Fast Action Could Help Attract Mortgage Market Investors

There is considerable private investor interest in purchasing government-sponsored enterprise debt, speakers at a Financial Services Subcommittee hearing said, but it may take a few government subsidy based incentives to bring new capital into the marketplace.

Ironically, the Subcommittee on Capital Markets and Government Sponsored Enterprises chaired by Rep. Spencer Bachus, R-Ala., analyzed ways to facilitate “continued investor demand in the U.S. mortgage market without a government guarantee.”

At least in theory, selling off GSE debt to private investors can help invigorate both the primary and the secondary mortgage market.

Investors are interested in GSE debt including questionable, securitized loans if some form of guarantee is part of the deal, said Ajay Rajadhyaksha, managing director at Barclays Capital.

However, what investors want “is plain-vanilla, low-risk mortgages,” said president and CEO of Redwood Trust Inc., Martin Hughes, and investors need incentives. One big problem for borrowers and investors are second-lien mortgages that are “whipped out” in cases where the first mortgage is under water and considered for a principal reduction modification.

Unless some incentives become available, he said, “we’ll be stuck in a vicious circle” where the private sector and the government see the other party as an obstacle.

Rajadhyaksha argued that each time securitized distressed mortgage loan debt is sold at a discount the investor takes a loss, so some form of government guarantee would add an incentive for prospective buyers. The hit that the mortgage-backed security holder will take during that migration “would absolutely be a capital stretch” unless the transaction “is a subsidy form.”

First, distressed debt may become attractive to investors if the MBS market has the option to receive “some form of cash insurance,” which currently is unavailable, he said. Also, it is necessary “to set up a bench mark” based on which the private securities sector would price a mortgage credit offer. And finally, by making clear the logistics of why they need to continue to invest in a specific market segment will help reinsure interested parties that prices charged “are market sound.”

The drive to secure a greater capital fusion from the private sector is challenged by a combination of cautious investor demand and lack of supply.

One of the issues that concern the industry is the fact that most mortgages in the United States are securitized through the agency mortgage-backed securities market and traded on a to-be-announced basis. Banking analysts have long warned that since the goal of TBA trading is to expedite agency MBS liquidity that leads to lower borrowing costs for American households, potential reforms to the U.S. housing finance system should take into account the effects of those reforms on the operation of the TBA market.

Hughes said investors are interested in purchasing mortgage debt. “The bigger issue is that there’s very little to buy and you can’t gain tractions” on all the best practices discussed if there are no loans to securitize. And the reason for that of course is because the government is cracking on the private sector.

“It’s a process,” Rajadhyaksha said, and the other risk is over stimulation of homeownership. The national homeownership rate changed from 64.5% in the early 1990s to over 69.5% recently and currently has decreased again. And that, he warns, is another reality in need of consideration.
It becomes a vicious circle. Chris Katopis, executive director of the Association of Mortgage Investors, agrees the crisis has shown that homeownership is not always the best option for everyone.

“We have significant private capital that is looking for attractive investments, but when you’re competing with the world’s largest SNL or the world’s largest REIT that is financed with the world’s cheapest cost of capital and have basically total access and control of basically 95% of the market you take a step back and realize that predominantly you will be adversely selected,” he said. Investors are forced to wait until the rules are set and they can understand what the processes are after all the problems are addressed.

These market insiders agree that there is still need for greater uniformity in the mortgage market, which can learn from the credit card industry markets and how they issue credit card securitizations—even though uniformity does not necessarily derive from regulation or definitions of servicing agreements.

The issuers are taking a great deal of responsibility, have built very robust programs and also have retained a great deal of risk. The difference is that when investing in an American Express card securitization the investor has the assurance of a $1 return on investment.

Going forward, “probably on an incrementally smaller scale,” Katopis said, “it may be the way to develop the mortgage securitization market and it has to start now. It will develop over time but if we sit back and wait until we write the perfect legislation, the perfect processes, we’ll be back here two years from now. The best way to develop efficient processes is by market-testing it.”

Obviously there are some important differences between auto securitizations and mortgage securitizations, in terms of duration, said Joshua Rosner, managing director at Graham Fisher & Co.

Also, there are increased disclosures inside the pool data, so standardization is easier.
In order for the private sector to compete with the public sector there may be a need to create some types of short cuts that would allow them to compete with the GSEs, Katopis said.