How Can I Sign New York Banking Word

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good afternoon everyone I'd like to ask everyone to come in and get settled so we can get underway begin our afternoon session we did a pretty good job this morning I think staying on track and we want to try to do it this afternoon but it's gonna be a little bit more of a challenge we've got three sessions here back-to-back so we're gonna get going in a second here in fact I will invite my panelists up to the stage and we'll get underway panels my panelists are engrossed in conversation among themselves that's how interesting they are yawn yawn Peter my name is Michael drain I'm a senior vice president at Ginnie Mae I lead our efforts in strategic planning and policy I'm gonna say just a couple of words about this session and then I'll introduced our panelists and then we'll start the dialogue I I think of this session as being partly a continuation of the dialogues that we've had at I'm pretty sure each of our four previous Ginnie Mae summits and we talked about MSRs really from the standpoint of industry practitioners who's buying MSRs who wants to own em MSRs who doesn't want to own em SRS why don't they want to own em SRS how our MSRs financed what's the difference between owning MSRs and servicing loans and how is that changing we talked about all of those things but as I said largely from the standpoint of Industry practitioners so today we're going to talk about some of those same issues but looked at from the standpoint of analysts of the industry analysts of the companies that perform these functions our panelists today are all individuals whose professional role in one way or another has been to analyze this industry that many of us are part of and the firm's within it so I think they'll have some good perspectives on an area that continues to change fairly dramatically from year to year so I'll quickly introduce the panelists and invite them to say more about themselves during our conversation first is Nancy Wallace who's a professor of finance and real estate at the University of California Berkeley Chris Whalen who was investment banker and author and from 2014 to 2017 was a head of research at Kroll bond rating agency and Peter sack as a managing director at Credit Suisse and the head of Credit Suisse's mortgage finance unit so Nancy I think I will start with you you achieved world renown as one of the co-authors one of the five co-authors of what I think is commonly known as the Brookings paper was published last spring the formal title was liquidity crises in the mortgage market and the way I would describe that paper was it was an attempt to elevate and illuminate the issues of liquidity in a world that was becoming increasingly dominated by non banks why don't you start by telling us a little bit about your professional field and and how you got to putting all that work into that paper and what some of the things are that you've been working on coming out of that great thank you very much for having me it's really a pleasure this has been an incredibly interesting conference for me so I'm the person that trains the people that go to all these firms so I train people and how to price mortgages and how to think about aggregate risk and how to do risk management and what are the tools of the trade how do you hedge how do you price how do you quote yields how do you assure that Ginnie Mae meets its mission to connect this bond market to the global capital markets and around the cry I've been working on mortgage markets for a long time I run a lab and we have 72 terabytes of data where by which was a very long process and putting together where we see into this market starting from the loans all the originators all the houses that have the loans not just on the residential side but also commercial and then over a long period of time what's the performance in the loans and we heard this morning much about the subprime market and understanding how that failed but the other story in subprime is there are still a lot of subprime mortgages outstanding and people are paying their mortgages so I think there's a lot to be learned from the prior data and obviously linking that to the current data which is much more Ginnie Mae which is the subject of today and also the GSEs obviously so what I got into this is obviously I'm right next to the San Francisco fed I do a lot of policy work I sat on a PIMCO board so I see a lot of what's going on in the in the mortgage market and a singular feature that I noticed was that nobody had the data so mortgage data is very complicated there's no mortgage loan ID so different from the bond markets that many people are used to there's no way of easily tracking the instruments and so my first mission a naively was to try to get the Treasury through the app stock or the Fed or someone to have an ID function for the mortgages hopefully one that showed Providence we never achieved that so that was a singular failure and coming out of the crisis but we also don't have really mortgage data sets that easily link the full contracting space like all the elements of loan-to-value debt service coverage something about income something about racial or ethnic status of the loans and so really understory even where the loans were originated who the true lender of record was so understanding the full surprise was essentially impossible pre-crisis now it's simpler because most things are going through Fannie and Freddie so there's a somewhat simpler supply chain but one of the big efforts that I was involved with it US Treasury is trying to build networks of how this market actually works and we heard earlier this morning that non banks are not all the same creatures and understanding their funding structures