Although the Obama administration's white paper on housing finance reform came up short on details, it reemphasized the importance of the securitization market in the future of housing finance.

The U.S. Treasury's white paper said that securitization, alongside credit from the banking system, should continue to play a major role in housing finance, although with greater risk retention, disclosure and other key reforms.

The administration believes that the securitization market requires meaningful reform so that private investors can confidently participate in the housing sector and provide an alternative funding source for mortgages outside of the traditional banking system and government-supported institutions.

The proposal also reiterated the government's stance on risk retention and said that the administration continues to work with federal regulators to set rules requiring securitizers or originators to retain 5% of a security's credit risk when sold to investors. The rules are expected to be finalized in 2011 and become effective in 2012.

"We are encouraged by the plan's objective of creating a level playing field through an increase in guarantee fees that removes Fannie Mae's and Freddie Mac's capital advantages," said Tom Deutsche, executive director at the American Securitization Forum (ASF). "This unfair advantage has restricted the ability of private capital to fully support our housing finance system and shifted that burden to the American taxpayer."

Deutsche added that the ASF also supports the plan's recommendation to let the higher conforming loan limits expire as scheduled in September. Those two measures, which could considerably limit the GSEs' market share, should be implemented over the short term while Congress decides the long-term fate of the existing GSEs, he said.


Future Still Hazy

The white paper outlines three options for housing market reform. Under the first option, a privatized system of housing finance would be implemented with the government insurance role limited to extending assistance to a narrowly targeted group of borrowers through the Federal Housing Administration (FHA), the U.S. Department of Agriculture and the Department of Veterans Affairs.

Under the second option, the administration sees a heavily privatized system with assistance from the FHA, but also the creation of a guarantee mechanism that would expand during periods of economic stress. The government would preserve the ability to scale up to a large share of the market as private capital withdraws in times of stress.

The final option also calls for a dramatically reduced government role in the mortgage market, limiting direct intervention to the FHA and other targeted programs while including a catastrophic reinsurance plan. Under this scenario, a group of private mortgage guarantee insurance companies (MGICs), through private capital guarantees and a government reinsurer, would provide reinsurance to MBS holders, who would be paid out if the shareholders of the MGIC have been wiped out.

Short-Term Implications

"While many of the proposals set out in the Treasury Department's white paper may take years to implement, some of the other recommendations such as raising g-fees may take place much sooner than expected," said Scott Buchta, head of investment strategies at Braver Stern.

An immediate impact will be on the limited refinancing options for certain loans. Buchta said, for example, that the recent U.S. Department of Housing and Urban Development (HUD) announcement that, as part of its ongoing efforts to strengthen the HUD's capital reserves, it will implement a new premium structure for FHA-insured mortgage loans through increasing its annual mortgage insurance premium (MIP) by a quarter of a percentage point on all 30- and 15-year loans would likely reduce refinancing options for these loans. According to HUD, this change will move the MIP fee from 85 basis points to 90 basis points to 110 basis points to 115 basis points.

"This will reduce the refinanceability of current FHA loans," Buchta said. "This action will have a negative impact on home prices, as many first-time home buyers use FHA financing, and any incremental cost will be reflected in how much a borrower can afford to pay for a home. Twenty-five basis points are equal to about 2.5% in home price, holding the payment unchanged."

Another change that is likely to impact borrower refinancing options is the reduction of conforming loans limits. In 2008, Congress approved a temporary increase in the loan limits to a maximum of $729,750 in high-cost areas; this limit was set to expire on Oct. 1. The report recommended that these limits be reset as scheduled to the Housing and Economic Recovery Act (HERA) limit of $625,500 in high-cost areas.

The reduction of this nonconforming loan limit will bring an end to the agency Jumbo conforming asset class. One implication of this recommendation is that high-balance conforming mortgages, particularly mortgages over the HERA limits, will become less refinanceable after Oct. 1, Amherst Securities Group (ASG) analysts said.

According to JPMorgan Securities research analysts, only about 13% of non-agency RMBS borrowers have mortgage loans that fall under the agency conforming Jumbo category. Fannie Mae has by far produced the larger share of conforming Jumbos relative to Freddie Mac. There has also been a class of GNMA II Jumbo securities that was created.

"Refi options for conforming balance borrowers will be limited to the private markets (i.e., bank balance sheets and any putative securitization market), and those rates are likely to remain higher than conforming execution for some time," explained FTN Financial analysts in a report.

Jay Menozzi, chief investment officer at UCM Partners, said in an email that most Jumbo borrowers will likely be able to refinance in the future. "We would think that a significant portion of these borrowers would fall between the $417,000 to $625,000 loan sizes and would still be eligible for agency conforming Jumbo execution provided that their credit remains very strong, current LTVs are low and they have full docs," he said.

Menozzi also believes that banks are likely to ramp up their Jumbo origination platforms - both agency conforming and nonconforming - which will narrow the spread between non-agency Jumbo loans and agency conforming mortgages.

However, banks are likely to limit lending to borrowers with pristine credit. "We do not foresee a significant pickup in non-agency issuance yet and would think that we'll see around $2 billion to $4 billion in new issuance of non-agency RMBS securitization deals," Menozzi said. "More importantly, some of the main impediments to new-issue Jumbo securitization are regulatory uncertainties that confront private-label securitization. The new risk retention rules may potentially trigger the consolidation of the entire deal that would lead to much higher capital charges that those against whole loans."

While some borrowers may be left in the lurch as the origination for agency conforming Jumbos begins to dwindle, investors can look forward to less supply and an improving convexity profile in this market, ASG analysts added.

"Many seasoned prime and Alt-A fixed-rate bonds are currently trading above par and any refinancing impediment will improve their convexity profile, making them more appealing investments relative to agency MBS," Menozzi said.

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