There is a significant disconnect in the Jumbo mortgage between the primary market and the secondary market. Since the 2008 financial crisis the once-thriving and vibrant non-agency, Jumbo MBS market has evaporated. Despite some attempts to resuscitate the Jumbo secondary market the gulf between investor needs and what consumers want remains large. Most of us are familiar with the expression “the elephant in the room.” Wikipedia defines this expression “as an English metaphorical idiom for an obvious truth that is being ignored or goes unaddressed.” Wikipedia goes on to say “the idiomatic expression also applies to an obvious problem or risk no one wants to discuss.” The application of this expression perfectly describes the dysfunctional gap between the terms investors want and what originators representing consumers need.
Since the financial crisis destroyed the liquidity in the Jumbo secondary market little progress has been made to restoring order. The reasons are tied to the enormous amount of government subsidy lavished on the conforming market. And the conforming market has also impacted the jumbo market through significant increases in the historic loan limits for the GSEs in “high cost areas.” Many industry experts have estimated government insured or guaranteed mortgages represent 90% of the total current market.
The result of the government subsidy and the lack of serious investment in jumbo or nonagency MBS products have impacted the housing market and the economy. One company attempting to revive the jumbo secondary market is Redwood Trust, a REIT focused on jumbo loans primarily in California. Redwood Trust's latest financial statements revealed that it is not yet making money buying and servicing jumbo loans. Various industry players said the main issue is consumer demand is not in sync with secondary investor needs.
Jeff Seabold, the CEO of CS Financial, a highly successful mortgage banking firm based in Beverly Hills, said the gap between the yield Redwood Trust wants is 0.5% in rate above the market established by portfolio lenders like Union Bank and ING. The other major issue for the primary market according to Seabold and confirmed by Tim Pihl, the head of capital markets for Union Bank, is investors do not want products other than 30-year fixed, or fully amortizing hybrid ARMS. As Seabold explained, borrowers seeking mortgages above the maximum GSE loan limit for high-cost areas and $1 million often are comfortable with a 30-year fixed-rate loan. However, borrowers seeking loans above $1 million want interest only products. Coastal California properties often require mortgages greater than $1 million representing a major segment of the market. Interest only loans for financially sophisticated borrowers provide flexibility and some potential tax benefits. Borrowers also have the option of paying off principal on their own schedule and receiving the immediate benefit of a lower payment and increased cash flow.
In a nutshell, the Jumbo market, particularly in California, is being underserved due to the heavy government subsidy of conforming loans including loans at much higher than historical limits. Only a shift in the amount of government subsidy and a return to lower GSE loan limits will aid the revival of the jumbo secondary market. It seems relatively certain that post elections in November, GSE reform will happen, leading the way for nonagency insured jumbo loans to once again trade efficiently in the secondary market. The “jumbo in the room” will be a thing of the past. Napoleon once said, “Ability has nothing to do with opportunity.” Currently the huge amount of available capital represents the ability to invest in jumbo mortgages but the lack of activity indicates few are recognizing the opportunity. While the opportunity goes unnoticed, some commercial banks have stopped taking corporate deposits and stopped marketing to consumers for deposits for the lack of reinvestment opportunities. Some larger institutions are capital restrained due to legacy mortgage portfolios created during the 2005-2008 era. So what has to change to shape the future?
As mentioned previously, the wind down of the government subsidy of conforming loans and a rollback of the GSE loan limits will stimulate investment in jumbo mortgages. Confidence in hard hit markets like California needs to be restored through recognition not all geographical areas in a state like California are the same. The confluence of these factors will help rebuild the jumbo secondary market. Consumers and the economy will be the beneficiaries.