is absolutely essential and that was something we worked on a lot right after the crisis and trying to understand how the subprime market which was also largely non banks are heavily warehouse funded our repo funded or a BCP funded entities actually funded functioned and what their supply chain was how a mortgage flowed all the way through to these securitizer so the concern was that without these data it's very hard to see aggregate risk in the US economy and in my role as an academic or people or person training people to go into this market or working with regulators both a Federal Reserve System and also the US Treasury it's very important to meet the obligations of the bond market which is the bond should be actuarial we should be able to quote yields that people can believe in at least in an expectation sense and in order to do that we need the data so pre-crisis another problem was just the speeds at which you could sell alone which was my understanding the network was so important now the issue is understanding a counterparty credit risk and that was another function pre-crisis and the other derivatives markets of understanding clearing understanding how these networks work and now we have the situation where we really need to understand the counterparty risks and what kinds of risks are outstanding both in the economy and certainly for entities like the GSEs and especially Ginnie Mae let me throw the question is is there a dramatic difference between the data that you have available on counterparties when the counterparty is a bank versus when it's not a bank yeah so the big learning and the reason for the Brookings paper which is basically why we did the Brookings paper is that getting the funding structure of these entities is extremely difficult it's we didn't have the data so I had the data through bankruptcy filings a lot of these data are offshore or they're in a BCP so you can get it from the rating agencies in very complicated ways but we didn't we still don't really have the data on who the counterparties are what their capital structures are what the correlations are how many counterparties a given entity has how much they're using the repo market we simply don't know that information and the reason the only reason the brookings paper existed is that the Fed through D Fast & C car now has the Y 14 data and the y 14 data gives at least at least through the banking source of this capital information on the warehouse lines their margins how they're structured how many lies on average different entities but it's only the banking side of things so the Brookings paper is really uh in my view a clarion call that we need these information if we're going to understand aggregate risk related to the mortgage market and we do not have it and the effort has to be and I salute Ginnie Mae for its efforts to try through the discussion with a large opponent with the large non banks in January and also the effort to get a better handle on what their counterparty exposures are let me ask Chris to pick up from there Chris you're you were in a slightly different situation that as part of a rating agency you presumably had access to a lot of data because they were your clients so how would you talk about the implications of this transition from banks to to non banks as an analyst well first off thank you for the invitation Michael really the way I look at the world is non banks or the private sector banks are government-sponsored entities just like Fannie Mae and Freddie Mac and so expecting non-bank companies to compete in this Jurassic world where there are these super entities that have sovereign credit ratings is almost unreasonable I think in the ratings profession yes we get confidential non-public information from any issuer that seeks a rating but I think it's important to remember there private companies that are not depository as' and that are not subject to section 12 of the US Code have no you know compelling responsibility to disclose these are private businesses and even though they do fit into the grand scheme of things in terms of risk and you know the economy and everything else ultimately I think we have to respect the fact that they don't have subsidies the way a bank does they don't have Federal Deposit Insurance and access to the discount window in the ratings world you give a bank automatically a full notch uplift in their rating simply because of government sponsorship sometimes more than that by the way so you know in an aggregate sense if you step back and say what's changed in ten years Michael the risk is the same it's just now we have seen banks go from taking risk directly both as lenders as sellers of loans as packagers of mortgage-backed securities now the banks are simply providing credit to non banks mostly on a fully secured basis by the way and when you look at most non banks after their pledge of collateral their pledge of their MSR their pledge of the office furniture there's no net capital left that's just the way this industry works and it works because the loans and the securities are guaranteed by the United States today that is no longer the case for example if we were to take Fannie Mae and Freddie Mac out of conservatorship well the good news is the private label market will be much bigger but for me I work with an investment bank in New York that provides financing and TBA and everything else for small and mid-sized mortgage companies and when we do a repo transaction today with any collateral in the agency market it's all the same but if we were to mess around with Fannie and Freddie and start to pretend that they're private companies that changes a lot and the cost of capital to the non banks would change and they would all come to you Michael do you see much likelihood that