tiptree Financial, just offers products with loan amounts up to downgrade of the bank’s prime jumbo expanded its guidelines for the nonquali- $10 million. origination ratings assessment in August. The Federal Housing Finance Agency has Caliber Home Loans rolled out Elite Some lenders are mitigating risk “There are just things you can do faced a barrage of negative headlines lately, Access, with a $3 million limit that allows through cross-collateralization of the in a non-QM product to make the from a sexual harassment probe of Director for a 95% LTV with no mortgage insur- borrower’s properties, Furey said. For mortgage process more convenient Mel Watt to a court ruling declaring the and less cumbersome for the ance and 700 credit score. The Dallas- example, a borrower can use their equity agency’s leadership structure unconstitutional. borrower.” based lender cited rising home values as in other properties or assets as collateral But will the flood of bad news affect policy one reason for creating the product. for the new super jumbo loan. related to oversight of Fannie Mae and Fred- Other niche products, including home Despite the looser underwriting and fied mortgage jumbo offerings, moving to die Mac? equity lines of credit up to $3 million, are large loan balances, lenders and inves- a $4 million loan limit from a $3 million Analysts say the biggest impact of all the also hitting the market. tors don’t appear to be particularly limit established when the program was attention — albeit negative attention — may “But home values don’t mean anything concerned about taking on the additional rolled out in January. be to elevate the profile of a relatively obscure if there’s no marketable liquidity for the risk. Rather, they view the product as a agency that poses significant personnel and product. The marketable liquidity is being strategy opportunity to reach a borrower More loans being securitized policy questions that the administration will driven by confidence in the values,” Furey segment unserved by banks. On the prime jumbo side, it will do up have to address sooner or later. said. Verus Mortgage Capital, a corre- to $5 million, but it will go above those “It’s kind of turning D.C.’s attention to the spondent aggregator headquartered in amounts in both programs on an excep- future of housing finance a little bit more than Relaxed underwriting standards Washington, D.C., is offering loans up to tion basis, said CEO David Adamo. it has been for some time,” said Ed Mills, a In addition to raising maximum loan $5 million for borrowers previously locked “There’s been a proliferation of ex- policy analyst at Raymond James. balances, lenders are easing other terms out of jumbo financing. panding guidelines to accommodate In July, a three-judge panel for the U.S. as well, including going up to 95% loan- “Their alternatives are cash or private these larger loan balances, particularly Court of Appeals for the Fifth Circuit ruled to-value ratios. If a borrower has a large money loans,” said its president, Dane the ones that fall outside of traditional the agency’s leadership structure, in which a enough nest egg of liquid assets, some Smith. “We’ve seen the borrower demand. prime jumbo credit guidelines in the single director is shielded from presidential fir- lenders are also willing to forgo tradition- They’re great loans, great borrowers, they non-QM product categories,” Adamo ing without cause, violates the Constitution. al employment and income verifications. have really attractive credit risk profiles.” said. “There are just things you can do in But a more explosive story broke 10 days “Overall, these specialized products The higher loan amounts even apply a non-QM product to make the mort- later in a report by Politico about an investi- that didn’t exist three years ago have to credit-impaired borrowers, where gage process more convenient and less gation into allegations that Watt, an Obama expanded dramatically, as rates rise and the previous limit was $2 million. Verus cumbersome for the borrower than if they appointee whose term ends in January, made refinance volume shrinks,” Furey said. purchased a few of these loans on a test were to go through the traditional route inappropriate sexual advances toward an “These unique niche products are picking basis, liked the borrower profile of the ap- of a typical prime credit jumbo product.” employee. On Aug. 2, Politico also reported an up a segment of purchasers that may plicants and decided to offer the program These loans are being bundled in secu- investigation into the FHFA’s inspector gen- have been locked out of the market.” on a broader basis, Smith said. ritizations with those under $1 million, he eral, Laura Wertheimer, for allegedly taking The relaxed standards mirror activity There are a number of factors for the said. But with each deal there are more steps to undercut her office’s oversight of the in the traditional prime jumbo market, as recent popularity of these loans, he said. and more super jumbo loans included agency in response to pressure from Watt. evidenced by recent securitization pools. “People that are doing well, the econo- and as a result of the successful execution Mills and others said the effects of the In July, mortgage aggregator Annaly my’s doing well, they’re looking to buy a the origination community has gotten recent scandals on the agency’s current Capital pooled lightly seasoned prime house but they recognize or are surprised comfortable with increasing the loan leadership — and how it handles the conser- and jumbo loan originations with an when they don’t fit into a traditional box. amounts. ASR vatorships of the government-sponsored en-

