The Securitization Market Is Seizing Up

After my interview with Andy Sandler of Buckley Sandler, who said he is seeing a freezing of the credit markets because of the foreclosure fiasco and put-back tsunami, I decided to call on one of the well known banking experts in the market—David Ellison, Portfolio Manager of the five star FBR Small Cap Financial Fund.


So have the wheels of the credit market come off the rails?

David Ellison: What I'm hearing the bigger companies are looking at the processes now. They are not being aggressive in issuing new mortgages. They want to make sure they get the process right. All the securitizations are getting bogged down. This is not an issue of banks not wanting to lend. They want to make sure on the front end they have all the appropriate information on the back end ready. The smaller companies are in better position because they are not directly securitizing loans. And when they sell a loan, they don't own it. Its a simpler process.

You bring up an important issue and what I'm more concerned is what's going on the very front end which you bring up. If I go in for a mortgage now, will it been bogged down because they are so backed up with the other stuff or because the banks will have to additional stuff and will delay it?

LL: What kind of impact will this short term moratorium have for the auto dealers and other industries that rely on securitized loans.

DE: There are two parts to this. If you are originating a loan that's going into securitization, that system I think been slowed down dramatically because the banks will need additional stuff and make sure it has to be done right. Non-securitized loans have not been impacted.

The real question is we don't know for sure that how much of the lending that's happening out there is being securitized. Now one could say you have had some stats that 80-90 percent of all the mortgages that are being originated are being put to Fannie, Freddie and FHA. They're not being sold but being put to them for insurance purposes.

Now that's a big number right? I don't think we fully understand what kind of impact this can have on the securitization market yet because we haven't heard from Fannie, Freddie and FHA. Once they decide what they need to do, we'll get a better sense of what is going on.

What you are seeing now is one of the final things that needs to get done to have securitization make sense and move forward. They have to clean up the processes. It will be more expensive for the borrower, underwriter and lender. At the end of the day, a lot of the securitization was not tested for this environment.

It was not tested because they thought home prices would never go down and if there was a foreclosure, you would make money. Now its the other way. In a sense we are testing the drug on the public versus having a FDA phase one, phase two, phase three.

So how many millions of people do we kill financially in this country because we didn't test these products? And how many balance sheets in the financial services industry blow up because they didn't fully test the products and didn't understand them because there was not enough time to test them? It was all about newer, faster, "safer" products. So now we are going through this process of understanding the downside of securitization.

The trial is being done in real time and we are killing a lot of people and we are killing a lot of companies. And unfortunately, the people are not getting bailed out, but the companies are. So that means is there really any downside for these companies to come out with additional new products to try and solve this problem? So that's the cycle we are in right now. They brought it on themselves. They wanted to sell these products because they made a lot of money on them and now we are seeing the other side.

So, credit will be restricted for a while in the securitization process, which is a big part of lending unfortunately.

LL: How long do you think the lending will be slow?

DE: It depends on a lot of things. You are writing things that are a month early. We have not heard from Fannie or Freddie, the FHA, the Federal Reserve. We haven't heard from FASBY yet, we haven't heard from the legal profession because typically they'll tell you what is an appropriate stance to do and everyone then follows suit.

Right now, the legal profession has not agreed on foreclosure procedures. So now you have different foreclosure proceedings going on from different companies on the same loan. So the legal profession needs to weigh in on that.

We are early in the game here. We are still trying to understand the full impact of what is wrong. You could also have a huge class action lawsuit which could also impact the system. Hopefully it won't get that bad, but this is the downside of securitization.

LL: How would you characterize the lending process?

DE: The best I can understand it right now is the lending that is being sold into securitization is being impacted. Auto loans tend to be securitized so that would be impacted more than say a commercial loan because they are not securitized. On balance, most commercial loans are put into bulk portfolios. Residentials are mixed.

Typically, the securitization volumes of residential mortgages have come down on a variety of reasons. One being the big securitizers are gone- Lehman, Goldman, Merrill, Countrywide. Its not about FICA scores, down payments, its about paperwork. And that something that can resolved quickly if you pay attention to it.

In addition to auto loans, other loans that would be impacted are factored loans and mezzanine loans which are typically securitized or put into pools. Then you have one off loans which are specialty loans which are also typically securitized. If you want to do equipment leasing that has grown into a securitized industry. So its leasing, autos, consumer finance (if you want to buy a washing machine)—all of these types of loans are securitized. And of course so are credit cards.

LL: How will all of this shake out?

DE: Before this, we were dealing with asset values that have been going down. This inning is about the rules of the game. What will the rules going to be? How will we foreclose? How will we collect?

We are playing a totally different game now. It's not about home prices, interest rates, spreads, margins, its not about loss reorganization. Its about the rules of the game which is underneath all that. And that game will hopefully be over in three months or something and it will be ok and we'll be back to the basic ok- home prices are going up or down, jobs are going up or down.

The normal things we have been battling over the last two years. Maybe you call it the seventh inning stretch with an announcement from the league saying we're not going to use bats anymore. We're going to use sticks. And of course then the whole game changes. I don't think anyone will benefit from this slow down.

We need to get back to the whole securitization problem. We securitized first, and worried about the impact and the side effects later. We are now at the later.

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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."