Tag: Fannie Mae

NY Times article about Fannie and Freddie

Posted on by Evan in For Professionals, General Mortgage Info., Housing & Real Estate

The NYT did a great article about foreign participation of Fannie Mae and Freddie Mac mortgage-backed bonds on July 21st.

The article quantifies the involvement of foreign investors in buying mortgage-backed bonds (which helps keep bond yields/ interest rates low). The article suggests that in the past few years Fannie Mae and Freddie Mac officials were “selling” mortgage-backed bonds as investments to foreigners by describing them as securities which were implicitly backed by the US Government even though the US has no legal obligation to bail Fannie Mae and Freddie Mac out. However, based on Henry Paulson’s recent comments it looks likes this may actually be the case.

Here is a link to read the article for yourself.

Fannie Mae & Freddie Mac in the news…..

Posted on by Evan in Credit Crisis, General Mortgage Info., Housing & Real Estate

Unless you live under a rock you are probably very familiar with the turmoil ongoing in the financial sector of our economy. This turmoil brought Indymac Bank to its knees last Friday when the Federal Government seized it’s assets for failing to maintain adequate capitalization. This bank failure is the 2nd largest bank failure in US history. Their failure has brought increased concern over the financial well-being of mortgage industry titans FNMA (Fannie Mae) & FHLMC (Freddie Mac).

Most people have heard of Fannie Mae and Freddie Mac but may not understand much about them. The media has recently done a great job of generating fear and panic surrounding these two companies but has yet to explain the crucial roles that these two entities play in our economy. It is my objective with this blog posting to clear some of this up and answer the following questions:

  • Who are Fannie Mae & Freddie Mac?
  • What exactly do they do?
  • Why are they so important?
  • Why are they currently in the news?
  • And what would be the implication of their financial failure?
  • What’s next?

Who are Fannie Mae & Freddie Mac? and What exactly do they do?……A Brief History
To first understand who Fannie & Freddie are let’s take a look at why they exist. Prior to these two entities (before 1938) the mortgage industry was fairly simple. A local or regional bank would collect money from individuals and businesses in the form of deposits and lend that money back out in the form of mortgages (or other types of loans).

This system worked pretty well for many years except for a couple limitations.

One problem with this system was that a bank was limited to lending out only a portion of the deposits they took in. Therefore, if a bank had $10 million in deposits they would have the ability to lend out only portion of those assets (say $9 million or 90% for example) depending on the prevailing reserve requirements. A reserve requirement is the minimum amount of deposits a bank must hold relative to the loans outstanding.

A second problem was that banks were typically limited to lending in the local area in which they were located.

Then came the national banks. These larger institutions had branch presence across the country. This gave them the ability to collect $10 million of deposits in New York City and redistribute these funds in the form of loans in another state (Illinois for example).

This system also worked fairly well for a number of years except during times of economic contraction when bank runs would occur. A bank run is when a large number of individuals withdraw their deposits from a bank for fear that the bank is going to fail.

This happened frequently during the Great Depression and stock market crash of 1929. The result was that when the economy needed monetary infusions to help boost growth the opposite would occur because banks would suffer huge declines in their reserves.

To rectify this problem, Franklin D. Roosevelt founded the Federal National Mortgage Association (Fannie Mae) in 1938 as a government agency. This agency was to provide liquidity in the mortgage market by buying mortgages from banks which they then chopped up and securitized into mortgage-backed bonds (avid ‘rate update’ followers should know what these are) that were sold to investors.

From a banks perspective, they were now able to lend a borrower an amount of money for a mortgage, sell the mortgage to Fannie Mae (and book a small profit), then lend that same amount of money again, and again, and again. Conceivably, as long as investors were willing to buy the bond backed by the original mortgage there was an endless supply of liquidity available for mortgage lenders. With this financial invention “securitization” was born and the period of credit expansion in the US was underway.

Add Freddie Mac
In 1968 the Federal Government decided that they no longer wanted Fannie Mae on their Federal balance sheet so they privatised the company. So that Fannie Mae would not act as a monopoly they also chartered the Federal National Mortgage Association (Freddie Mac) to compete with them.

To this day both companies are in existence as publicly traded entities and continue to provide liquidity to the mortgage market through the same purchase & securitization process described above.

Why are they so important?
Virtually every bank and lender out there is running at or near the minimum reserve requirement ratio which is currently set at 3% (simply put). Therefore, if a bank has $100 billion in loans outstanding, they have to have at least $3 billion in capital as backing (the reason Indymac failed last Friday was because they fell below this 3% level).

What Fannie Mae & Freddie Mac allow banks to do is to continue to lend even if they are getting close to their reserve requirements because as soon as they lend the money on a mortgage (increasing their loans outstanding and decreasing their capital), they get the cash back from the sale of the mortgage (decreasing their loans outstanding and increasing their capital).

Why are they in the news?
Fannie Mae & Freddie Mac are currently in the news because they are experiencing financial difficulty.

The current problems at Fannie Mae & Freddie Mac are twofold.