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They may not have assets to qualify for super jumbo bank financing.” likely won’t have much bearing As a result, money-center banks are What the FHFA Scandal on efforts to reform the GSEs. not Verus’ competition for these loans. Reform of the housing finance The growth has been all along the Means for GSE Reform system has already been intrac- credit spectrum. “There are a lot of table enough. common-sense loans out there, and if we The biggest impact may be to focus the administration’s efforts on “GSE reform has many can find a common-sense loan to buy in selecting a nominee to succeed Director Mel Watt complex economic and politi- the super jumbo space, we will do that,” cal moving parts and thus won’t Smith said. be materially impacted by any By Hannah Lang Luxury Mortgage, a Stamford, Conn.- one or two individuals,” said based subsidiary of Tiptree Financial, just Mark Zandi, chief economist of expanded its guidelines for the nonquali- Moody’s Analytics. The Federal Housing Finance Agency has terprises — are likely limited, mainly because Some suggested the ultimate “There are just things you can do faced a barrage of negative headlines lately, Watt is near the end of his term and attention outcome of the court case over in a non-QM product to make the from a sexual harassment probe of Director has shifted to naming a successor. (The FHFA the agency’s constitutionality is a mortgage process more convenient Mel Watt to a court ruling declaring the declined to comment for this story.) bigger factor in determining the and less cumbersome for the agency’s leadership structure unconstitutional. “This would have a huge impact if this was agency’s future. “If we see any borrower.” But will the flood of bad news affect policy in the first six months of the tenure, not in the rethinking about the agency’s related to oversight of Fannie Mae and Fred- last six months,” said Mills. leadership structure, it won’t be fied mortgage jumbo offerings, moving to die Mac? But if the administration had not been fo- because of” this pair of scandals a $4 million loan limit from a $3 million Analysts say the biggest impact of all the cused on selecting a new nominee to run the “but because of the constitution- limit established when the program was attention — albeit negative attention — may agency, the recent scandals may be acceler- al questions raised by the Fifth rolled out in January. be to elevate the profile of a relatively obscure ating that process. Attention to the agency Circuit or the choice of a deeply agency that poses significant personnel and could grow next month; the House Financial ideological successor to Director More loans being securitized policy questions that the administration will Services Committee plans an FHFA oversight Watt,” said Jim Parrott, a fellow On the prime jumbo side, it will do up have to address sooner or later. hearing for no later than Sept. 27. at the Urban Institute. to $5 million, but it will go above those “It’s kind of turning D.C.’s attention to the “Each one of these headlines ... brings more The agency has had a full amounts in both programs on an excep- future of housing finance a little bit more than focus to the transition ahead more so than workload in Watt’s last year as tion basis, said CEO David Adamo. it has been for some time,” said Ed Mills, a necessarily defining the transition,” said Isaac director, such as a proposal to “There’s been a proliferation of ex- policy analyst at Raymond James. Boltansky, the director of policy research at establish minimum risk-based panding guidelines to accommodate In July, a three-judge panel for the U.S. Compass Point. “So at a minimum it’s just get- capital requirements for Fannie these larger loan balances, particularly Court of Appeals for the Fifth Circuit ruled ting more attention within a White House that and Freddie. But some items on the ones that fall outside of traditional the agency’s leadership structure, in which a I think at times has not prioritized financial the agency’s policy agenda are prime jumbo credit guidelines in the single director is shielded from presidential fir- regulatory nominees in its to-do list.” not tied to Watt’s leadership. For non-QM product categories,” Adamo ing without cause, violates the Constitution. Still, Boltansky agreed that the recent example, the second phase