Comments on: Bottom Testing in Mortgage Land

By: bobo7874

bobo7874 — Tue, 13 May 2008 21:29:00 +0000

I don’t necessarily care about REITs in particular, what I do care about, is FASB and SEC rules providing financial/securities rules that help too-big to-fail-institutions over other financial entities. Check out the credit spreads of AA over high yield post-1990 when major changes were made to 3a-7, 2a-7, grandfathering of old instruments against the 1998 modification to 2a-7. When these institutions received financial/securities rules putatively favorable to them, credit spreads increased. Conversely, when their putatively favorable financial/securities rules were weakened credit spreads shrank. That suggests to me that these putative advantages help them, and increase financing costs to the real economy by reducing competition by other institutions.

By: Ginger Yellow

Ginger Yellow — Tue, 13 May 2008 16:51:00 +0000

Moreover, I think any impact of the rules in either direction is far outweighed by investor sentiment. In this current market, and for the foreseeable future, “select financial institutions” are going to have a massive advantage finding investors for paper they sponsor over other entities, regardless of accounting treatment.

By: Ginger Yellow

Ginger Yellow — Tue, 13 May 2008 16:49:00 +0000

But why should Reits compete equally here? An ABCP conduit seems like a spectacularly bad funding structure for an institution investing in lumpy, relatively illiquid long term assets like real estate. It proved bad enough for the sec arb conduits investing in smaller tranches of things like CMBS. Surely debt finance for real estate should be long term, not commercial paper.

By: bobo7874

bobo7874 — Tue, 13 May 2008 14:42:00 +0000

Of course financial institutions dominate. The question is whether “select” financial institutions dominate at the expense of smaller players like REITs, and thereby increase financing costs for the real economy. When I said “select financial institutions” in my prior post, I was thinking money center banks and prime brokers. And I do think the 10% obligor rule hurt REITs and other smaller financial entities.

By: Ginger Yellow

Ginger Yellow — Tue, 13 May 2008 13:01:00 +0000

I’m struggling to envisage a world in which financial institutions didn’t dominate. Conduits borrow short and lend long to finance assets, which is exacly what banks do. Now often those assets are trade receivables, but it makes far more sense for most companies to finance your assets in a bank sponsored conduit (where investors can be more confident the sponsor will be around to provide liquidity) than to set up your own. You’re still going to need liquidity support from a highly rated firm or you won’t get a good rating on your CP.

By: bobo7874

bobo7874 — Tue, 13 May 2008 10:53:00 +0000

Thanks, you’ve persuaded me that the banks’ competitive advantage due to FASB & SEC works differently than I’d thought. But I am pretty confident it exists and that is why select financial institutions have dominated since the 10% obligor rule and other changes. I need to think about this some more.

By: Ginger Yellow

Ginger Yellow — Tue, 13 May 2008 09:01:00 +0000

Thanks for the clarification, although if anything it makes your point even more obscure to me. The vast majority of conduits these days would seem to fall into the diversified support category – liquidity and hedging support from one or more banks, credit enhancement from third parties (programme wide) and the seller (asset specific). Which suggests the competitive advantage for “single support” conduits isn’t that strong. Indeed, given that a single support structure gives all exposure to expected loss to one party, I’d argue its least favoured under current rules.

By: bobo7874

bobo7874 — Tue, 13 May 2008 01:42:00 +0000

This is my terminology:

Diversified support conduit = liquidity & hedging support from multiple third parties, ie, deficiency obligation for third parties.

Securities arbitrage conduit = credit & liquidity support by a seller; hedging support by a seller, ie, deficiency obligation for a seller

Single support conduit = credit, liquidity & hedging support by the sponsor, ie, deficiency obligation for sponsor

Unitary support conduit = credit, liquidity & heding support by the originator or related persons, ie, deficiency obligation for originator

2a-7 and other rules favor single support conduits, which is the structure where banks have an advantage. The preferred treatment for QSPEs under Statement 140 over VIEs under Fin 46 also helps banks by reducing discretion and thereby increasing complexity and need for a highly creditworthy sponsor.

By: Ginger Yellow

Ginger Yellow — Mon, 12 May 2008 16:20:00 +0000

Sure, but allowing securitisation vehicles to not be dummy companies would kill it. Also, I’m not familiar with your terminology. ABCP conduits are conventionally broken down into securities arbitrage, single-seller, multi-seller and SIVs, based mainly on the underlying assets (SIVs being the excetpion). Your terminology seems to apply to the liquidity support, however. Is that right?

I’d also add that a) Basel 2 greatly reduces the capital advantages of conduits for banks, and so will level the playing field in itself when introduced in the US, and b) Reits and other non-bank sponsors will still be disadvantaged in that investors are paying a lot more attention to the liquidity providers than they used to. A strong bank sponsor will be able to fund its conduit far more cheaply than a non-bank sponsor or a weak bank until we get into another mad bull run.

By: bobo7874

bobo7874 — Mon, 12 May 2008 15:51:00 +0000

Ginger Y,

Historically, there’ve been at least 4 types of conduit structures: diversified-support conduits, securities arbitrage conduits, single-support conduits, and unitary support conduits. FASB and the SEC through 2a-7 and other rules gave single-support conduits an edge over the structures previously used by REITs and other sponsors. Using the other structures wouldn’t kill securitization, just increase competition for banks, and reduce their profits.