The federal government is trying to get taxpayers off the hook
for billions of dollars of potential losses if another mortgage
crisis arrives—and in the process, it is quietly giving birth to a
new asset class.
Under government control, mortgage-finance giants Fannie Mae and
Freddie Mac next year plan to ramp up sales of new types of
securities that in effect transfer potential losses in a housing
downturn to private investors.
Called Connecticut Avenue Securities by Fannie Mae and
Structured Agency Credit Risk by Freddie Mac, the securities are
essentially bonds whose performance is tied to that of a pool of
mortgages. If the mortgages default, investors in the bonds could
lose some or all of their principal.
Proponents of the risk-transfer deals see them becoming a
mainstay of the bond and housing markets over time, perhaps even
entering major bond indexes tracked by mutual funds and
exchange-traded funds.
The sales are especially notable because issuances of
private-label mortgage-backed securities, which also give private
investors mortgage exposure, are still moribund.
"To many people, mortgage credit risk is still a bad word," said
Laurie Goodman, director of the Housing Finance Policy Center at
the Urban Institute, adding that she isn't optimistic that the
market will revive soon.
But to the extent that yield-starved investors do want to take
on such risk, Fannie's and Freddie's new securities are the only
outlet.
"Right now, the [transactions] are almost the only way for
investors to get exposure to new residential mortgage-credit risk,"
said Steven Abrahams, a mortgage analyst for Deutsche Bank AG.
Fannie and Freddie already have sold about $25 billion of
securities since 2013 to private investors, including money
managers such as BlackRock Inc. and Invesco, hedge funds,
real-estate investment trusts and other investors.
Earlier this month, the Federal Housing Finance Agency, which
regulates Fannie and Freddie, said the companies would transfer to
private investors in 2016 the credit risk on 90% of the unpaid
principal balance of the riskiest mortgages the companies
back—where homeowners get a mortgage of more than 20 years and make
less than a 40% down payment.
Fannie and Freddie don't make loans. They buy them from lenders,
wrap them into securities and guarantee to make investors whole if
the mortgages default.
In practice, that has meant that investors have taken on the
risk of losses if interest rates rise, but have left the government
with the risk if borrowers default. The new securities—along with
other methods Fannie and Freddie use to lay off risk—mean that the
government is increasingly transferring that default risk to
private investors as well.
For example, in June Freddie Mac sold $950 million of the
securities covering $18.4 billion of Freddie-backed loans. If a
severe housing downturn emerged in a few years, those mortgages
could be expected to suffer a 2% loss, said Moody's Analytics chief
economist Mark Zandi, hitting Freddie with losses of $368 million
without the protection. Instead under the terms of the June deal,
Freddie would lose only $143 million, while the private investors
would lose $225 million, Mr. Zandi said.
In exchange for taking that risk, in that deal investors got
yields of between 1.15 percentage point and 7.55 percentage points
above a benchmark short-term interest rate.
Some market watchers note that the companies' programs are still
nascent and that the market has yet to show how much appetite it
has for the new securities. Fannie's and Freddie's early deals only
protected them from losses beyond a certain level, though the
companies have begun to sell "first-loss risk" as well.
"We're going from no place to some place," said Lewis Ranieri,
the financier who co-invented the mortgage-backed security.
"There's still a question of whether [the securities sales] can be
expanded to really provide the goal of making the government the
guarantor of last resort."
Among other outstanding questions are at what price investors
will buy the securities in times of market stress and how much
issuance it will take until the securities, which now are
structured as Fannie and Freddie corporate debt, easily trade on
the open market. Right now, the debt trades infrequently and tends
to stay with the investor who first bought it. New capital
standards have caused banks to pull back from dealing in all sorts
of bonds, cutting off that avenue for trading as well.
Although BlackRock has bought portions of the Fannie and Freddie
deals, it has done so on a limited basis, said Kevin Chavers,
BlackRock's managing director on a panel this month hosted by the
Securities Industry and Financial Markets Association, a trade
group.
BlackRock's "primary concerns are the lack of liquidity in that
marketplace and the lack of liquidity is largely driven by the
capital requirements that dealers are required to maintain," Mr.
Chavers said.
Hedge funds and money managers have made up the bulk of the
earliest investors, with REITs, banks and insurance companies
participating to a lesser extent.
Over the next year, proponents of the risk-sharing deals hope
for the development of some of the features of a more mature
market. New York-based Vista Capital Advisors, a financial-products
company specializing in the corporate bond market, hopes to release
indexes based on the Fannie and Freddie bonds early next year, said
Richard MacWilliams, managing partner at Vista.
Vista hopes to release products later in the year based on the
indexes that would allow investors to trade Fannie's and Freddie's
credit risk more easily, Mr. MacWilliams said.
Write to Joe Light at joe.light@wsj.com
(END) Dow Jones Newswires
December 29, 2015 06:15 ET (11:15 GMT)
Copyright (c) 2015 Dow Jones & Company, Inc.
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