this evolution is going to continue in a way that would see today non banks large non depositories actually seeking to become banks and would that even make sense yeah well you've seen a distinct trend among the banking industry over the last ten years in a couple ways one the portion of their balance sheet that they allocate the holding whole loans is slowly declining it used to be 20% and it's down or at 11 they're not selling as many loans they're looking at keeping larger higher quality loans on balance sheet and largely withdrawing from the market so for example the FHA market and you could blame this on False Claims Act activity by the Department of Justice but I think it's a more profound trend it has to do with the price of the risk it has to do with the fact that our friends at the Fed are constantly forcing interest rates down to to try and propel consumer activity in the economy and so you're left with a corpus of assets didn't no longer have any carry and this is a big deal for the industry because 10 and 20 years ago just owning the loan against funding was kind of okay you didn't have to sell a loan you could just sit back and earn the spread today we're at the lower bound of interest rates and we have a flat yield curve and it's a good friend of mine a very veteran short term Treasury traitor said to be goes Chris it's different when you have a flat yield curve at the lower bound because there's nowhere to go you know for it's an operating business so I think the banks are not going to come back for a while it's Basel it's a whole list of reasons why they just don't see the risk adjusted returns of a wonderful family loan as being that attracted especially a small loan if it's above a half million dollars and they can collect 25 basis points on it and high FICO borrower okay they'll buy those all day long but they'd rather have a five million dollar jumbo made to a condo purchaser in some big urban area that's your sweet spot now Peter why don't you step in here you're a representation in a way of something that's been talked about a little bit earlier as well today which is the banks are perhaps not directly participating in mortgage origination and servicing in the way that they might have the larger commercial banks anyway 10 or 15 years ago but that doesn't mean that their exposure has lessened they're playing they're playing another role in the system why don't you talk about that yeah that's true the one effects of the the migration to a non bang market or more of a non-bank market in the jinnee space certainly has been well it's true that the banks still have risk in the form of bilateral repo there has been you know one noteworthy event of the last couple of years has been the growth of the securitization market for MSR financing and that has you know it's attracted a lot of attention and it implicates a lot of you know what would have been described as sort of some benefits and some costs and certainly one of those costs is as Nancy alluded to earlier you know potentially a reduced visibility into a number of data elements that would be helpful to you know be more observable and maybe some complexity also in the balance sheet and the capital position of some of the counterparties but it comes with a lot of benefits as well which is you know to name a few an increasing diversity of funding sources in securitization market investors across REITs and money managers and insurance accounts at least at the moment a substantial reduction in funding cost given you know that different from negotiated bespoke bilateral repos you're putting the marketing cop to provide financing it implicates new risks in that market conditions can change ambassador appetites can evan flow and that can create some disruption on the other hand it allows originators to letter their maturities in a way that they certainly can in the overnight repo market it still implicates some mark to market risk but you know subject to a lot of constraints or or least benefits in the part of the the MSR investors so that has been you know that has been a signal development the last couple of years it's it's certainly the case that banks own a lot of loans on their balance sheets big loans and different kinds of loans and they are participating in the market and providing funding in significant ways even if they are not always directly the originator of the but there is a greater capital markets involvement in geni and an MSR is in particular than there had been before and I think that you know you could argue that those diversification and funding cost benefits the broadening of the market are away from just banks you know maybe made more serve you know benefits that that at least offset the you know the negative components some of these new sources of capital and and you've had a lot in the structure that you worked out initially with Ginny and I think is now spreading to the GSEs some of these new sources of capital have never before there represented by institutional money managers who I think it can be said have never before had this kind of direct exposure to MSRs that they have now and there's the numbers are getting pretty large so I'd be curious for any of the panelists what what observations would you make about that these new sources of capital that are coming onto the scene how are they going to assess whether their investment has been successful or not and how are they going to use their own resources to kind of figure out what the risks are and whether this is really a good long-term investment proposition oh I think it's fascinating that the the audience for EMA sources expanded enormous ly as our colleague was just describing but at the same time that asset class has been whipsawed by the same forces that the bond market