The Insurance, Housing and Community Opportunity Subcommittee of the Financial Services Committee held a hearing yesterday focused on identifying government barriers to the housing market recovery. Michael Farrell, Chairman, CEO and President of Annaly Capital Management, Inc, testified about the reasons private-label securitization has been unable to restart.
Annaly, according to Farrell, is the largest residential mortgage Real Estate Investment Trust (REIT) on the NYSE, and the company along with their subsidiaries own or manage approximately $100 billion of residential mortgage-backed securities.
From his direct testimony, Farrell laid out four reasons why from his perspective, private-label market is stalled.
"First, the economics don’t work. In order for the math to work, either primary mortgage rates have to rise, the rating agencies’ senior/subordinate splits have to come down, and/or return requirements by the secondary market have to decline. And yes, for good or for ill, the private-label market is still critically dependent on the rating agencies as the arbiter of credit quality.
"Second, there is a higher yielding alternative for investors who want to take residential mortgage credit risk—legacy private label MBS and seasoned loans that have been repriced by the market after the events of the last few years. The return to investors from re-securitizing legacy MBS is higher than securitizing new mortgage loans. As long as this relative value disparity exists, it will impede the restart of the new-issue private-label market.
"The third reason is the difficulty in sourcing enough newly-originated loans. Without the outlet to sell mortgages into securitizations, banks have gotten more comfortable holding non-conforming loans on their balance sheets, but only by tightening underwriting standards, including requiring sizable downpayments. As long as underwriting standards are so stringent, I don’t see a vibrant private-label market developing.
"The fourth reason is the uncertainty over the future regulatory environment. The many different mortgage modification programs and delays in foreclosures have made it difficult for investors to analyze cash flows. The uncertainty over the capital rules related to the definition of “Qualified Residential Mortgages” and risk retention and Basel III is also putting a chill on the lending markets and concentrating origination in only the few largest banks."
A final challenge that Farrell noted was a difficultly in getting many Agency MBS investors to turn to non-Agency MBS, as their investment guidelines preclude taking the credit risk. He noted that lowering the conforming limit, increasing guarantee fees and reducing the FHA's reach would move in the right direction of raising private-label interest. However, the result would likely be tighter underwriting standards and higher fees for those borrowers.
In answering the question of impediments to restarting private-label MBS, Farrell painted a bleak picture of the road ahead. As a cornerstone of any efforts to reduce the government's role in mortgage financing, addressing issues that have kept private-label capital on the sidelines present the largest hurdle toward recovery in the housing markets. It is the tenuous balance of creating standards and rules that appropriate regulate the market, ensure quality of the MBS, while also providing financing that is affordable and accessible to consumers.
Addressing these issues and easing the extreme level of uncertainty will, at least, begin to loosen the bolts on the door.