The differential in pricing between Fannie Mae and Freddie Mac MBS has widened over the past year despite a high level of refinancings and issuance. But concerns are growing that investors’ preference for Fannie mortgage-backed securities could increase even more as refinancings decline later this year, according to officials at the Mortgage Bankers Association (MBA). Both GSEs are wards of the federal government.

When there is a big drop in MBS insurance, “how do you protect the liquidity in the market for both Fannie and Freddie MBS?” asked MBA chief economist Jay Brinkmann.

It’s an issue the chief economist has been wrestling with for the past year.

As the larger government-sponsored enterprise, Fannie has always enjoyed some advantage in pricing. Freddie’s securities have “been on the cheap side for some time,” said Mahesh Swaminathan, a managing director at Credit Suisse.

But over course of the year, Fannie and Freddie prices have drifted apart to the point where the quarterly averages have been “near historic-wide levels,” the MBS market expert said.

Liquidity and prepayment speeds are often cited as reasons for this widening.

Current trading in Freddie MBS ranges from $10 billion to $20 billion a day, compared to $200 billion a day for Fannie MBS.

Prepayment numbers have suggested to investors that Freddie speeds on average tend to rise “a little more” than Fannie’s when bonds rally and rates drop, Swaminathan said. Also Freddie’s issuance has “trickled down” over the past couple years.

Lenders delivering loans to Freddie also are affected by a pricing differential.

However, Freddie makes up the difference through a “market adjustment payment” to its lenders.

“If the large payment differential remains and the market adjustment payment is not adequate enough, business would migrate to the superior execution,” Brinkmann said in an interview.

MBA has been working on the MBS pricing issue for the past 18 months, talking with various industry and government officials about ways to address it. MBA president and chief executive David Stevens spoke about the MBS issue at the trade group’s recent secondary market conference in New York. “The major lenders want to address this now rather than waiting until it becomes more problematic,” the MBA official said.

Recently, Bank of America (BofA) senior vice president Matthew Tomiak called for the creation of a single GSE instrument for securitizing Fannie and Freddie guaranteed loans.

The Federal Housing Finance Agency (FHFA) has already set a long-term goal of merging Fannie and Freddie’s securitization platforms. But the GSE regulator could take more immediate steps to make Fannie/Freddie securities more “homogenous and fungible,” Tomiak said at an American Securitization Forum conference in Washington.

Hunton & Williams attorney Amy Williams said the FHFA could create a single-agency MBS under Fannie and Freddie’s charter without seeking congressional approval.

The securitization attorney said that once a single-agency MBS instrument is created and trading, even mortgages originated in 2011 and 2010 could be converted into a single-agency MBS. “I think those things are doable within the charters,” Williams said at the ASF conference.

She noted the FHFA’s initiative to provide investors with more loan-level data on securitized mortgage would enhance investor acceptance of a single GSE security.

MBA’s proposal calls for making Fannie and Freddie securities similar enough so they can be delivered under the same TBA (to-be-announced) contract.

“If we could get Fannie and Freddie deliverable into the same TBA contract,” Brinkmann said, “that would benefit the liquidity of the Freddies and conceivably, when we go into this slow market, even benefit the liquidity of the Fannies.”

If that’s enough to fix the problem, MBA has not ruled out moving to a single GSE security. “The goal is to make these securities attractive enough to investors,” Brinkmann said.”

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