End of Fannie, Freddie would mean RMBS comeback

Thu Mar 13, 2014 12:37pm EDT

NEW YORK, March 13 (IFR) - The Senate Banking Committee's agreement on winding down Fannie Mae and Freddie Mac, the country's biggest mortgage financiers, brings the US government's plan to end its dominance of the housing finance market a step closer to reality.

And that could finally take the brakes off the RMBS market as private institutions assume the role of the two agencies, which currently own or guarantee some 60% of US home loans.

Committee Chairman Tim Johnson and Senator Mike Crapo on Tuesday outlined the proposal to shut them down after months of talks that included soliciting input from the Obama administration.

They intend to introduce draft legislation soon, and while passage by the full Senate (or House) is not assured, there is wide agreement the US housing finance system needs an overhaul.

Under the new proposal, private interests would absorb the first 10% of any mortgage losses before an industry-financed backstop would kick in.

And that is unlikely to put off investors who have already welcomed risk-sharing securitization deals from Fannie and Freddie with a 3% private risk threshold - deals that were multiple times oversubscribed.

"Freddie's STACR and Fannie's CAS programs were a precursor to what we are hearing about now, where the government acts as a catastrophic insurer and the market bears the brunt of the 3% credit loss," one securitization banker told IFR.

"Whether it's 7% or 10%, that's for the regulators to decide. But as far as selling credit risk goes, there is plenty of demand."

Indeed those deals, along with REO-to-rental trades from the likes of Blackstone, have been embraced by investors keen for supply, which has been thin since the financial crisis.

Non-agency RMBS was just under USD20bn last year - a far cry from the USD1tn at the market's 2006 peak - and both mutual and pension funds are now flooded with cash to spend.

Moreover, clarity from the Consumer Finance Protection Bureau in January about what loans qualify under its guidelines removed a big barrier.

HIGHER COSTS?

The new scheme would see formation of a Federal Mortgage Insurance Corp (FMIC) to replace Fannie and Freddie, which were taken over by the government in 2008 in the midst of the subprime mortgage meltdown.

FMIC would be funded by user fees and, most crucially, would guarantee 90% of mortgage credit risk.

John Sim, a mortgage-bond strategist at JP Morgan, was more cautious about whether the private market has the depth to handle the additional supply - or the additional risk.

"The new system will be selling off the bottom 10% of the risk, whereas the current system merely guarantees it with a nominal fee," he said.

If the private market fails to adequately absorb all the new RMBS product, then spreads could widen - and in turn that could mean higher rates for retail home mortgages.

Even without that, rates could rise because the 10% private-label piece may have to offer the kinds of richer yields available in the STACR and CAS products, said Mitch Flack, co-head of the securitized unit at asset manager TCW.

"The proposed 10% first-loss taken by private investors is a good step," Flack said.

"The question is: will this actually reduce the credit box for mortgage lending and the market's overall ability to reach the volumes of mortgage lending that we've seen in the past?"

DEEP CHANGES

But private capital is already playing a role in the jumbo market for mortgages in excess of USD417,000 on a single-family home, or USD625,000 in high cost areas such as New York or California.

And that will naturally expand if plans to shrink those conforming loan limits by 5% each year for five years - as outlined in the new bill - were put in place, the banker said.

He also reckons some players, including REITs and specialty finance companies are already maneuvering to take up the slack on smaller mortgages, while banks such as Chase and Everbank would probably remain more focused on the jumbo issues.

Even so, it's a massive revamp and regulators will be extra careful in managing it.

The current infrastructure for US residential mortgages - from mechanisms for pre-approved origination to guarantees and pool servicing - has been in place for decades.

"This has been designed so that a transition from Freddie and Fannie is seamless," said Brian Ye, a managing director in the mortgage strategy team at JP Morgan.

"The current system of issuing loans via Fannie and Freddie works well, as there is a deep liquid MBS market. The Fed even buys these securities - so the last thing it wants to do is to disturb any of that."

And others insist that, as long as there is a guarantee ultimately underpinning the mortgages, it doesn't matter which entity provides it.

As one banker put it: "It's just an acronym."

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