The Federal Reserve’s September decision to buy $40 billion of government-sponsored enterprise (GSE) mortgage-backed securities (MBS) a month is having a dramatic impact on the mortgage market in the US.
MBS makes up 30.2% of the Barclays Aggregate Index, and the Fed’s decision to buy pretty much all of it is removing a substantial chunk of supply from the fixed-income markets.
Rick Rieder, chief investment officer of fixed income at BlackRock, says the effects of this – the country’s third bout of quantitative easing – will be felt this year.
“For the first time, you might start to see a bit of asset price pressure in the US housing market,” he observed in December. “Treasuries account for 35% of the Barclays Aggregate Index and mortgages account for 30%, so two-thirds of the index is now being bought by the Fed. They are purchasing assets and keeping rates down and taking out a lot of supply. There will not be a lot of fixed-income supply in 2013.”
Housing floor
The Fed is buying around $1.3 billion of agency-backed mortgages a day and has indicated that it intends to keep doing so until there is substantial improvement in the US job market. Although this is the Fed’s third stab at it, the mortgage-purchase programme provides a solid floor from which to launch a turnaround in the housing market.
“The trends for recovery in US housing are good,” says Barbara Novick, vice-chair and head of government relations at BlackRock. “But the level of government support is not sustainable.”
| The private-label market has vanished Agency market share pre and post crisis |
 |
| Source: Thomson Reuters, Federal Agencies, Sifma |
The US government now owns between 15% and 25% of the MBS market. “Because this is president Obama’s second term and he is not running for re-election, the political environment is such that he can address housing,” says Novick. “If they miss this window of opportunity, they miss it for a long time.” Given the need to wean the mortgage market off state support, the invigoration of the non-agency securitization market must be an urgent priority. In 2012, around $6 billion of non-agency residential mortgage-backed securities were issued and expectations for 2013 settle at around $15 billion to $20 billion.
“The pick-up in home prices has given investors a sense of confidence that we won’t go down much further, and so mortgages are regaining their appeal,” says Adam Yarnold, managing director and head of US non-agency mortgage trading at Barclays in New York.
He adds that new securitization structures being put in place by the non-GSE issuers offer investors greater comfort and could lead to an increase in deals backed by newly originated loans in the private market.
Mike McMahon is a managing director at Redwood Trusts, which issued $2 billion of non-GSE mortgage-backed paper last year. “We had a strong interest in making sure the private label market was restarted, so talked to investors about what they would want to see from a deal to gain comfort,” he tells Euromoney.
As a result, the firm made several improvements, eliminating qualifiers around reps and warranties, and strengthening language around early payment defaults.
Competition in this space remains very limited. McMahon says there is little incentive for banks to originate loans, given that their own cost of funds and continued uncertainty around the regulation means banks are unlikely to return to the market.
JPMorgan and Bank of America are rumoured to be considering issuance in early 2013, but any deals are expected to be small.
Few packages to buy
As for non-banks, McMahon says competition is almost nonexistent. “We invested heavily in building a conduit to purchase loans from an expanding number of originators and we haven’t seen anyone do something similar,” he says. “Some issuers are looking to buy bulk packages instead of setting up a conduit but there are very few packages to buy.”
Stephen Abrahams, securitization analyst at Deutsche Bank, says that until there is greater clarity about mortgage regulation,the private securitization of newly originated loans will be muted. The definition of a qualifying residential mortgage will determine the level of risk that needs to be retained by the originator and has been under discussion since a draft in spring 2011.
He says that once there is clarity, there is no reason why even modest operations could not get into the business of originating loans.
The potential for private capital to fund the mortgage market could be sizeable, depending on relative cost. At present, Redwood’s deals are about 40 basis points off of GSE equivalents but if the fees charged by the GSEs increase by 10bp to 15bp – in addition to the servicing fee of 25bp – private deals and agency deals become much more competitive.
“The private market then becomes in line with conforming jumbos and originators may well then choose to sell to the private market, which can move quicker,” says McMahon. “It potentially doubles the share of the market for jumbo originators.”
