As housing finance agencies seek to rebuild their balance sheets amid a favorable bond market, Moody’s Investors Service expects bond financings to become a more significant part of HFAs’ mortgage funding sources, reversing the downward trend since 2011, a note to clients says.
Due to the ineffectiveness of bond financings in the last five years, many HFAs turned to the secondary market for more cost- effective mortgage financings, Moody’s says.
As a result, bond financing, which prior to 2011 financed nearly all of HFA single-family mortgage loans, plunged to being 33% of HFAs’ mortgage funding source in 2013.
“We expect HFAs to issue more bonds to finance single-family mortgage loans because bond-financed mortgages are more profitable and provide dependable long-term annuity income to HFAs, mortgage subsidies from prior bonds allow HFAs to issue new bonds at higher interest rates while remaining competitive and profitable, (and) HFAs with surplus mortgages can over-collateralize new bonds to bring down their borrowing costs which makes bond financing practical,” the client note says.\
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Although the secondary market will continue to be an important funding source for HFA single-family programs, HFAs generally favor using bonds because bond-financed mortgages provide a more profitable long-term revenue stream. Furthermore, bond-financed mortgages are a better fit for HFA’s operations and help them to rebuild balance sheets that have been shrinking since 2010.
“We expect this downward trend to moderate in 2014 and start improving in the next three to five years,” Moody’s says.
The report further notes that bond-financed mortgages are beneficial to HFAs in the end because they are:
A better fit to HFAs’ operations: Compared to the stable annuity income from bond-financed mortgages, the one-time, upfront income generated by selling mortgages or mortgage-backed securities (MBS) in the secondary market is more volatile. After every secondary market sale, HFAs must reinvest sale proceeds for a short period when they reuse sale proceeds to originate mortgages or MBS, exposing them to reinvestment risks. The annuity income from bond-financed mortgages, on the contrary, is dependable, has no reinvestment risks, and better supports HFAs’ ongoing general and administrative needs. HFAs can better budget for their long-term program operations with income from bond-financed mortgages instead of from any secondary market funding activities.
More profitable: Since mortgage loans and MBS are generally the highest yielding long-term assets (compared to the short-term cash generated by secondary market funding activities) on HFAs’ balance sheets, they drive long-term revenue growth and boost HFAs’ profitability. Additionally, HFAs can earn up to 4.5% in profit (present value of future revenue stream as a percentage of bond par amount) by issuing bonds to finance mortgages, compared to about 1%- 2% in excess of par amounts if they sell the same mortgages in the secondary market.
A way to rebuild HFA balance sheets: HFAs retain ownership of bond-financed mortgages, which helps them to rebuild balance sheets. Most HFA balance sheets have shrunk since 2010 as low interest rates and high unemployment caused rapid mortgage prepayments and high mortgage defaults that contributed to substantial reduction in HFAs’ mortgage and bond portfolios. Furthermore, limited bond issuance in the last five years has prevented HFAs from adding new loans to their balance sheets.
Moody’s also notes that subsidies allow HFAs to issue bonds at higher interest rates and remain profitable.