Freddie Mac announced yesterday that it will purchase substantially all 120 days or more delinquent mortgage loans from the company’s related fixed-rate and adjustable-rate mortgage Participation Certificate (PC) securities.
The way Freddie Mac has structured the purchases will cause a one-time pain, most of which will be borne by investors who bought Freddie Mac MBS securities during the February settlement cycle, Bank Of America Merrill Lynch analysts said.
What the agencies plan to do with the loans once they are bought out is still unsure. Mark Hanson, vice president of mortgage funding at Freddie Mac, spoke this morning on a call hosted by BofA Merrill and said that, at the moment, there is no intention to resecuritize the large portfolio that is amounting of these delinquent loan buyouts.
However, he said that in the past Freddie Mac had not considered the option simply because they’d never really dealt with such a large volume of loans. At present the firm hasreceived “a lot of dealer interest” and re-securitization advice.
Jesse Litvak, a mortgage trader at Jefferies, said that if the scenario presents itself, where these loans become the supply for new deals to get done in non-agency space, getting a rating for these structures could be a big hurdle to ever getting them off the ground.
Litvak also noted that if the government intends to take the delinquent loans, extensively modify them and then try to go to the market to sell them (as loans or as bonds) — this could be a long process. “The rating agencies could take forever to figure out appropriate credit enhancement levels for yards and yards of delinquent loans,” he said.
Hanson said that the buyout won’t impact the current modification strategy that is in place. “We will try to modify all borrowers via [the Home Affordable Modfication Program] and if borrowers don’t qualify, they will revert back to our more traditional loss mitigation efforts,” he said.
The market should be concerned about the moral hazard this recent move creates. The current repurchase agreement means that certain borrowers – those that make their way into a federal home loan mortgage corporation purchase – will have an advantage over those borrowers that don’t.
“The Freddie Mac borrower gets a call and gets to stay in his home and gets new terms that will keep him there [where] the MTA guy that has the same exact house and same exact problem gets no love,” Litvak said. “The Fed/Treasury et al is clearly trying to come up with creative ways to help solve the mortgage problem but as we have already come to see in the last two years their decisions carry some very large unintended consequences.”
Backstop Role Not Impacted
Hanson said that Freddie Mac remains committed to its role of creating liquidity in the market and said that the purchase should not impair or limit its ability to be a backstop.
According to BofA Merrill, as of the December 2009 monthly summaries, the Fannie Mae portfolio was $772.5 billion and Freddie Mac portfolio was $755.3 billion. If these numbers stay constant until the buyout date, and both the GSEs are able to buyout all the delinquent loans, then the portfolio sizes will become $899.5 billion and $824.27 billion, respectively.
The portfolio size limit during 2010 is $900 billion each and the GSEs need to bring down their portfolio to $810 only at the end of 2010.
“This would mean that agencies would have to rely on both runoffs and sales to bring the portfolio down to $810 if GSEs continue to buyout delinquent loans aggressively,” analysts said. “As properties underlying the delinquent loans are liquidated it will also help in lowering the portfolio limit. The portfolio limit will be much more of a problem for Fannie Mae than Freddie Mac as they will be much closer to their limit of $900 billion once they buyout most of $127 billion in delinquent loans.”
Other Analysts Thoughts on GSE Buyouts
With both GSEs announcing plans to buy out 120+ day delinquent loans, the impact to higher coupons was swift. Late afternoon yesterday, Fannie Mae announced that it is considerably increasing its purchases of delinquent loans from single-family MBS trusts starting in March.
The market repriced to substantially faster speeds in the near term. For example, FNMA 6.5s have dropped 26 ticks through mid-morning from yesterday, while FNMA 4.5s are off just 3 ticks. Also, both the FNMA 6% and 6.5% rolls have dropped 3/32nds in the past 24 hours — unheard of when most rolls move a plus on their worst days. FHLMC Golds, however, have fared better than FNMAs given their swift buyout plan, unlike FNMAs. Real and fast money also have been shedding higher coupons, particularly 6s and 6.5s.
Speeds on the credit-impaired vintages across the coupon stack are expected to soar. For example, Credit Suisse analysts calculated the impact on buyouts on FHLMC Golds 30-year speeds in February (reported in March) on 2007 vintages will be 69 CPR on 6s, 88 CPR on 6.5s and 99 CPR on 7s. Overall speeds for February for this vintage for these coupons respectively are expected to be 74, 90 and 99.
On the FNMA side, they assume a three-month buyout period beginning in March (reported in April) with speeds on the 2007 cohort to experience an additional CPR of 36 on 6s, 53 on 6.5s and 72 on 7s resulting in overall speeds of 51, 63 and 77 CPR, respectively.
Credit Suisse analysts said this was a positive development for agency MBS as it will remove a large amount of the prepayment uncertainty. In addition, it injects potentially some $60 billion in reinvestment demand in March and as much as $115 billion over the next few months they said.
The difference between the two GSEs in their buyout approach "raises some interesting trade implications," said Barclays Capital analysts in a research report. Gold/FNMA swaps already experienced some repricing yesterday on the news, but analysts expect it has room to reprice further since FNMA is staggered while FHLMC Golds will be mostly cleared this month. They estimated, for example, that 15 SMM on a $107-16 price for FNMA 6s should theoretically cause FHLMC Gold/FNMA for March settle to reprice by 1-1.5 points.
They also expect FNMA premium rolls to cool with additional negative impact related to the uncertainty over the magnitude of the expected buyouts per month. Finally, up in coupon should continue to do well in FHLMC Gold space, analysts said as speeds on premiums should remain muted. As such, 6.5s and other super premiums should carry and OAS extremely well, they added.
Credit Suisse analysts said that once these buyouts are completed, they anticipate speeds will remain elevated relative to the past couple of years as a result of the ongoing cleanup of new delinquencies and modestly higher voluntary prepays.