of a said. “There are just things you can do in But a more explosive story broke 10 days developments likely will not impact broader common securitization platform a non-QM product to make the mort- later in a report by Politico about an investi- discussions about FHFA reforms with Watt’s for the GSEs has been delayed to gage process more convenient and less gation into allegations that Watt, an Obama exit at hand. the second quarter of 2019, after cumbersome for the borrower than if they appointee whose term ends in January, made “If we were at a different point in the five- Watt’s term has expired. were to go through the traditional route inappropriate sexual advances toward an year term, I think that there would be more of Boltansky said the elusiveness of a typical prime credit jumbo product.” employee. On Aug. 2, Politico also reported an a window for legislative consideration of the of GSE reform is unchanged by These loans are being bundled in secu- investigation into the FHFA’s inspector gen- FHFA’s governance structure, but given that the recent scandals. ritizations with those under $1 million, he eral, Laura Wertheimer, for allegedly taking we’re a few months and possibly even less “The reality is the system said. But with each deal there are more steps to undercut her office’s oversight of the from President Trump getting to tap the next works as is, it’s a significant and more super jumbo loans included agency in response to pressure from Watt. head of the FHFA, I seriously doubt that either driver of the economy and any of and as a result of the successful execution Mills and others said the effects of the chamber of Congress is likely to focus on this the substantive reform propos- the origination community has gotten recent scandals on the agency’s current issue,” he said. als that we see being considered comfortable with increasing the loan leadership — and how it handles the conser- And analysts widely agreed that the carry considerable execution amounts. ASR vatorships of the government-sponsored en- agency being cast in a more negative light risk,” he said. ASR

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liquidity need for midsized investors to preserve affordability of current single-family rental properties, a lack of financing options for properties valued under $100,000, and the need for stan- dardization in asset and property management practices,” according to an FHFA document. Workshop attendees also proposed changes to Fannie and Freddie’s existing programs, including underwriting cash flows and offering non-recourse loans. The FHFA said while it rec- ognizes a potential need for long-term financing for midsize investors owning affordable single-family rental assets, it is “premature” to allow GSE involvement in this segment of the rental market. “The effects of their participation on rent growth, long-term affordability, for-sale assets, and homeowner- FHFA Halts GSE Pilots in ship is insufficiently understood without significantly more exten- Single Family Rental Market sive research and analysis,” the agency said. The agency said the market for larger rental investors may not The Community Home Lend- need additional liquidity from Fannie and Freddie ers Association also expressed concern about the pilot pro- By Elina Tarkazikis grams in a March 2017 letter to the FHFA responding to reports that Fannie Mae was provid- The Federal Housing Finance Agency is the agency said ing $1 billion in financing to the ending single-family rental pilot programs The pilot programs run through the govern- Blackstone Group unit Invitation that were aimed at testing the need for ment-sponsored enterprises were launched Homes. The association ques- greater involvement from Fannie Mae and two years ago in response to growth in the tioned the transaction’s mission, Freddie Mac in the market. single-family rental market. risk, lack of transparency and “What we learned as a result of the pilots Fannie and Freddie provided data and impact on communities and is that the larger single-family rental investor other assistance for the test runs, while the consumers. market continues to perform successfully with- FHFA administered its own impact analysis The CHLA issued a statement out the liquidity provided by the Enterprises,” from a range of investors, lenders, rating saying it was “pleased” with the FHFA Director Mel Watt said in an Aug. 21 agencies, data providers and consulting firms. FHFA’s decision. The GSEs “can press release. The existing single-family rental The agency also held a single-family rental now go back to focusing on programs will remain in place and the move workshop in June 2017, where it collected ad- smaller investor loans for afford- does not preclude future proposals on additional feedback from stakeholders. able single family rental proper- dressing housing needs using SFR strategies, “Workshop participants noted a potential ties,” it said. ASR

34 Asset Securitization Report September 2018

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