Uncategorized

Call activity escalates in legacy PLS

admin | January 17, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The legacy private label universe becomes increasingly callable as it pays down and more deals’ balances fall below the threshold to execute a clean-up call. A fairly seismic shift occurred late last year when banks, led by Wells Fargo, began calling legacy trusts en masse, reducing the outstanding legacy universe by $15 billion. This call activity is likely to remain elevated and expand to non-bank shelves, though the motivations to call a deal differ depending on who holds the rights. A profile of the outstanding universe helps assess which shelves have a greater likelihood of being called across both bank and non-bank trusts.

The right and motivation to call varies by holder

Holders of the rights to collapse outstanding trusts and take back the underlying loans vary – with banks, REITs, mortgage servicers and specialty finance companies all having some ability to call outstanding deals – though these holders differ in their motivations. Banks that own servicing and call rights on their legacy shelves are only likely to execute the par call when it’s economically feasible. First, from a regulatory capital perspective, banks would likely not be able to hold mezzanine or subordinate bonds that trade below par which would allow them to call deals where the underlying loans trade at a discount. Additionally, banks would not likely call deals with large amounts of non-performing loans which would drive the collateral price below par as they require additional risk-based capital.

Conversely, non-bank holders of call rights have significantly more latitude to own securities that would make collateral calls where the loans trade below par economically efficient and hold non-performing loans. A side by side analysis of Countrywide’s CWL shelf illustrates this disparity in call incentive. Deals called by mortgage REIT New Residential (NWZ) and subsequently re-securitized had a much lower percentage of always performing loans (APL), a 1.75 bp lower average gross WAC (GWAC), and an average price below par – fully 6.5 points lower than other parties who executed calls on CWL deals last year (Exhibit 1).

Exhibit 1: Comparing collateral calls across the CWL shelf in 2019

Note: Average collateral price assumes a 4.0% yield to price employing the Amherst ALIAS Pay Model Fair Value base case scenario. Source: Amherst Insight Labs, Amherst Pierpont Securities

Legacy bank issued deals called last year where the collateral was not re-securitized had high percentages of APL, low percentages of NPL, and average prices above par (Exhibit 2). Until recently, clean up calls on legacy bank shelves have been limited to loans backing BOAMS and BOAA trusts that were ultimately re-securitized by third parties. However, calls executed by Wells Fargo in the fourth quarter of last year may signal an increased appetite by banks to portfolio loans that can be called at par when the WACs are far greater than coupons of new loans being originated for portfolio retention. This increased appetite is likely fueled a need to add high yielding assets to offset deposit growth and protect net interest margin given the current low interest rate environment. Absent a material sell off in rates and steepening of the yield curve, banks could continue to actively collapse legacy trusts stocked with high WAC loans with strong performance histories.

Exhibit 2: Wells Fargo led calls of bank issued legacy trusts last year

Source: Amherst Insight Labs, Amherst Pierpont Securities

Call risk on bank versus non-bank shelves

Calls on legacy bank shelves appear poised to remain elevated this year due to the substantial outstanding volumes coupled with meaningful premiums on a few large bank shelves. While the average price of collateral backing WFMBS trusts is below par, estimates are that roughly half of the remaining deals are still trading above par, and the collateral price is below $99 on just three outstanding deals. Call activity on that shelf is expected to continue on deals trading above par. Average prices on loans backing Wells Fargo’s legacy WFALT Alt-A shelf are trading north of a three point premium over par, but the calls are likely to be localized to prime collateral despite the significant premium. Across legacy Bank of America trusts, loans backing the BAFC and BOAA shelves are trading at north of a point premium to par and appear to be likely call candidates this year with loans backing BOAMS trusts trading at a slight premium where more seasoned 2002 to 2004 trusts appear more likely call candidates (Exhibit 3).

Exhibit 3: Estimating call candidates across legacy bank shelves

Note: Average collateral price assumes a 4.0% yield to price employing the Amherst ALIAS Pay Model Fair Value base case scenario. Source: Amherst Insight Labs, Amherst Pierpont Securities

Call activity across non-bank shelves is also expected to remain elevated due to favorable fundamentals. Non-performing loan buckets should continue to shrink along with the frequency of loan modifications, pushing prices on collateral pools higher. Home price appreciation and amortization should exert downward pressure on LTVs of legacy pools, creating another potential tail wind to loan prices. The combined effect should expand the potential universe of callable trusts to include a growing population of legacy Alt-A and hybrid ARM loans.

Investor impact

The impact on investors to a trust being collapsed depends on their bonds’ position in the capital structure: mezzanine or subordinate bonds that trade at a discount have potentially significant upside optionality to call, while premium senior bonds may have significant downside risk.

admin
jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.