has been dealing with which is the Federal Reserve you know Emma Soares were the best-performing fixed income assets in 2018 and as today is trading it you know extremely high multiples compared to the historical x' the thing I worry about a little bit with investors is that sure they thought god this is a great asset class we're really interested all the big buy side investors are either involved in m/s ours or they've also become a sponsor behind a lender at the same time but I think that the full appreciation for the capital components of the asset and particularly the degree to which you're short a put position essentially with respect to capital in the event that the cash flow going through the asset is insufficient to take care of loss mitigation so you have to be willing to be patient and you have to be willing to really work with your servicer and your lenders in order to manage that asset through the lifecycle which could be 15 20 years so I worry a little bit that as we normalize interest rate policy at the Fed we may see some of the pricing move back look at what we've just been through I mean a 10-year is headed through 2% so I think when we look at earrings this quarter and look at the effectiveness of hedges versus the long position in the MSR it's going to be very interesting to see how both the banks and the non banks are managing that right and also these are runnable markets so they have never been safety and soundness stress tested so it's very hard to understand what the cycle effects on some of these players are because a we don't see into the markets well especially the stuff that's offshore and securitized and B there's no unified way of stress testing of them as things stand now and we know know there like an IO and we know there were huge losses when interest rates turn against you in that kind of a market and are these firms really set up to deal with that and right now we have no transparency or visibility into that truth well I think it's important to consider also that the transactions that Michael was alluding to and I just remembered I need to say at some point out loud that like my comments or my personal opinion this is the bank maybe I speak from the transactions that I'm thinking of it that I think Michael was alluding to our financing transactions those securitizations are essentially loans to the MSR owners they are not themselves principal trades in the MSR so the the buyers and those securitizations whether their money managers as many many are but also reads and insurance accounts they're not really buying MSR per se they're collateralized by MSR so they have exposure to the market value of the asset but these are fundamentally an alternative to repo financing they're not actually MSR trades I do think that as the market continues to evolve and and we've been impressed personally I've been impressed by the extent of expertise among the investors in those transactions so far and how well they understand the asset but I think it probably will continue to evolve such that some of the elements the structural protections because it's a pretty nuanced legal transaction given the liens and the the dispute resolution issues and so forth some of the financing transactions will probably lead to an increasing liquidity in the underlying asset and and and inform structures on MSR principle trades settler from the financings and and that so this is an evolving environment I don't think that we've left quickly from a bank funded market to a money manager funded market in one's one fell swoop but there have been some incremental evolutionary steps in which I think jenny has been a very constructive you know participant an innovator that are leading us to a place where you know ideally we'll have a market with greater liquidity a diversity of participants and you know potentially a greater therefore risk mitigation through market turbulence and and other you know unforeseen events well you know one thing we should mention Michael is if you looked at three four years ago compared to today on the terms for financing MSRs they've improved dramatically I'm a little bit concerned that we may be at the point where it's as good as it gets in this cycle and so the question is can we go through rising defaults and not see banks start to back away from that seventy percent haircut on jinny assets and go back 60 or 50 because what is absolute death for the non-bank sector is if they get caught off the banks can kill them with a phone call well I think that that is probably the may be the leading argument for greater diversity of funding survives that it's not one phone call with with a person in a bilateral repo it's actually a structure that defines the events that can cause changes in the terms and it's a market transaction where one person at one institution might have a view that's different from diversity of other buyers so except for the contracts I haven't seen as much on the security side but a lot of these contracts you have more than for one institution you have more than one provision of financing and so the Covenant says I've seen are very much a daisy-chain that if any one of them pulls the line all the rest of them get to I think that's kind so it can run quite quickly once you get a spark I think that is commonly the case but I think part of the concept of the of the capital markets transactions is well it's certainly the case that often lenders will have multiple repo arrangements that all have covenants that are triggered by the occurrence of you know some event that precipitates an event of default that triggers a default under all the repos the structure of the securitization transactions to date I think it could be that it mitigates a bit that risk of a domino effect a ceetain effect because