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 including:
- 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 it.
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.