Buyout-driven prepayments on agency MBS with coupons of 6% or higher could accelerate this year.
This is in contrast to 2009, when capital constraint served as a disincentive to agency buyouts (but not Ginnie Mae buyouts), Art Frank, director of MBS research at Deutsche Bank Securities, said in a December outlook report.
Last year, if the GSEs wanted to buy out a nonperforming loan, they had to immediately write it down to 40% of face value, "approximately the market bid side price for pools of seriously delinquent nonperforming loans," the report noted.
The capital for this loss was costly and had to be obtained from the U.S. Treasury Department, Frank explained. The agencies had to pay a 10% dividend to the Treasury for it. "For the GSEs, buying out a 6.5% loan at par, then borrowing 60% of the face amount and paying 10% on the loan is not, of course, a profitable business model," he said in the report.
This month, however, new accounting standards come into play that aim to "eliminate off-balance-sheet liabilities that have the potential to come back onto the balance sheet." They are causing the agencies to bring all of their loans onto their balance sheets at par "not at 40% of face amount, where they [had been buying out] delinquent loans."
"In other words … all GSE loans delinquent and performing are already on the balance sheets at par, so buying loans out of pools will have no impact on the GSEs' balance sheets anymore," the report said.
"Of course the GSEs will maintain loan loss reserves against the delinquent loans on their balance sheet, typically for two years of expected losses, but this is substantially less than reserving the entire present value of the loss," another section of the report notes. "In addition, reserves have already been held against the guarantee fee business outstanding, so the incremental amount of reserves held for a buyout will not be very huge."
According to a Dec. 24 Barclays Capital report issued in response to the Treasury's changes to its preferred stock agreements, "The definition of 'mortgage assets' counted against the [agencies'] caps now explicitly states that it ignores changes [due to the accounting shift]. That is, MBS guarantee related assets and liabilities which will be consolidated onto Fannie Mae/Freddie Mac balance sheets will not count toward the portfolio caps."
When asked about Treasury's recent changes to the agencies' preferred stock agreements, Mr. Frank said high-premium MBS buyout-driven prepays are likely to be seen "perhaps more than if [the agencies] had a more stringent portfolio cap" for 2010.
The main prepayment concern for these coupons this year "is delinquency-related," and even a return to lower rates would not change that, Frank told this publication.
The net effect of the Treasury announcement is a slight positive for current coupons but a negative for high premiums because the agencies now have more room in their portfolio to buy out seriously delinquent loans from the latter, he said.
The Treasury's move "solidifies government support of Fannie Mae/Freddie Mac," Barclays said. "The larger portfolio caps and change in their definition pushes out the timing of portfolio shrinkage. This should be a positive for MBS investors, as the GSEs can now serve as a backstop for the market once the Fed exits."
Among other reasons the Treasury's changes are considered on a broad basis to have strengthened the Fannie Mae and Freddie Mac going into this year is the following, according to Barclays.
"The maximum amounts of preferred stock Fannie Mae/Freddie Mac can draw from Treasury are now the greater of $200 billion or $200 billion plus the cumulative amount drawn from 2010 through 2012," its researchers note, explaining later in their report: "Because the preferred stock limits are expanding with any new draws, this takes unplanned receivership off the table as an endgame for the GSEs.
"This solidifies the government's support of Fannie Mae/Freddie Mac; GSE credit should no longer be a concern for the foreseeable future."
Barclays also noted, "Although Treasury pushed back the commitment fee by a year, keeping the senior preferred coupon at 10% is more evidence that conservatorship will late indefinitely."
However, Barclays said, "For debt investors, the improvement in the GSEs' fundamental/credit situation should be tempered by increased supply expectations.
"Delinquency buyouts are another source of uncertainty for near-term supply," the Barclays researchers added.
