The U.S. government has recently been aggressively pursuing measures to help the beleaguered housing market. One measure that has been getting a lot of attention would allow Fannie Mae, Freddie Mac and Ginnie Mae to purchase mortgages greater than the conventional conforming loan limit, which is $417,000 according to the Economic Stimulus Act of 2008.
"The Fannie Mae and Freddie Mac jumbo programs are off to a very slow start," said Art Frank, director and head of MBS research at Deutsche Bank Securities; however, he expects the program to ramp up and see meaningful volume by the fall.
The numbers support Frank's assertion. As of Thursday last week, there were only six Freddie Mac jumbo pools, which totaled $14.68 million, and two Fannie Mae pools, totaling $2.61 million. The Ginnie Mae program has seen more volume, though, as $80.46 million of jumbo securities in approximately 17 pools had been issued by the beginning of May, according to the agency.
In what some call a bow to political pressure, Fannie Mae last week made a noticeable attempt to jump-start its jumbo program. The GSE offered to buy for its portfolio new jumbo-conforming loans at the same price as regular conforming loans through the end of the year. "This means that although jumbos are not TBA-eligible, we will be pricing them as if they were," Fannie Mae said in a press release. In other words, Fannie is buying these securities at a price that sources said is above the fair value that the market would probably pay for them.
"If they are buying them at a flat price to TBA, it's hard to see how anybody else would be able to compete with that," a source said. "Fannie is doing this for the good of the homeowners, although that would take the secondary market away from these securities for as long as Fannie is doing this."
Sources also said that investors are not going to buy the loans at these levels because it makes no economic sense given the prepayment risk inherent in these securities. The same sources said that Fannie Mae is probably going to buy only a limited amount. Fannie officials have no comment on this issue.
According to a veteran market observer, Fannie Mae is going to price jumbo conforming loans for portfolio purchases on top of where they price conventional loans, which should push down the spread of jumbo conforming rates over conventional rates. This will have a significant impact on high-cost states such as California, where the median home price is right around the conforming limit.
"One of the things that really crushed the housing market was the period last fall when mortgage rates were at 6% and jumbo rates were 8% or higher," the observer said. "Home prices in California were so high that financing became unavailable for many properties. If jumbo conforming rates are close to conforming rates, prospective home buyers will be able to obtain reasonably priced financing for the purchase of homes that, because of the cost of jumbo financing, had become unaffordable."
Freddie Mac Forms Ties
Unlike Fannie Mae, Freddie Mac has committed to pricing its jumbo securities only a point back from TBA, sources said.
However, it has also made major moves to kick-start the jumbo initiative. In mid April, the corporation agreed to purchase billions of dollars of new conforming jumbo mortgages with original loan amounts of up to $729,750 from Wells Fargo Home Mortgage, Chase, CitiMortgage and Washington Mutual. These mortgages will be used to fund properties in 224 high-cost areas that exceed Freddie Mac's $417,000 loan limit under the Economic Stimulus Act of 2008.
One problem, Deutsche Bank's Frank said, is the fact that these securities are not eligible for TBA, which means that originators don't quite know how to price them in the primary market.
"It's kind of like the chicken and egg problem," Frank said. "Unless you have a liquid secondary market going, you don't know where to price stuff. This is why I think Freddie did the right thing by going out there and making a deal with some of the larger originators. Once they start originating, they could see if the market will bid them better than Freddie Mac could bid them."
By participating in the stimulus program, Freddie Mac has developed a "credit box" of eligible product with prices that, firm officials say, have been positively received by the lender community. Although the current program has geographic limitations, the credit box is fairly flexible, as the program still accepts up to 90% loan-to-value mortgages and covers an array of product types including fixed-rate, adjustable-rate, interest-only, refinance and limited cash-out mortgages.
"We are providing a forward price lock for the entire loan and putting those loans on our balance sheet," said Bob Ryan, vice president in charge of single-family loan pricing for Freddie Mac. "At this time, this affords lenders the ability to hedge out that risk and provides great liquidity for them." Ryan explained that one of the most difficult things in the market right now is that MBS investors aren't buying many securities backed by jumbo loans. But now that Freddie Mac is providing forward coverage on these loans, originators have some comfort. He added that the pricing on the loans under this program is better than those of comparable jumbos.
Ryan said that lenders under the program are now in the process of ramping up their origination, so the market should start to see loans under the jumbo program close and settle by May. Freddie Mac expects that, throughout the year, this program will produce roughly $10 billion to $15 billion in volume.
