Xceed Preps to Securitize Loans
The $942 million Xceed Financial Credit Union is prepared to begin securitizing the loans it originates once the NCUA has approved a final securitization rule.
COO Ray Shams said the El Segundo, Calif.-based credit union has been working with legal and financial firms for months to help it prepare for the day when its newly-launched lending CUSO, Global Enterprise Resource Group, will begin issuing securities backed by the credit union's loans.
“Our goal is to be able to provide better products and services for our members at a more favorable price,” Shams said. He argued that securitizing loans for investors would be a more efficient and cost effective way to handle the assets than selling them.
In June 2014, the NCUA Board proposed a securitization rule and accepted comments on it until September 2014; however, it has not yet proposed a final rule.
The Federal Credit Union Act allows credit unions to sell their loans, something that Shams acknowledged many credit unions, including Xceed Financial, are already doing.
However, by securitizing loans instead of selling them, credit unions would have the ability to better control their assets and, most importantly, gain access to new markets and vehicles, he said.
The credit union will start off by securitizing its auto loans, but Shams added that his eventual goal was to securitize jumbo and other non-conforming mortgages that it made to serve its members but could not sell on the secondary mortgage market administered by the Federal Housing Finance Agency.
“That was my goal from the very beginning,” Shams said. “We were talking about mortgage lending and liquidity options, and I thought, why couldn't we securitize our own loans and cut out the middleman?”
Shams said Xceed has not been beta testing loan securitization per se, but has spent months meeting with investment banking and legal firms to plan for when the federal agency might allow securitizations.
In addition to ensuring the credit union complies with NCUA regulations, its CUSO would have to comply with Securities and Exchange Commission rules throughout the securitization process, Shams confirmed.
Because these additional layers of compliance would increase costs throughout the process, Xceed Financial would need to generate a sufficient volume of loans to securitize in order to make the effort worthwhile, Shams explained.
While he expressed confidence that the credit union has already generated enough loans to successfully begin the securitization process, he declined to say just how many loans would be required to maintain it.
Volume is crucial for credit unions looking to securitize their loans – the NCUA's proposed regulation limits credit unions to securitizing loans that they have originated. If and when the rule is passed, the agency would likely not allow credit unions to securitize loans they have purchased or refinanced from other institutions.
“Securitizing loans presents more complex risks than simply making and selling loans,” the NCUA wrote in the proposed rule. “Allowing FCUs to purchase loans for the purpose of issuing asset-backed securities would add an additional layer of risk, in an area that is uncharted for both FCUs and (the) NCUA.”
“Accordingly, for safety and soundness reasons, the proposed rule limits FCUs to securitizing only loans they have originated. To avoid confusion, the proposed rule clarifies that the purchase and re-underwriting of a loan does not meet the origination requirement.”
“Well, that's extraordinary,” said Daria Boxer, an attorney with the Los Angeles-based Mitchell Silberberg & Knupp LLP, in response to the rule. “That limitation will effectively prevent many credit unions from being able to take advantage of securitization at all.”
She pointed out that when credit unions refinance an existing loan, they don't just rubber stamp the old one – they complete their own underwriting as if they originated it from the beginning.
Boxer was not alone in her objection to that aspect of the proposed rule. Nearly all of the 18 comments the agency received on the proposal took issue with the origination requirement, and one of those belonged to CUNA.
“Allowing credit unions to securitize loans they have not originated would be important for several reasons,” CUNA wrote in an Aug. 25, 2014 comment letter. “The ability to purchase loans for securitization will give credit unions without enough originations of a particular loan type increased opportunities to package their own loans. In addition, credit unions may hold loans that they have purchased for other reasons prior to contemplating sponsoring a securitization. Credit unions should be able to include these loans in a securitization transaction for risk management.”
Boxer also pointed out that eliminating the origination requirement from the final rule would open doors for credit unions to form loan securitization CUSOs.
Where a single credit union might not have the loan volume to justify the expense of securitizing them, it could team up with three or four other credit unions to have enough loans to securitize, she said.
If the NCUA moves forward on the securitization rule, Boxer and Shams agreed the agency would also need to finalize a rule that would create a legal safe harbor for the investors who buy bonds backed by credit union loans. Essentially, the safe harbor rule would assert that if the NCUA or a state agency were to take over the credit union, any assets that the credit union used to underpin a bond would remain attached to the security, and the NCUA would not take on the assets to cover the loss.
“I really don't see where investor demand will come from if this safe harbor rule isn't in place,” Boxer said.
Shams acknowledged the possibility that Xceed might team up with other credit unions throughout the securitization process, but also made it clear that the cooperative would also move forward with the idea on its own.
He also said he expects the credit union would be able to offer a bond prospectus to potential investors within six months after the NCUA finalized the rule.
“Obviously I can't predict exactly how long this might take,” he said. “There are other institutions involved other than just us. But we believe we have the interest and we have done our due diligence, and I think it will be a matter of months before we will have our first offering.”