With the Senate version of the GSE bill proposing severe portfolio growth restrictions, mortgages might have to find a new marginal buyer, according to an analysis by Lehman Brothers.
The Senate GSE bill currently under consideration calls for outright portfolio caps and strict guidelines on what the GSEs could retain, restricting collateral to only mortgages for securitization and risk management purposes. The proposal also allows the agencies to retain loans that cannot be placed in the capital markets but it remains unclear what mortgages will qualify under these restrictions.
"Even in a favorable rate environment, the long-term impact of a severely constrained GSE portfolio would be significant," Lehman Brothers analysts said, adding that under this scenario, the GSE mortgage share would plunge from its current 21% to an almost insignificant number. Lehman added that even if the decline in holdings is mostly achieved with limited active sales, the question remains as to who would be the new marginal mortgage buyer taking the GSEs' place. Analysts further noted that the mortgage market would need to find an investor that could hold mortgages as an integral part of its core business model and would be seen as a backstop bid for the sector. Banks and overseas investors do not fit the bill because their appetite for the product does not really depend on relative value. "Under the Senate restrictions, even if the immediate impact is small, the long-term impact would be much more significant," Lehman analysts said.
By contrast, Lehman said that a scenario where the minimum leverage capital is raised would be severe in the short term but would have little longer-term implications. In both the Senate and House of Representatives versions, the regulator has the authority to change the minimum capital held against the portfolio. Although there will be a one-time adjustment, over time the change in leverage would not significantly restrain the GSEs' ability to grow. "Even under the most restrictive capital increase scenario of 4% capital charge, the agencies would still remain significant players in the mortgage market," Lehman analysts wrote.
Under both scenarios outlined above, the GSE guaranty business as a revenue source should increase, with the GSEs potentially extending this part of the business to weaker credit borrowers, Lehman analysts said. If this happens, this could have important implications for debt pricing, specifically in the nonprime market. Lehman reported that in 1999, the GSEs started to go down in credit quality from a guarantee fee standpoint, a move that was hugely successful in fixed rate Alt-A MBS where the majority of loans falling under the conforming limits are securitized as agency MBS. More recently, non-traditional mortgage products developed within the last two years present more opportunities for the agencies to grow in terms of their guaranty business.
Aside from the lack of bipartisan support, researchers do not expect any action on the proposed Senate GSE bill this year with the legislative calendar bogged down by a Supreme Court confirmation hearing, pension reform, the Federal Reserve chairman confirmation and hurricane relief efforts. After this year, Senator Richard Shelby's (R-Ala.) first chance to introduce this bill would be next February to May, after developing bipartisan support. But if the Senate bill fails to get this support, and the Bush administration remains firm on its opposition to the House of Representatives version of the bill, it is probable that nothing would happen on the legislative front with regards to this issue, Lehman analysts added.
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