The jumbo securities under the program, according to Ryan, are currently trading roughly a point to two points behind TBAs. "So it's a pretty big spread," considering the constraints that the program is operating under, Ryan said. One of the constraints, he said, is that the program is currently scheduled to stop by the end of 2008, so the security will cease to exist as currently contemplated by then. And this causes liquidity concerns. "That is partially why these would trade back so much from TBA," Ryan said.
Ryan is encouraging investors to get involved and to view buying these securities as an opportunity, especially at these wider spread levels. "I think originators are ramping up and are going to see a better execution," he said. "I think the spreads will tighten, execution will improve, mortgage rates will decline more. It's been a little bit of a slow start, but it's coming, and people need to get involved."
Ginnie Mae Catches Up
Historically, Ginnie Mae securities have traded better than FNMA and FHLMC Golds. However, these securities have typically struggled with low volume, falling significantly behind the two other GSEs.
Still, times have changed, and Ginnie Mae could benefit if the Federal Housing Administration Modernization Act is implemented and borrowers come back to the FHA program because of the subprime crisis. The new jumbo initiative is also expected to produce more volume for this product.
Origination is starting to ramp up, according to figures from the FHA. The administration reported that it has run approximately 4,400 jumbo loans through its underwriting process, using $417,000 as the threshold for "jumbo" loans.
"We'd rather have higher GNMA supply, even if perhaps they do not trade quite as well," said Michael Frenz, executive vice president of Ginnie Mae.
According to Frenz, securities from the new jumbo program had been trading at roughly 1 3/8 and 1 1/2 points behind GNMA IIs but have recently traded inside of a point back. Frenz said that there has been some support for these securities, with a major buyer already expressing an interest in investing heavily in these GNMA jumbo securities.
What are the implications of these securities not trading at TBA? According to Frenz, non-TBA product trades either better or worse depending on the underlying collateral, presumably worse if the collateral prepays faster. However, Ginnie Mae is trying to help investors better predict prepayments of the new jumbo product by increasing disclosures on these jumbo securities - for instance, by providing increased data on LTVs and credit scores. "We have heard that as supply increases in this type of asset and as we improve disclosures, spreads may narrow to 3/4 of a point," Frenz said. Also, when the FHA Modernization Act is in place, the permanent loan limit should be within the $500,000 to $550,000 range, making it easier to argue that they are TBA-eligible.
The jumbo program is so new that many lenders don't have the technology to support this type of loan. One major mortgage originator in California has set up the lending infrastructure, including the IT technology, to get going on the jumbo program. But for the most part, the lack of such infrastructure elsewhere remains a drawback that is hindering the growth of GNMA's jumbo program, according to Frenz.
Kevin Cavin, an analyst for FTN Financial, said that his firm has been trading securities from GNMA's jumbo program, which are currently trading at a discount to regular GNMA bonds. "Right now, the reason that these jumbo securities are trading at the back of TBA is that, since they are not TBA-eligible, they have reduced liquidity, and with the higher loan balances, they have more prepayment risk," Cavin said. According to Cavin, interest in this product has come from traditional GNMA investors such as money managers, GNMA funds, insurance companies, banks and pension funds. He added that, despite the lack of liquidity in the GNMA jumbo product, there is an advantage in buying this type of collateral: It is a higher yielding bond with no credit risk since it carries the GNMA explicit guarantee from the U.S. government.
Legislation Update
There have been recent initiatives in the U.S. Congress to make the loan limits permanent. Rep. Gary Miller (R-Calif.) is seeking a permanent increase in the loan limits for all three agencies.
Congress might also change the time frame for the eligibility of these mortgages.
Currently, the only loans that could fall under this program are those that were originated between July 1, 2007 and Dec. 31, 2008, although the GSEs could still securitize loans originated in January 2009.
Deutsche Bank's Frank said that Congress might reconsider this time frame, despite the fact that the Bush administration did not seem to want the higher limits to go beyond the end of this year.
However, the provision on jumbo loans might just form part of the GSE regulatory bill that was passed by the House of Representatives almost a year ago and has been stalled in the Senate ever since. Chris Dodd (D-Conn.), chairman of the Senate Banking Committee, has shown some interest in moving the reform bill forward. It might even pass this year, though the final version could be a political compromise and not anything like the current House version, according to Frank.
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