The Securities Industry and Financial Markets Association said Thursday that newly-originated loans to borrowers in high cost areas as defined in recently-passed housing legislation will qualify for incorporation into To-Be-Announced eligible MBS. The TBA market facilitates the forward trading of MBS issued by the Fannie Mae (FNM), Freddie Mac (FRE) and Ginnie Mae by creating parameters under which mortgage pools can be considered fungible (and thus do not need to be explicitly known at the time a trade is initiated) — hence the name “to be announced.” The TBA market is the most liquid, and consequently the most important secondary market for mortgage loans. Homeogeneity is key here, of course, so in an effort to “minimize liquidity disruption in this important market,” SIFMA said it will limit the inclusion of higher-balance loans to 10 percent of the total balance of a pool eligible for TBA delivery. (Note that SIFMA said “minimize,” not eliminate.) “We expect higher balance borrowers to receive both rate relief and increased liquidity as was desired in the legislation, while retaining the overall liquidity of the TBA market,” said Sean Davy, managing director at SIFMA. “This arrangement preserves the overall homogeneity of the market while at the same time minimizing the risk of a negative impact on mortgage rates for lower balance loan borrowers, or, potentially, all borrowers.” When mortgage loan limits were temporarily increased in February, SIFMA recommended higher-balance mortgages be pooled separately, in part due to the temporary nature of the program. By excluding jumbo conforming mortgages from TBA trades, borrowers were forced to pay a premium over traditional conforming mortgages; the move by SIFMA Thursday signals that spreads on jumbo conforming mortgages relative to traditional conforming mortgages could tighten up. Rates and liquidity But what about everyone else? The inclusion of jumbo conforming mortgages could end up raising conforming rates for all borrowers as traders price in the new loans, although HW’s sources suggested that the 10 percent limit was likely “just the right proportion” to keep the TBA market on track. The concern, as it was explained to us, is that prepayment behavior on jumbo conforming mortgages is likely quite different in trajectory than what’s observed in more traditional mortgages; the liquidity of the huge TBA market is predicated on the idea that the underlying loans share the same basic characteristics. Remove that assumption, and risk locking up the only secondary market for mortgages that’s still functioning right now; which is why SIFMA limited the higher-balance inclusion to 10 percent of a given pool. “We expect the market to smoothly digest the change made under the new SIFMA guidelines and continue to provide liquid and efficient pricing for mortgage securities,” elaborated Davy. “The importance of preserving the liquidity and stability of the TBA market cannot be overstated.” The move also reflects a permanent shift in the market that still surprises some market participants; moving a good portion of the jumbo mortgage market into GSE hands and out of the private mortgage market. It’s a shift that likely won’t be undone anytime soon, given the pricing power for jumbos that will accrue to the GSEs via TBA inclusion. “Banks must be really hurting — or counting on GSEs to die of mission-inflicted wounds,” said one of HW’s sources, and analyst that asked not to be named in the story, “or else I would have thought they would lobby against making the loan increase permanent.” Shares in Freddie Mac were at $5.96, up 7.39 percent, on the news; Fannie saw its shares rise 6.09 percent to $8.10 when this story was published. Disclosure: The author was long FRE when story was published; indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

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