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News Analysis


OCC gives regulatory approval to JPM CRT

JP Morgan Chase has won favourable regulatory treatment from the Office of the Comptroller of the Currency (OCC) for its innovatory CRT transaction priced in October, say well-placed sources.

“The OCC blessed the deal and JP Morgan received the capital treatment it desired. There are multiple independent confirmations that it got green lit by the OCC,” says a structured debt specialist in New York.

The regulator declined to confirm whether it had given its approval. “The OCC does not comment on matters pertaining to specific financial institutions,” says a spokesman.

It is believed that the OCC extended its blessing to the ground-breaking deal last month.

Designated Chase Mortgage Reference Notes 2019-CL1, the trade, thought to be around US$65m in total principal, was the first CRT note to be offered by a bank rather than by one of the two GSEs (SCI 10 October 2019). The big question in the market was whether it would win approval from the OCC. Indeed, JP Morgan Chase reserved the right to collapse the deal if it did not.

While some in the market felt they were sure JP Morgan Chase would have made very sure its ducks were in line before they sold its CRT deal, others were more cautious. So, the news that the OCC has given the nod of approval to this new structure is sure to be a big talking point. It is thought it could be the augur of a major new CRT market, with bank issuers stepping up to take their place alongside the established GSE issuers.

Like Freddie Mac STACR and Fannie Mae CAS deals, the JP Morgan notes are linked to a reference pool of loans which determine performance of the deal. Investors buy credit-linked notes and the proceeds cover any future losses on the reference pool of loans.

The reference pool consists of 979 prime residential mortgages with a total balance of US$757m. There are seven tranches, each paying a spread over one-month Libor, though exact terms of the transaction have been carefully hidden from public gaze.

If the loans in this pool defaulted, JP Morgan would, in normal circumstances, have been obliged to cover the delinquency with increased loan loss reserves and capital. But the OCC has determined that as a result of the CRT deal this is not required on this particular pool of loans.

In reaching its momentous decision, the OCC is likely to have considered whether the deal was unambiguously synthetic and whether risk transfer was properly achieved. The issuer has been down this road before: it issued a CRT deal in 2016 which did not receive favourable treatment from the OCC. On this occasion it looks like it made sure it left as little to chance as possible.

The economic impact is different than that enjoyed by the GSEs - which have to make good principal and interest payments on guaranteed MBS - the capacity to reduce loan loss and capital requirements is highly significant.

It of course raises the possibility that other banks will attempt to follow suit. While the OCC has not given carte blanche to all would-be bank issuers of CRT and each transaction will be evaluated on a case by case basis, the result achieved by JP Morgan is sure to be of interest to other financial institutions which carry significant mortgage liabilities.

“Does this mean that we are going to see billions and billions tomorrow? No, but it does feel like we’re moving further along the path the Treasury laid out in September when it stated that inconsistencies between the capital treatment of transfers of mortgage credit risk from GSEs and private issuers were a potentially unwarranted gap,” says Chris Helwig, an md at Amherst Pierpont in New York.

However, in another departure from the GSE model, the principal and interest payments are obligations upon the issuer so the investor acquires counterparty exposure to JP Morgan Chase. In this sense, the JP Morgan deal is a hybrid of CRT and unsecured corporate debt, which means that only the most well-rated bank issuers like Wells Fargo and Bank of America will be able to follow suit.

The deal also covers the first 8% of losses - double the amount covered by STACR and CAS deals. So it covers a larger collar of risk, from first loss up to double A-rated risk. This means such deals might be of interest to investors than have been unable hitherto to participate in GSE deals due to restrictions on investment on the grounds of credit rating.

But, in general, market sources expect that a similar pool of investors to those that buy GSE deals might want to buy bank-issued CRT deals, should the market now take off.

It is also important to see the OCC’s action in the context of a general offensive, led by FHFA director Mark Calabria, to reduce the footprint of the GSEs. More broadly shared syndication of mortgage-related risk is a clearly stated objective, and JP Morgan Chase’s deal lights a path for others to follow.

Simon Boughey

03/03/2020 16:34:32

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