US agencies need to stop over-leveraging the system
The Federal Housing Finance Agency's risk transfer programmes are sponsoring egregious risk taking in the name of attracting private capital to housing finance.
The programmes include securitizations of reference mortgage pools — a clever trick allowing Fannie Mae and Freddie Mac to bring deals backed by loans they have already securitized, but without a government guarantee. It must be nice to securitize the same loan twice.
These deals would not get done without the backdrop of low yields and fund performance targets. That reality is a rant for another day though. The most frustrating issue with Fannie and Freddie is that they are increasing leverage in the system, at the same time as crowding out private transaction sponsors.
The dire state of affairs was made clear on Monday when Freddie Mac announced that it was planning a risk-sharing securitization without the loss severity caps present in all of its other Structured Agency Credit Risk (STACR) deals. There will be no government guarantee for the notes and investor returns will be tied to actual losses by the mortgage pool. Freddie will have effectively re-securitized the same mortgages, while limiting its exposure to those mortgages.
So why has the private market not been able to bring such deals?
Part of the reason lies in a lack of non-agency supply. The GSEs have launched programs to purchase loans with LTVs as high as 97%, and GSE backed loans do not expose lenders to lawsuits over representations and warranties on mortgages. That means it is easier for lenders to finance loans via the GSEs than through private securitization vehicles.
The full details of Freddie’s new issuance have not been disclosed but the agency’s previous risk transfer deals have included structural protections like 10-year maturities, as well as the loss severity caps missing from the new deal.
Private market deals have not so far offered these protections, but with a more diverse market, and less agency buying of mortgages with lower credit standards, perhaps these features would not be the sole preserve of the GSEs.
Freddie said in a release on Monday that the agency believed it would transfer more and more of its credit risk in agency RMBS to private investors through actual loss deals like the one it is planning now.
That means the agency will be sponsoring greater leverage in the mortgage market, by issuing risk transfer deals on top of its traditional guaranteed deals. That does not bode well for the return of non-agency RMBS, and it incentivizes another housing bubble.