A journey of 1,000 miles begins with a single step.
It's fitting my inaugural post is a review of Deutsche Bank's
inaugural MBS and Securitization Conference. The conference attended
by some 60 investors from roughly 40 companies highlights DB's poor
standing in the world of structured finance (SF). Deutsche Bank has
never been a major player in the securitized finance market though it
has spent billions trying to be. In 1996, DB bought Morgan Grenfell to
create Deutsche Morgan Grenfell and hired senior bankers from Goldman
Sachs and Merrill Lynch. When the Russian Currency crisis hit, DMG
fired all but 3 of its SF staff after paying almost a billion dollars
of guaranteed bonuses. They tried again after the Banker's Trust
purchase and this is their third attempt. Third time is a charm right?
Nope. The conference demonstrated the lack of gravitas so evident at
Goldman, Morgan Stanley and even, may they rest in peace, Bear Stearns.
Deutsche bank event planners decided to hold this poorly attended
conference not in a fancy hotel (like Citi or Wachovia) but in an
auditorium two stories below street level in their "marque building" 60
Wall Street. Fortunately, the poor catering did not make me sick. Good
job of impressing investors.
Deutsche Bank's chief economist, Peter Hooper, presented his view of
the US Economic outlook which he summed up in two words, cautiously
optimistic. Dr. Hooper discussed the downside risks of the economy
- Recovery from the financial crisis will likely take a decade.
- Household balance sheets continue to pay off debt instead of spending.
- Home prices continue lower with the overhang of inventory and the wave of foreclosures.
- European sovereign debt issues.
Dr. Hooper concedes the downside risks are potent and the US
consumer is extremely vulnerable to external shocks (i.e. fuel prices,
debt ceiling, and etc). However the upside risks has him feeling ...
well ... cautiously optimistic. The upside risks are:
- Pent up demand for durable goods. For example, the total light
vehicle sales is significantly below the 12 year historical per capital
break even rate and business equipment spending is rising from historic
40 year lows.
- Household saving rate is poised to fall.
- Employment rising
- And an expected rise in household formation. (Time for your kids to move out and get a job!)
Wanna buy a nice new house in Las Vegas?
Steve Abrahams, Head of MBS and Securitization Research, discussed
the current US real estate market and how investors should think about
Not surprisingly, the US housing markets is weak. Heavy housing
supply suppresses home values especially in the sand (AZ, CA, NV, and
FL) states. Tight credit prevents all the most pristine borrows from
getting loans and unemployment hurts increased household formation.
Despite Dr. Hooper's prediction, Mr. Abrahams predicts home prices to drop nationally another 5-11% through 2012 (Florida
of course will take much longer.) The major driver of home prices is
the significant supply of houses from foreclosures. Moreover, DB
predicts the private RMBS market will not return until 2012 where they
expect $20B of new supply. In 2006, private RMBS issuance totalled over
$800B. In 2010, a single RMBS deal was issued for $244m.
Like everyone else in the market, the restart of future private MBS
securitization requires the regulatory environment to stabilize.
DB recommends buying credit and buying shorter duration agency paper.
Commercial Real Estate grows but slowly.
Commercial mortgage backed securities, unlike MBS, economics are
improving. Prices on AAA rated CMBS securities increased significantly
over the last 12 months and almost $10B of new
securitization occurred in 2010. DB predicts 2011 CMBS issuance will be
close to $40B because:
- Banks have healthy balance sheets. TARP did its job and the money has been repaid.
- Increasing CRE delinquencies is offset by investors calling the
bottom of the economy. CRE and CMBS performance typically lags the real
economy by 18 months.
- Cap rates are the lowest level since the crisis began.
- Lastly, rents have stabilized with the exception of apartment buildings.
The conference had several investor panels in which participants
talked their book. As investors, we are still driven by our quarterly
P&L and the panelists didn't deviate from this golden rule. One
panelist complained bitterly how all the residential mortgage loans are
securitized by Fannie Mae and Freddie Mac. If these two wards of the
state went away the private securitization market would take over. When
questioned by a conference attendee, the panelist said mortgage rates
would likely climb 200-300 basis points and the market would loose a
buyer of last resort (unless the Fed could be convinced to go back in).
One panel had rating agency representatives discussing the
importance of ratings in SF v2.0. As I expected, rating agencies still
haven't received the message no one trusts them anymore and won't for a
very long time, if ever. Rating agencies, who played the village idiots
in the financial crisis, do not have the models or personnel to
adequately rate securities. Additionally, the Dodd-Frank Act and other
regulations now excludes regulatory agencies from considering ratings.
When asked, none of the rating agency executives knew when their
ratings will be relied on again.
Deutsche Bank's conference did not cover any new ground or
earth-shattering pronouncements. DB like other investment banks are
trying to restart the formerly very lucrative originate to securitize
market in an uncertain regulatory environment. I wish them luck and
hope next years conference is much much better.