The increase in the GSE conforming loan limit will most certainly diminish the size of the non-conforming or jumbo market, some experts said.
"It is going to allow for a commensurately smaller issuance in jumbos and bigger issuance in Agencies especially in the first quarter of next year," said one MBS analyst. "It just continues the inexorable squeezing out of the prime-label market."
Fannie Mae and Freddie Mac last week announced that the conforming limit for single-family mortgages in the lower 48 states will be $300,700 for next year. The limit went up from $275,000 this year.
According to Art Frank, head of mortgage research at Nomura Securities, the raise was permitted by federal law because the October Federal Housing Finance Board average housing price index went up 9.36% above its October 2000 level, allowing both agencies to up their limits by the same percentage, which, rounded to the nearest $100, amounts to $300,700.
Frank said that aside from slightly increasing agency market share at the expense of jumbos in 2002 and boosting the average loan size in agency 2002 pools, it would also make 1994 to 1997 premium jumbos "a little more callable as many of those loans have remaining balances in the high $200's and can now refi into conforming at 3/8% lower rates."
Analysts also believe that the higher limits would adversely affect the business of leading prime lenders such as GMAC-RFC, Wells Fargo, Chase, Bank of America, Countrywide and Cendant.
Given the competitiveness of the market, the difficulty in hedging servicing portfolios and market conditions in late 2001 where there has been a drastic shift from rapidly falling to rapidly rising interest rates, the loan limit increase will be a very significant competitive challenge for prime players.
However, some experts believe that although the GSE larger loan sizes would shrink the jumbo market somewhat, it would not have that much of an impact, since this sector is skewed towards super-large loans. The average loan in the jumbo market is about $400,000. With the increase, only about 10% of jumbo borrowers, those in the $275,000 to $300,000 range, were added to those qualified to refinance into a conventional loan. This would not make that much of a difference on prepayment speeds, analysts said.
An increase in
California concentration
One of the short-term effects expected from the raise in the GSE limit would be the increase in the percentage of mortgage loans from California in a lot of private label deals.
"As California real estate continues to outpace the market, it would be more difficult to have a conforming balance loan in this region as oppose to parts of the midwest where the average home price is about $150," said an MBS analyst.
This could become a problem because when investors look at the collateral of a deal, they would want to know how much California exposure is in there partly due to diversification of risk issues. This is especially true for those buyers of subordinate tranches who would probably not agree to a collateral concentration in a particular region bigger than 35%.
"The higher-cost areas are going to increasingly populate jumbo deals," said the analyst. "Investors are going to have to price that in accordingly, which would also negatively impact the jumbo market."
Adverse TBA selection
According to David Montano, director of mortgage research at Credit Suisse First Boston, the increase in GSE loan balances should result in more TBA "adverse selection." Montano said that with this, the prepayment differential between TBA pools and the cohorts is likely to increase.
With average loan balances increasing very rapidly, newer production has much higher average loan balances than moderately seasoned paper. Also, within the same pools there may now be a wider dispersion of loans, ranging from $100,000 to $300,000, each loan size having different prepayment characteristics.
The cohort as a whole will reflect the weighted average prepayment which is composed mostly of smaller loans. The TBA deliverable pools, on the other hand, are composed of the larger loans that will prepay much faster. This is why the differential in average loan balance between what is TBA deliverable and what is the cohort as whole can be larger now that the loan limits have increased.
Montano said that this is going to put potentially more pressure on the GSEs to provide more detailed loan balance information on their pools. Currently, information on average loan balances is available but this is not always that useful because the distribution of loan balances is not completely disclosed. The number of large loans in the pools is unknown.
This would help clarify the pricing on deals because otherwise, without disclosure, everything is going to be priced to the worst case. Increased disclosure would ideally lead to some tiering in the market, where people would pay more for lower loan balances.
