Fed, not GSEs, should be mortgage securities backstop: BofA

Analysts at Bank of America Securities say they are in the minority in believing Fannie Mae and Freddie Mac should return to serving as the main backstop buyers of agency mortgage-backed securities.

BofA Securities has said the return of the GSEs as major MBS purchasers "would be welcomed in managed form, particularly given their retained portfolios are well below the $225 billion (each) caps as set by the Preferred Stock Purchase Agreements" its latest Agency MBS Weekly report said.

Until 2022, the federal government supported the mortgage market through quantitative easing programs, including heavy MBS purchases by the Federal Reserve. That support wound down when the Fed began shrinking its balance sheet, a process known as quantitative tightening, in March 2022.

Are the GSEs growing their mortgage portfolios

Recent data shows Fannie and Freddie have been gradually expanding their retained mortgage portfolios.

Freddie Mac reported its mortgage-related investments portfolio increased to $116.4 billion in September from $113.5 billion in August and $94.4 billion one year earlier. Most of that portfolio is mortgages, but the unpaid principal balance of agency securities it holds rose to $30.9 billion from $30.6 billion in August and $25.4 billion in September 2024. Its non-agency holdings increased to $889 million, up from $700 million a year earlier.

Fannie Mae's retained portfolio grew to $98.8 billion in September from $93.3 billion in August and $87.9 billion a year before. It held $37.9 billion in its own MBS, $3.7 billion in other investor MBS and $110 million in non-agency securities, compared with $32.5 billion, $367 million and $192 million respectively in September 2024.

After the September data came out, the Community Home Lenders of America, said the GSEs were heading in the right direction for the right reasons.

These purchases help to lower mortgage rates, the group said.

"Young families need all the help they can get today to buy their first home, but the too-high mortgage-to-Treasury spread is hurting them," said Rob Zimmer, head of external affairs, in a press release. "CHLA has long argued the GSEs can help such families, in a safe and sound manner, by increasing liquidity for GSE mortgages."

On Oct. 21, the group and the Independent Community Bankers of America urged regulators to allow the GSEs to buy more of their own MBS to help bring down rates.

Given the size of those retained portfolios, "they have ample room to add," said the BofA Securities report from Jeana Curro, Chris Flanagan, Ge Chu and Ko-Hsiang Kao.

A recent opinion piece by Christopher Whalen, chairman of Whalen Global Advisors, also argued against the GSEs being allowed to buy securities, saying that it makes little sense as interest rates are falling, origination volumes are rising and spreads are narrowing.

The BofA Securities analysts also pointed to a note in the Freddie Mac third quarter filing that the U.S. Federal Housing, formally the Federal Housing Finance Agency, now permits it to hold no more than $40 billion of single-family MBS.

Before the 2008 financial crisis, Fannie and Freddie regularly bought MBS to support their price performance. It was a practice critics including former then-Fed Chairman Alan Greenspan called problematic two years before the companies were placed into conservatorship.

At his press conference following the latest Federal Open Market Committee meeting, Chairman Jerome Powell said QT is ending.

Who should be the MBS buyer of last resort?

This has reopened the question of who should be the backstop purchaser of MBS in order to support the mortgage market.

The role is better suited for the Fed rather than the GSEs, "but there are valid points for (and also against) each party re-entering in size," the BofA Securities analysts said.

Among the pros for the Fed being the backstop including its history of purchasing Agency MBS in times of housing market or overall financial stress. The asset class does not require any sort of Congressional approval to buy or own.

Past programmatic buying by the Fed has resulted in meaningfully lower mortgage rates, and it buys both conventional and government (Ginnie Mae) MBS. Fannie and Freddie purchases would focus only on conventional, the analysts said.

The Fed buys its mortgage-backed securities in the TBA market.

"In doing buy-and-hold, the Fed has actually absorbed the true worst to deliver collateral," BofA Securities said. "We think this practice would be very much appreciated particularly as negative convexity in cheapest to deliver has gradually worsened via larger conforming loan limits and the increased share of specified pools."

On the other hand, adding MBS to the balance sheet is "largely inconsistent with this current Fed," with members who prefer a Treasuries-only portfolio. In September, Michelle Bowman, vice chair for supervision, said the Fed should actively sell its MBS holdings, in a speech at the Forecasters Club of New York.

Why the GSEs are the better backstop than the Fed

As for the GSEs as the backstop, they can add to their MBS holdings right away, are in the market regularly so have expertise and trading acumen, plus they were the backstop before the Great Financial Crisis.

"While there is some criticism that the outsized GSE portfolios may have led to their demise in 2008, we note the credit quality of their products are far stronger now, partly due to underwriting enhancements post GFC but also due to the tremendous equity borrowers have amassed during the pandemic," the analysts said.

But being the backstop complicates their prospects for an eventually initial public offering or other form of conservatorship exit.

"It will likely be hard to lure in private investors if the GSEs have to carry out said mandate," the report said. "Moreover, a growing portfolio would essentially require that the lofty capital requirements the GSEs currently have stay in place (we were optimistic they would be lowered), limiting their return on equity, which is another likely deterrent for prospective IPO participants."

As they would only be able to purchase conventional MBS, buyers of government program securities would not see a benefit.

Ignoring Ginnie Mae MBS purchases seem illogical if the government's goal is to improve home affordability, the analysts continued.

In its section titled "unknowns," the report notes that letting Fannie Mae and Freddie Mac grow their investment portfolios is "hugely politically unfavorable," plus any asset purchasers would be funded by more GSE debt issuances.