Cerberus Sold the First Post-Crisis Mortgage Bond Backed by Home Equity Lines

(Bloomberg) -- Cerberus Capital Management has sold a kind of mortgage bond that hasn’t been seen since the financial crisis. Not many financial companies are seen following in its footsteps.

The asset manager’s FirstKey unit sold $174 million of securities last week backed by home equity lines of credit, the first such offering in more than a decade. The bonds were designed to be safer than their pre-crisis competitors.

“I think there will be more deals but home equity lines of credit will still be a small sector,” said Ed Reardon, head of mortgage research at Deutsche Bank. Most of those loans are made by banks, which can fund them relatively cheaply on their balance sheets instead of bundling them into bonds.

The loans are harder to package into bonds than conventional mortgages because of the way they’re put together. Home equity lines of credit, also known as Helocs, often allow a homeowner to borrow any time for five or 10 years, known as the drawdown period. After that there’s a repayment period of 10 to 20 years. It’s typically a floating-rate loan, and can be tapped in emergency situations, such as if a borrower loses his or her job.

Investors that buy bonds backed by these loans often don’t know exactly how much money will be lent out during the drawdown period, and how long it will take to be repaid. That kind of financing is often more easily provided by a bank, said Reardon.

First Lien

Even in its pre-crisis heyday, bonds backed by home equity lines of credit were a small subsector of the mortgage bond market, peaking at about $35 billion of issuance in 2004, according to Deutsche Bank. The bonds sold by the Cerberus unit are safer in part because they were backed by more first-lien lines of credit, or loans that are first to be repaid if a borrower defaults. Older transactions were backed by a greater proportion of second-lien loans.

Borrowers for the FirstKey Helocs in the latest offering completed all necessary documentation, while deals from a decade ago may have been backed by Helocs with less information or spottier underwriting. Borrowers also had average equity in their homes of about 35%, compared with 0% for some pre-crisis deals.

Demand for the bonds didn’t prove to be overwhelming. FirstKey had to pay higher prices to borrow than underwriters had expected, paying 1.05 percentage point over benchmark rates, compared with original forecasts of around 0.9 percentage point. The loans were originally made by TCF Financial Corp., a Minnesota-based bank, then bought by the Cerberus unit to bundle into bonds.

Another key difference between the FirstKey sale and pre-crisis offerings was the lack of a bond insurer. Guarantors have a much smaller role in the asset-backed securities market after many stumbled in the financial crisis.

“Pre-crisis, you couldn’t get a AAA on a Heloc-backed bond without a bond wrap,” said John Kerschner, head of securitized products at Janus Henderson Investors. “But this one, in my opinion, was a true AAA, based on its structure and safer collateral.”

Balances on Helocs have continued their declining trend from 2009 with a drop of $6 billion in the first quarter to a total of $406 billion, according to a May report from the Federal Reserve Bank of New York. Balances were over $600 billion at their peak in 2009.

While borrowers’ untapped home equity has been steadily rising over the last decade, changing laws have made Helocs less attractive for borrowers. The Tax Cuts and Jobs Act of 2017 affected how much of the interest on the loans can be deducted, including limiting deductions to lines of credit used for home renovations. Other post-crisis regulations sought to “shut off” Heloc capacity from borrowers if home prices fall.

To contact the reporter on this story: Adam Tempkin in New York at atempkin2@bloomberg.net

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Dan Wilchins, Christopher DeReza

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