those are not events that are there events that are fairly empirical they they're a factual situation and not a decision on the part of the person in the credit department at the bank to waive were not waived the event of the default I don't think anyone is under the illusion that this is already this has been perfectly figured out but what but I you know my personal opinion is that we're in a point today versus a couple years ago where we've gone from an asset that is at least a bit constrained with respect to devaluation by the fact that there are de minute there are very few people who can actually there's very little leverage available because there are a few people who can actually provide the funding to now a market where at least for some of the large market participant lenders ms or owners there is a much greater availability of financing and that probably is very hard to say rate adjusted but that certainly seemed to at the time given the significant reduction in funding cost that resulted very quickly from the emergence of those transactions does seem to have been related to an increase in liquidity and a reduction in or an improvement in valuation of the underlying asset and that's just generically true in capital markets right the thing becomes more financeable and to appreciate what you know what's interesting is that the evolution from the short-term financing to the term financing the credit suisse did such great work on to perhaps even an equity owner of the MSR and in turn the servicer and to basically the sub-servicer and if i could say go buy bank because to me the risk adjusted returns of the sub-servicer as a bank you know flag star for example are much much higher than a small non bank with no float trying to finance the whole MSR or maybe participating part of the excess strip out just so they can get more cash to go do it again these are cash constrained organizations so if we could eventually get an insurance company or a fund that has long-term capital to fund these assets I think that would be an optimal if you will replacement for a bank so so do you think then that if we and and this is of interest to me because of course Ginnie Mae has talked quite a bit recently about our desire to find ways of bringing non-traditional capital to finance MSRs are you are you suggesting that if we were successful in being able to do that and non-traditional capital had a bigger a bigger role that that would be a path for the re-emergence of banks purely on a operational servicing because of the advantages that they have with well with being able to capitalize themselves I think possibly and in particular if you look at the rules for small bank holding companies below three billion dollars they are very flexible small bank holding companies are not subject to Basel so right off the bat you can keep a hundred percent of your tangible common equity at the parent level in mortgage servicing assets it's like the old reg Y that's what it is to me a well-run firm that has float and it has a fee income from servicing but at least shares the capital risk in the asset is is a much better business model is much more stable will all banks come back no but I think there are enough of them out there that do like the residential asset that they will kind of go back to the future if you will and have mortgage specialization banks that do that primarily maybe with a retail component in the wholesale component since we've gone into but I think in order for this to work and I'm a big believer in securitization that's what I teach so I hope you're right we need transparency into these vehicles and that's going to be through the data mechanisms that Jenny is trying to build so that we understand what all of the implications of these new instruments really are and I think that's been a chronic failure and all these experiments that people are way out ahead of where the actuarial data are to understand what we're talking about whether we've increased risk or decreased risk and I think we're in that place right now we just don't have the information are you talking just to be clear are you talking about I'm talking about long level data that are linked with specific issuers of specific counterparty specific contracting elements on the MSR well it's like ed DeMarco said this morning you want to make it easier to make these public deals with reggae be now and all of you know err Kaplan has done a lot of work on this at milk and the complexity of the deal documents today is is really daunting in terms of getting into a public market just one other comment back to the Brookings paper when we were given permission to write that paper for Brookings because I'm a mortgage person and we all speak a language that many macroeconomists have no idea what we're talking about we have to rewrite that paper five times to get it into plain English I mean to explain these contracts in plain English which the SEC now requires all of us to do is actually very difficult and to get normal you know highly educated macro people that are very concerned about macro-prudential policy making to understand what we do in plain English is imperative and that took a lot and I fought myself that I had to learn to speak plain English to write that paper with my colleagues at the Fed and I think it's a fault of our industry that we don't make that effort very frequently speaking of macro-prudential policy making I think and also speaking about demarco he made a comment this morning that I'd like to get people's thoughts on and it was about capital and he was talking about and I hope I do justice to this that there are disparities in how the various people that take opinions about how much capital of say a non bank should have as as Ginnie Mae does there are