Archive for June, 2010
Mortgage spreads to Treasury notes widened out somewhat from recent lows following the withdrawal of the Federal Reserve from its $1.25trn mortgage-backed securities (MBS) purchase program, although it was not the fallout some analysts expected.
The June 2010 outlook from PMI Mortgage Insurance Co., the principal operating subsidiary of The PMI Group (PMI: 0.00 N/A), suggests part of this widening may have little to do with the absence of demand and more to do with a broader economic flight-to-quality.
The spread between 30-year fixed-rate mortgages (FRMs) and 10-year Treasury notes historically moved in a band of around 100 to 200 basis points (bps). In times of financial stress, mortgage spreads will blow up to more than 400 bps over Treasurys. By the end of 2008, PMI noted, mortgage-Treasury spreads shot up to around 300 bps, putting upward pressure on mortgage rates and bringing down demand.
In response, the Fed began its agency debt- and MBS-purchase programs, which pulled in spread sharply to around 120 bps by the end of April 2010. But questions remained over whether the withdrawal of the Fed's demand would cause spreads to widen out again. Analyst expectations ranged from a widening of zero to more than 100 bps, with PMI's own estimate coming in at 25 bps of widening.
About a month after the Fed's program ended, spreads were up by about 45 bps, partially due to a flight-to-quality unrelated to the Fed's program, according to PMI. But a coordinating rise in triple-A corporate spreads — which rose about 25 bps over the same period — indicates forces other than the end of the Fed's MBS demand are driving spreads higher:
"Removing that [25-bps rise] from the increase in mortgage spreads leaves about 20 bps as the impact of the Fed's MBS purchase program's cessation," writes PMI chief economist and strategist David Berson. "Not only is this estimate on the lower end of the range but mortgage rates have been declining over the past month in reaction to the general flight-to-quality."
"Yields on 30-year FRMs have slipped by around 25 bps since the Fed's program ended — but they might have fallen by about 45 bps if the Fed's program were still in place."
Additionally, spreads between conforming and jumbo 30-year FRMs typically has been around 10-40 bps, but ballooned to more than 150 bps during the financial crisis. Over the past year, however, the jumbo-conforming spread dropped sharply to around 70 bps at the end of May. Berson warned the spread decline may overstate the scale of improvement in the jumbo mortgage market.
"While the jumbo mortgage market may be better functioning than it was over 2008-2009, it still lacks the liquidity to allow for a full recovery in the upper-end housing market," he wrote. "The recent successful (if small) private label MBS sale by mortgage REIT Redwood Trust is a positive sign, but it is just the first step in a long journey of recovery for the jumbo mortgage market."
Write to Diana Golobay.
Disclosure: the author holds no relevant investments.
The Home Affordable Modification Program (HAMP), which so far falls short of expectations for completed modifications, is likely to display similar re-default trends seen in other modification programs, according to Fitch Ratings.
In a structured finance special report today, analysts at the credit-rating agency noted that residential mortgage-backed securities (RMBS) servicers have stepped up loss mitigation resolutions, with modifications accounting for 70% of all mortgage workouts.
As of May 2010, Fitch noted that roughly 15% of non-agency RMBS loans by balance — including nearly 35% of RMBS subprime loans — received at least one modification. This is up from 10% and 25% respectively in September 2009.
Fitch currently expects anywhere from 55% to 75% of modified loans within RMBS to re-default after 12 months.
"Fitch continues to believe that, when properly done, modifications can benefit both homeowners and RMBS investors," analysts wrote. "However, modification performance or sustainability continues to be affected by the borrowers’ desire to keep their property, as well as having sufficient cash flow to make the modified payments."
HAMP, which provides incentives for servicers that modify mortgage payments to within 31% of the borrower's debt-to-income ratio, is structured to maintain a borrower's cash flow and ability to remain current on payments, Fitch said. But existing modification programs with similar guidelines show substantial re-default behavior.
