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Putting the brakes on housing reform

Next FHFA head Watt expected to slow or stall GSE contraction

December 11, 2013
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Investors in agency mortgage-backed securities probably greeted the confirmation of Rep. Mel Watt, D-N.C. to the Federal Housing Finance Agency as an expected risk, with some more exposed than others. And while some investors should realign their holdings, one anlyst is warning that Watt may put the brakes on slowing the contraction of the balance sheet at the government-sponsored enterprises.

Sarah Hu, a mortgage-backed securities analyst at Royal Bank of Scotland (RBS), says investors in higher coupons in this segment probably greeted the FHFA’s recent decision to increase g-fees as good news – since larger coupons generally benefit from higher rates on Fannie Mae and Freddie Mac loans.

However, any gains made by those g-fee hikes could be lost on some of the risks that higher coupons could face with Mel Watt at the wheel, Hu suggested Wednesday.

“I think the market has concerns about the possibility of changes to the HARP programs,” Hu told HousingWire. “Because I think we expect him to do more to assist borrowers in terms of refinancing that is a major concern even though the risks may have already been priced into the market.”

Higher coupons – those holding 5s and above – will feel the greatest impact, Hu said. “They have bigger exposures,” she noted when discussing higher coupons. The biggest impact on them would be a HARP expansion, which would increase repayment risk.

Overall, Watt’s role as the new FHFA head is drawing mixed reactions. Those who believe lending standards should be loosened view his appointment as a possible catalyst for housing demand and homebuilders – a segment that responds to market factors in a far different manner than MBS investors – may see his tendency towards lax lending as good news. 

Jay McCanless, a Sterne Agee analyst, believes national lending standards may be loosened a bit under a Watt-reign.

“With Watt's confirmation, we believe homeownership expansion has two proponents in the Fed and the FHFA, which oversees the GSEs. The Fed's continuing policy of buying 10-year Treasuries and agency MBS to depress rates has held national average mortgage rates below 5% for several years,” McCanless wrote.

The FHFA announced that it would raise G-fees next year in an effort to continue the shrinkage at the GSEs. That announcement is being put into question with the Matt confirmation.

“Under the previous leadership, the FHFA was shrinking the GSEs as part of a strict interpretation of the 2008 GSE Conservatorship agreement rather than promoting homeownership. We expect Watt will have a liberal interpretation that includes widening credit availability and slowing or stopping the contraction of the GSEs' balance sheets.”

But it’s this more liberal interpretation that has Watt skeptics alerting the markets to some of the risks involved.

One key area of concern as highlighted by a former congressman and a professor of finance in an earlier HW article is the risk of Fannie and Freddie reforms being shoved under the rug, with a Watt-era more focused on expanding lending again.

For McCanless, Watt has the potential to unwind a key FHFA mandate that said the GSEs could only purchase conforming mortgages that met the CFPB’s version of the qualified mortgage rule – excluding the 43% debt-to-income ratio requirement.

McCanless says with Watt running the agency in the future expect him to “revive” certain affordable mortgages excluded under this standard – i.e. 40-year or interest-only mortgages, which could widen the pool of homebuyers spurring demand once again.