First, their loan portfolios have gotten very large which has raised questions about their solvency. In fact, today, Fannie Mae boasts a loan portfolio of $5.3 trillion. However, they only have $84 billion in capital which means their reserves are only about 1.58% of their outstanding loans. If they were a bank then the Federal Government would have already shut them down.

Second, they are losing A LOT of money which is putting further pressure on their capitalization ratio. These companies lose money when mortgages perform poorly because they guarantee the principal and interest on the mortgage-backed securities that they issue even if the borrower defaults. Therefore, during periods of rising defaults, delinquencies, and foreclosures-as is currently the case- these companies incur huge losses. In fact, according to their last two quarterly reports, they’ve lost over $11 billion in operating income over the last 6 months. These large losses coupled with their already low capitalization rate has investors concerned over their long-term viability.

What would the failure of Fannie & Freddie mean to the mortgage market?
The bottom line is that such a failure would be devastating to the mortgage market. The void that the loss of these two institutions would create in terms of providing liquidity in the mortgage market would be irreplaceable by the private sector.

In the event that these two corporations failed at best we could count on mortgage offerings that mirror the “non-conforming” or “jumbo” mortgage market today. These are loans that are portfolioed or securitized by the private sector and typically have much more stringent qualifying guidelines & (say good-bye to low down payment and investor loans) higher interest rates (currently non-conforming fixed rates carry rates in the 7-8.5% range.

At worst, mortgage lending would seize to exist except for seller contracts and private “hard money” loans.

What next?
The fate of Fannie Mae and Freddie Mac will likely be impacted on the health of the housing market & the Federal Government’s willingness to step in if need be.

Should we begin to see some stabilization in housing it would create incentive for borrowers to make their payments which would prevent foreclosures that cost these corporations billions. This could eventually allow Fannie Mae & Freddie Mac to return to profitability and hopefully rebuild their battered balance sheets.

However, should these two titans fail we believe the Federal Government will step in and nationalize these two entities to avoid an all out halt of mortgage lending in our economy. Of course, the longer-term problem with that is how the American taxpayer will pay for it.

Fannie Mae continues to tighten their guidelines….

Posted on by Evan in For Professionals, General Mortgage Info., Housing & Real Estate, Mortgage Qualification

Fannie Mae released an announcement yesterday which indicated they are tightening some of their guidelines to qualify for a new mortgage. The reason this is important is because Fannie Mae dictates underwriting guidelines for virtually all mortgage lenders.

There is one guideline change within this announcement that we feel will be impactful and thought we should share it with you.

It involves a buyer who is buying a new primary residence but has yet to sell and close on their existing residence. In this circumstance the buyer is required to qualify for BOTH mortgage payments (BOTH= the proposed mortgage payment on the new house & the existing mortgage payment). However, currently we are able to offset a portion of their existing mortgage payment by giving them a credit for the market rent that their home would earn if they chose to rent it out (even if this is not their intention). This helps them qualify for the new house. However, Fannie Mae has changed that guideline to the following (bold and italicized copy represent the changes):

1) If current home is being retained as a 2nd home (basically no rental income needed to qualify, but home is not being sold) – qualify with the full PITI payment on both properties plus borrowers must have 6 months mortgage payments in reserves for both homes!

2) If the home is being retained for an investment property & rental income is needed to qualify, you need the following: a) Evidence that the borrower’s have at least 30% equity in their current home, b) a copy of the fully executed lease agreement & c) evidence of receipt of the security deposit & deposit into the borrower’s account. If the borrower’s lack 30% equity (as verified by appraisal, AVM or BPO (Broker Price Opinion), you will also need 6 months’ mortgage payments in reserve on both properties*!

With average market times increasing (Washington County currently around 70-80 days) this will delay buyer’s ability to purchase a new home.

What you need to do?
Be sure your client gets pre-approved EARLY AND OFTEN!

FNMA email on why rates are rising….

Posted on by Evan in Economics & Interest Rates, General Mortgage Info.

I got this email from an industry insider today. Although the email string doesn’t indicate who wrote the email apparently it is from a Fannie Mae official who tracks the investment communities’ demand for mortgage-backed bonds. Why is this important? This email explains in detail who the typical buyers are for mortgage-backed bonds and why they aren’t buying right now. The lack of demand is ultimately the factor which is driving mortgage rates higher.

