Regulators plan to reshape the GSEs by slowly pricing them out of the market, according to a report from Deutsche Bank Securities.
Despite nearly three years of discussion regarding GSE reform, Fannie Mae and Freddie Mac remain in conservatorship and any comprehensive GSE legislation could still be a decade away.
In the meantime, Deutsche Bank analysts said that repricing guranty fees for Fannie and Freddie could redefine the mortgage market and reignite mortgage securitizations.
In February, the Obama administration's whitepaper on the future of mortgage finance asked Federal Housing Finance Agency to slowly begin repricing Fannie and Freddie guarantees “as if they were held to the same capital standards as private banks or financial institutions.”
The implications of this would mean that the capital held by the GSEs against credit risk would jump to 400 basis points, the level that banks have to hold against the safest mortgages, from the 45 basis points mandated by the GSEs' current charters.
"If the GSEs had to price to the same 15% after-tax return on equity that banks often pursue in healthy markets, it would need a pre-tax return in the low 20%s," Deutsche Bank analysts explained. "To get that on 400 basis points of capital, annual guaranty fees would have to run between 80 basis points and 100 basis points. Those higher fees would be an open invitation to banks."
Deutsche Bank said that as GSE guaranty fees reprice, banks making the safest loans — the 60 LTV, high FICO, low DTI loans — will likely decide to keep them. In essence, the higher regulators push GSE fees, more of the market share will likely be ceded to private capital.
"Through repricing rather than legislative reform, Washington can set the pace for pulling the GSEs out of the mortgage market and drawing private capital in," said analysts in the report. "That is exactly where the Obama administration has said it wants to go."
A slow repricing of GSE guarantees would also help reshape MBS, mortgage originations, private securitization and the Federal Home Loan Bank system.
According to Deutsche Bank analysts, the higher guaranty fees will make it more expensive and/or more difficult to refinance an agency loan. For investors, this means longer durations and less negative convexity in most MBS.
Higher fees would also slowly trim the volume of new agency MBS issuance as market share likely reverts to banks, and outstanding agency MBS balances drift lower. Bank portfolio lending to the best credits would likely rise, with both scale and niche lenders — lenders concentrating on geographies, borrowers or properties — taking share.
As a result, it is likely that private securitizations will reignite as these banks seek out better or different financing than the forms available from their deposit base or the Federal Home Loan Banks.