Analysts expect to give high credit rating to GSE successors

The future secondary mortgage market entities will receive high investment grade ratings, even as there is no clarity on their scope or form, Fitch Ratings said.

These bodies, whether they are totally new entities, a recast Fannie Mae and Freddie Mac or some hybrid of both that comes out of the housing finance reform process, will be appropriately capitalized, have ample access to the capital markets and be regulated by the government, said a report from analysts Bain Rumohr, Christopher Wolfe and Joo-Yung Lee. Those reasons provide support for a high investment grade rating.

"The timing and scope of prospective reform remains unclear," Fitch said in an accompanying press release. "The U.S. government is unlikely to vacate its role of supporting the residential mortgage market given how entrenched Fannie Mae and Freddie Mac remain in housing finance and the importance of the 30-year mortgage to the U.S. housing market."

The two government-sponsored enterprises ratings are directly linked to the U.S. sovereign rating because of the implicit guarantee and meaningful financial support provided by the government.

Legacy corporate securities from Fannie Mae and Freddie Mac will likely have indirect or explicit support from the government if and when housing finance reform is implemented. This is necessary to avoid a market shock for GSE legacy debt, Fitch said.

The actions that the Federal Housing Finance Agency took to reduce taxpayer exposure, such as credit risk transfer, as well as the introduction of the common securitization platform and its goal of a uniform mortgage-backed security have resulted in the GSEs having very different business models and risk profiles than before the financial crisis "and are also likely a reason for why reform efforts have been prolonged," Fitch said.

The report discusses four widely floated GSE reform plans: recapture and release, a utility model, a lender-owned mutual model, and a possible wind-down of Fannie Mae and Freddie Mac.

The wind-down would take five to seven years while a private enterprise was created to set securitization standards. This would eliminate government involvement in mortgage market entirely.

"Fitch assumes that the government would not explicitly guarantee new corporate debt obligations under any of the broad options listed above. Some paths assume that the existing Treasury line would remain intact to support the remaining entities should capital be needed in a significant economic downturn or during periods of material market disruption. However, access to a Treasury line by the remaining entities is not considered in Fitch's base case or incorporated into the potential stand-alone rating implications," the report said.

Under the recapture and release and wind-down scenarios, the entity would need to raise sufficient private capital to support a high investment grade rating.

If the GSEs became utilities, "with regulated rates of return and strong capital levels, ratings could be high investment grade," Fitch said.

With the lender-owned mutual scenario, the investment grade ratings would depend on the financial position and strength of those lenders backing them and the nature of their support.

"The ultimate path taken for reform has implications for the size and diversity of the secured and unsecured debt markets in relation to housing finance entities. Generally, Fitch believes the intent of many of the paths is to preserve a very liquid [MBS] market. However, the necessity to issue unsecured debt out of the entities that emerge from reform will likely be low to none," Fitch said.