The agency projects 65-75% of modified subprime and Alt-A loans, and 55-65% of modified prime loans, will redefault within 12 months of modification, including redefaults on already re-modified loans. The below illustrates historical re-default trends among private-label RMBS, not including loans receiving subsequent modifications:
Additionally, roughly 15% of all modified private-label RMBS loans receive additional modifications. For example, of all modifications performed in Q109, 18% were since re-modified, with another 6% liquidated at a loss since modification.
"It is apparent that structuring the modified payment so the borrower can afford to make the payment over a sustained timeframe is a key to success," analysts said. "Additionally, with the current home value of many borrowers putting them in a negative equity, or underwater status, many argue that principal reductions would materially increase the sustainability of modifications."
"Recent changes to HAMP modifications, which have introduced the potential for principal write-down, represent the administration’s efforts to address this situation."
The Principal Reduction Alternative (PRA), detailed by the Treasury Department in recent guidance, provides services with a new tool to complement HAMP. The PRA program addresses negative equity and could be used to reduce HAMP re-defaults, as the occurrence of re-defaults in rate and term modifications is historically higher than that of principal reduction, according to Deutsche Bank.
Write to Diana Golobay.
For the long suffering shareholders of the GSEs, Fannie Mae and Freddie Mac, the news of the FHFA directive to delist from the NYSE and other exchanges likely feels like the last nail in the coffin.
For them, it just might be. But for mortgage finance it's proving to be little more than a distraction.
To use the words of Bert Ely, of the monetary consultancy firm Ely & Company: "It's no big deal."
Ely has been fending off calls from journalists all day trying to get him to say otherwise, but he won't mince his words.
"It's fiction that these shares have any real value anyway," he said. "It was a pipedream that the government would stand next to the preferred shares, much less common ones."
In looking over quarterly reports Ely notes that the senior preferred (read: Fed money) is only slightly more than the net worth. This is indicative of a mortgage finance company with no real equity.
In essence, and let's be honest here, considering the GSEs are often positioned as an instrument of political housing policy, what really matters is not the wider bid-ask we'll see on the back of this announcement. And yes there will be less trading and therefore less liquidity.
But what really matters here is the ability of the GSEs to continue to sell mortgage-backed securities (MBS).
"FHFA's announcement prominently featured a disclaimer the decision doesn't mean anything about the companies, but most observers would disagree," wrote Jim Vogel in a note from FTN Financial, adding the firms will continue to file with the SEC.
"The spin of several recent FHFA announcements and decisions actually more closely aligns GSE liabilities — both debt and MBS — with the federal government's policy interests," Vogel adds. "It's an odd way of showing support, perhaps, but it's the better of two possible interpretations."
And that is exactly with what we are left with: interpretation.
Case in point, in an outlook report released by Deutsche Bank today, a huge problem confronting the Agency MBS space is regarding fails, that is, when securities that are supposed to be delivered or received on a given date are not actually delivered or received.
Pankaj Jha, residential MBS analyst at Deutsche writes that fails undermine the smooth functioning of the MBS market, creating headaches for investors and dealers, if not always losses.
The problem is that GSE fails are at an all time high with no signs of abatement:
Even more worrying is Jha's point that, "it is important to realize that one fail will ordinarily set off a chain of fails. A fail problem is rarely confined to one dealer failing to another dealer or customer."
Today's announcement of course would seem to have nothing to do with problems such as these. But it's clear that the effort to distract did not go unnoticed.
As Vogel puts it, the "various legislative feints and thrusts to "close down" the GSEs are supported in part by the market's treatment of the two as viable economic entities. Moving the stock quotes to the OTC market might make the whole mess less obvious."
Agreed. But the real situation is this: the GSEs are nationalized. And the new owners have no real idea of what to do with them.
That's the challenge of the day, not delisting.
It's a challenge that so far is getting plenty of discussion, but no real solution.
Jacob Gaffney is the editor of HousingWire and HousingWire.com. Write to him.
Efforts to reform US banking after the worst financial crisis since the Great Depression fall short because they don’t empower risk managers, according to Cliff Rossi, who held that job at three of the country’s largest mortgage lenders that helped fuel the housing boom.