Here’s a copy of the email-
These are Fnma’s comments on the selloff in MBS…
Bit long but addresses the questions:
1. Why aren’t mortgage rates better (i.e. why is the spread between treasuries and MBS the greatest since 1986)?
2. Why is FHA pricing so good?
3. What is likely to happen with jumbo pricing in the near term?
4. Why are arm rates so volatile right now?
Many of our client’s will appreciate this info….
The Capital Markets Sales Desk has fielded a large number of calls from customers simply asking, what’s going on? Why is the mortgage market trading lower every day? The following are reasons that could help explain why mortgages are struggling and why current market conditions are so volatile. The question is, why are mortgages widening or losing value vs other benchmarks like treasuries? Mortgages are widening for a number of reasons. First, there are no buyers. The dealer community is quite full and has no more balance sheet to hold mortgages. In addition, with the market so volatile, dealers don’t want to own mortgages at this time. Another reason why dealers do not have an appetite for risk is quarter end. Most dealers are experiencing a quarter end in March and have become even more conservative. Banks are not buying either. They are more concerned with retaining capital to cover potential losses in other sectors. Banks and other securities firms have written down an astonishing amount of losses since the subprime mortgage market fell apart last summer. According to Bloomberg, as of February 8th, write-downs by banks and securities firms around the world had reached $120 billion. Therefore, banks remain defensive and prefer to either retain capital or put it to work in other AAA rated sectors. Asia has been noticeably absent as well. Asian banks generally buy on strength and its obvious there hasn’t been any strength exhibited in the mortgage market recently. Also, Asia is generally more active at the end of the month so their absence this week is not a complete surprise.
Money managers and hedge funds aren’t buying for the long term either. What they are doing is called momentum trading. They are buying at the wides (cheap) and selling at the tights (less cheap). Since they are buying and selling, they are not taking any production out of the market leaving the market to trade in a volatile fashion. The market is also trading very thin so exaggerated price movements occur when larger blocks are brought to market. Okay, we know that dealers, domestic banks, Asia, money managers and hedge funds are not buying. But, who is selling? Well, we know servicers have been selling. When the market sells off, the current coupon increases and servicers attempt to keep their hedges in the current coupon. Therefore, servicers need to sell lower coupons (longer duration coupons) and purchase higher coupons (shorter duration coupons). This is called moving up in coupon and is a form of shedding duration. However, in large market moves, servicers may need to sell without the corresponding purchase of the higher coupon. This is called outright selling. The outright selling and duration shedding from servicers has put extra downward pressure on mortgages. Originators are also selling. Although, with higher mortgage rates, originators aren’t selling as much as they were a month ago, the amount they are selling remains significant.
Okay, servicers and originators were the two expected suspects, but are there any other sellers? Unfortunately there are, and this group of sellers is what brings fears to the market. Thornburg Mortgage, a mortgage REIT that specializes in Jumbo and Super Jumbo mortgages received a margin call from JP Morgan in late February. A margin call is a demand for cash on an under-collateralized loan. Thornburg was unable to meet a $28 million margin call and may be forced to liquidate its holdings. We are hearing talk of a $4.4 bln list of Non-Agency ARMs and pass-throughs out for the bid from Thornburg today. Another seller may be Carlyle Capital Corp, which is an investment bond fund located in Guernsey, UK. CCC missed four of seven margin calls totaling $37mln and another margin call notice is expected. According to Bloomberg, the fund raised $300mln in July and levered the money to purchase approximately $22bln in various forms of MBS. A portion of this $22bln is expected to be sold, and some market participants venture that a portion is being marketed today.
Although this is only two of the many accounts that participate in the MBS markets, their forced sales could have major repercussions. For example, let’s say the bonds that are sold are sold at very low dollar prices. That may cause other market participants to mark their own portfolio down to current market levels. This may cause further write downs. The fear of further write-downs has banks on the defensive to a point where they want to preserve capital. If banks are preserving capital, then they are obviously not investing in MBS.
The few investors who do have available capital are putting their money to work in more profitable sectors. Municipal Bonds and certain classes of CMBS are yielding more than Agency MBS and have a AAA rating. Despite the inherent “cheapness” in the mortgage market, there are still other safe investment options that are more preferable at the moment.
In summation, we have more sellers than buyers. The selling bias puts pressure on mortgages, forcing mortgage prices lower and wider. The usual buyers of mortgages aren’t buying or are buying other investments at cheaper prices.
Another trend we’ve noticed is a flight to quality within the mortgage market. Generally, when the market experiences a flight to quality, money is moving into US Treasuries. However, with treasury yields so low, market participants are buying the next best thing, GNMA MBS. GNMA MBS has the explicit guarantee of the US Government. Purchasing GNMAs allows an investor to enjoy the explicit guarantee while yielding considerably more than US Treasuries. In times like these, banks prefer to own GNMA MBS vs conventional MBS for a reason other than the explicit government guarantee. The reason is capital. Banks have to hold a certain amount of capital against their investments. However, they are required to hold significantly less capital against their GNMA holdings vs. their conventional MBS holdings. With the flight to quality within the mortgage market, and a preference by banks for GNMA MBS, it is no wonder why the GN/FN swap spreads have gapped out to astonishing levels. The current GN/FN 5.5% swap has gapped out from 18/32s from January 22nd, to its current level of 59/32s. Another thing to keep an eye on is ARM issuance. The yield curve has steepened in recent weeks (current difference in yield between the 2yr treasury and 10yr treasury is 208 bps). Generally, when the curve steepens, the difference in ARM rates and 30yr mortgage rates increases. Therefore, one may assume ARM issuance is likely to increase now that the curve has steepened. However, due to the lack of liquidity in the market, ARM MBS is trading extremely cheap. In other words, the correlation between a steep yield curve and lower ARM rates has decreased. Because lenders can’t sell their current ARM production in the secondary market at respectable levels, they can’t lower their offered rates. When liquidity improves, look for ARM issuance to increase.