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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

The Next Trillion-Dollar U.S. Mortgage Market Meltdown May Be Coming

Housing-Market / US Housing May 30, 2014 - 04:16 PM GMT

By: Money_Morning

Housing-Market

Shah Gilani writes: The fourth securitization deal of big investor-owned single-family homes for rent is here.

Is this just another Wall Street gamble that will wreck the economy again, or is this time different?

You be the judge.


I'll tell you where I stand....

It's Already Begun

After buying more than 200,000 single-family foreclosed homes resulting from the mortgage meltdown, institutional investors are now spreading their risk through the system.

They're selling the risk of owning inventoried homes through securities with pools of underlying rental properties as collateral... to the same institutional buyers, who in their previous desperate hunt for yield, are back for more.

In the fourth deal of its kind, Blackstone Group L.P.'s (NYSE: BX) subsidiary Invitation Homes will close on almost a billion dollars' worth of real estate owned (REO)-to-rental credit-enhanced structured securities on May 30th.

Last year in November 2013, Blackstone's Invitation Homes packaged up 3,207 of the more than 40,000 single-family homes it purchased for $7.5 billion since late 2011. The first-ever REO-to-rental securitization raised $479 million and was six times oversubscribed.

After Blackstone's successful issuance of securities, two other industry leaders in the REO-to-rental market, Colony Capital's subsidiary Colony American Homes and publicly owned American Homes 4 Rent, followed suit.

The latest deal, with an issuance of $993 million of securities, is the second deal from Invitation Homes and the biggest to date.

Keefe Bruyette & Woods, an institutionally oriented broker-dealer and full-service investment bank, estimates that REO-to-rental securitizations could grow to $900 billion to $1.5 trillion. The bank says their issuance estimates assume 15% of purchases by institutional investors, with just 35% of their inventoried homes going to market.

All four deals are constructed similarly, and all have substantial portions of securities rated top-notch by three major rating agencies.

Bonds Collateralized on Thin Air and Opinion

Let's look at Invitation Homes' first template deal, Invitation Homes 2013 SFR1, to see if anything's different this time.

Invitation Homes structured the deal by getting a non-recourse first-lien floating-rate mortgage loan on the underlying 3,207 rental homes from German American Capital Corporation. German American is a "significant subsidiary" of Deutsche Bank AG, the bank behind Invitation Homes' deals. The mortgage loan gets funded from the proceeds of sale of the securitization certificates.

The certificates represent six different "tranches" that make up the structured deal. The deal is "structured" to provide "credit enhancements" to various tranches up the ladder. Essentially, in structured deals the credit enhancements desired are nothing more than better ratings.

Better ratings on laddered tranches, all the way up to top-notch "AAA," result from redirecting cash flows and principal prepayments and losses in a manner that it is theoretically supportive of a "AAA" bond.

If you think you've heard that before, you're right. Structuring was behind more than $2 trillion in losses suffered by the world's largest financial institutions during the credit crisis and mortgage-backed securities meltdown.

Invitation Homes 2013 SFR1 was issued last November. At the time, according to raters of the deal, the company was borrowing more than the relative value of the underlying collateral homes than any recent vintage residential mortgage-backed securities deals. Their "cushion" was "smaller than apartment complex" deals that had come to market.

Rating agencies noted that underlying properties had already seen appreciation gains of around 40% in some regions where homes were concentrated.

Concentration of collateral homes didn't seem to be much of a deterrent either to investors, even though clusters were dense in hardest-hit areas that had seen significant bounces: Phoenix, Riverside-San Bernardino-Ontario, and Florida.

Underlying homes cost $444.7 million and had $96 million in repairs, for a total cost of $542.8 million. Still, the collateral value of the homes was calculated at $638.8 million.

The valuation was not the result of appraisals, but real estate broker estimates. Based on the "cost" of the collateral the deal's loan-to-value is 88.4%; based on the brokers' valuation, the loan to value is 75%. Elsewhere in the mortgage securitization market, the highest LTV in a 2013 deal was 69.7%, where homes as collateral for bonds didn't have government backing.

Thanks to the magic of structuring, the three ratings agencies rating the deal - Moody's, Kroll, and Morningstar - gave 58% of the deal their highest ratings. In total, 91% of the deal received "investment-grade" ratings.

The coveted AAA rating moniker was stamped on 42% of the deal, even though only about 30% of all 2013 structured commercial mortgage-backed securities deals got the AAA stamp, and just 6% and 9% of packaged "prime" loans got that rating.

As a reference, subprime mortgage securities deals managed to get only 20% to 25% of their tranches credit-enhanced to AAA.

Moody's said of the deal that net cash flows relative to the size of borrowings was "very low" compared to apartment deals. And that "future expenses may also be bigger."

Meanwhile, Fitch Ratings, which didn't rate the deal and hasn't rated any of the other deals, said they disagreed with rivals' strong ratings because of the "limited track record" and incomplete historical data on rents and vacancies, and how those vary over economic cycles.

The Repeat Collapse Is Primed

Fast forward to Invitation Homes' latest giant deal, and nothing's changed.

Invitation Homes 2014 SFR1 is backed by a floating-rate loan secured by mortgages on 6,537 properties.

Deutsche Bank is the sole structuring lead, and Moody's, Kroll, and Morningstar have given the largest tranche in the deal, worth $477.48 million, their highest ratings.

It doesn't matter that 70% of the collateral homes are located in California (26.8%), Florida (32%), and Arizona (10.8%).

It doesn't matter that securitizing their REO-to-rental properties is all about leveraging their equity (Blackstone had a tiny $65 million equity in the first deal).

It doesn't matter that securitization deals have no more than 25% equity at stake, while bank credit lines for the same types of private deals require 40% equity, or that banks are doing these deals and selling them to their institutional clients clamoring for yield.

Speaking of yield, to prove that low interest rates are forcing investors out on the risk spectrum (sound familiar?), Invitation's latest deal pays AAA buyers only 100 basis points over one-month LIBOR, hardly commensurate with historical precedent.

So what if economists at the Federal Reserve have warned "that if large landlords take on too much debt they might feel pressure to hold fire sales of their properties, flooding the housing market with supply." Or that they've said, "Financial stability concerns may become more significant should debt financing become more prevalent or if the share of homes owned by investors in certain markets rises significantly further."

Maybe this time is different.

Maybe this time, after some property values have already risen 40%, they'll keep going higher and higher, like they did before.

Maybe leverage is a good thing for the banks and deal-makers maximizing institutional investors' returns. Maybe renters will be more inclined to stay and pay rent in houses when they can't afford them, as opposed to walking away like homeowners did back when.

Maybe institutional buyers paying up for insufficiently collateralized deals to pick up a few extra basis points while using their own leverage to increase returns are right that rates will keep going down, and the housing market is a one-way ticket to Dreamland.

Maybe those who forget the past aren't doomed to repeat it.

Maybe. And then again, maybe pigs will fly this time.

Source : http://moneymorning.com/2014/05/30/the-next-trillion-dollar-mortgage-meltdown-may-be-coming/

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