Western Asset Management Co. is helping to resuscitate the market for mortgages not backed by the government.
The Pasadena, Calif.-based bond firm is partnering with three mortgage lenders to make loans that are ineligible for government backing, said Travis Carr, chief operating officer of Western Asset's mortgage real estate investment trust. The company will buy the loans and later may have them securitized by a Wall Street bank, Carr said.
"We can get access to higher-yielding loans that we think have very attractive borrower profiles, but don't fit this qualified mortgage credit box," Carr, who is also the mortgage-backed product manager for Western Asset, said in a telephone interview.
Demand for the private mortgages, known as nonagency, is growing after the Consumer Financial Protection Bureau's regulations on qualified mortgages took effect this year, and government-controlled mortgage-finance companies Fannie Mae and Freddie Mac limited themselves to buying loans conforming to those rules. The regulations require lenders to ensure borrowers can repay their loans and also expose lenders to potential legal liability on mortgages with a debt-to-income ratio above 43%.
Western Asset, which manages $469 billion, plans to invest in mortgages made to self-employed borrowers who may not have the documentation for qualified mortgages and interest-only mortgages. Those loans, in which homeowners only pay interest, not principal, also aren't qualified mortgages. The loans Western invests in will have a wide range of FICO credit scores since borrowers who take out interest-only loans likely will be prime borrowers, or those with the highest credit scores.
Borrowers who have lower FICO scores will generally have to make larger down payments for Western to purchase the loan, Carr said.
Buyers of mortgage-backed securities are finding a dearth of opportunities as deals tied to new non-agency loans contracted to $1.6 billion this year through April, according to data compiled by Bloomberg. At the height of the market in 2005 and 2006, nonagency lending totaled $1.2 trillion annually. Returns also are shrinking on nonagency mortgage bonds. Investors reaped gains of 10 percent in 2013 compared with 21% in 2012, according to Amherst Securities Group LP. This year through March, the debt returned about 3%, Amherst said.
The rates charged to borrowers of the non-qualified loans will be 1 to 2 percentage points above conforming rates, Carr said. The average rate for a 30-year fixed mortgage was 4.12% last week, the lowest since October, Freddie Mac said in a statement May 29.
If the loans are securitized, Western would sell off the senior bonds in the pools to third-party investors and keep the subordinate tranches, which tend to have higher yields, according to Carr.
The firm plans to team with up to eight lenders in total across the U.S. to ensure geographic distribution of loans, Carr said. It will invest in the loans through Western Asset Mortgage Capital Corp., its REIT, and potentially a private-equity fund with a lockup period.