disparities in how though different entities assess how much capital is required in this business and he seemed to feel that was very important to work hard to get that on more a level playing field in order for us to be in the place where we need to be when we inevitably hit adverse circumstances so what are thoughts of the the panel about capital requirements for non banks in particular and where we should be going there well I'll start I think you know again the non banks are compared and you must compete with government-sponsored entities so right off the bat they have a very tough road to hoe funding you in the 80s and 90s little mortgage companies could issue their own pass-throughs and Sulli's securities to money market funds they're not allowed to do that anymore after in fact before long-term capital management failed they changed reg to a seven and they handed a banking industry a monopoly on short-term finance so all of the risk is in the banking sector and the assets are owned by the GSEs let's remember and the non banks are essentially allowed to rent them and play with them but they don't have enough capital to own them on a free-standing basis and that to me you know it's almost hard to answer your question Michael because if I'm competing with a bank that runs at 15 to 1 and has subsidized funding it's kind of hard for me to set a level playing field if I got rid of the GSEs and I just had Ginny as the policy vehicle okay maybe that broad is the market enough that we have a room for the private sector at work but the differential in pricing is still going to be rather dramatic I may be a couple points wouldn't green I mean the other interesting thing that was brought up earlier is the role of the fh all these with advances and that that is a pooling equilibrium they're making everybody pay the same amount whether they're big whether they're small and it is bringing liquidity to the small guys in a fairly transparent way and it seems to be having quite a large effect in terms of mortgage flow for the smaller originator who then hold it on their balance sheet so it's possible that that vehicle could weather I'm not so sure about pooling equilibria when you're trying to price risk but it is at least a model that would make it more accessible and more of a level playing field hey look Seldon new platform to the Home Loan Banks let anybody who has eligible collateral play or even private deals and then unfortunately we don't need the other two corporate entities we have just a few minutes left here so I'll ask a question and anyone can jump in and answer with your thoughts we in a in a paper we wrote not that long ago that talked about our observations from a series of meetings that we had with our largest non-bank issuers earlier this year we were I think fairly frank in acknowledging that this world that were operating in has changed a whole lot and speaking for Ginnie were were proud of the work that we've done to try to keep up with that in our you know risk management and and policy work but there's no presumption that that we've been completely as successful or that we're all the way there there is certainly a whole lot more work to do so I'd be interested in any thoughts anyone has looking at the government now as to what what the government can do and I mean let's let's say apart from housing finance reform and conservatorship all of that let's make that a separate issue but what what can government do to better adapt to the world that we're operating in now in terms of you know capital regulation or policy or programmatic changes or you know anything and anything you can think of what's what advic might you give well my one's easy as an academic and working with regulators of various types is to increase the long level accessibility of what you actually do and I think that's a huge problem being able to track loans into pools and then how we split the pools into the IOPS or whatever we're going to create out of the pools we need transparency in that full supply chain and that could be very easily provided by Jenny and right now it really isn't and that would be very helpful for these capital markets in terms of just understanding competition who are the players how is risk aggregating at least in the type of products of course we don't see into the financing piece of it and if you could provide that and I think that the Council of State banking supervisors could make a make that more open as well and I think that is the intent through there through the Federal Reserve System and I think that is also really positive so on that side that would be a big advantage well two things Michael I think number one it should be at least a medium-term goal of FHA and Ginny Mae to make the resolution process the claim process the loss mitigation process no more costly than the GSEs there's no reason for that bifurcation I know it's difficult to say oh my god and then the other thing is I think you know working with a couple of issuers myself I would like to see Ginny clarify exactly what their expectations are from issuers especially if we're going to tell everybody to manage their business to a Moody's single B rating having written a finance company methodology I'd like to know which parts of the document we should focus on and I think that would be very helpful for for a lot of non banks thank you Peter we have just a few seconds any any closing vets of refinish have no suggestions for the object well I would like to I'd like to express my appreciation for our panelists all of them came in from out of town for this Nancy came a very long way so this has been wonderful I wish we could go on for a longer but I very much appreciate your time and I appreciate the attention of the audience thank you very much [Applause]