How private-label investors are beating the GSEs at their own game

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Fannie Mae and Freddie Mac enjoy considerable market advantages because of their lower cost of capital and significant government subsidies. But with some conforming loans, the private market is finding a way to compete with the government-sponsored enterprises.

"Overall, it's newsworthy that, my gosh, there might be a better execution out there than the GSEs' for some product," said Tom Millon, the president, CEO and chairman of the Capital Markets Cooperative.

More high-balance conforming mortgages with strong credit characteristics are finding their way into private-label mortgage-backed securities, according to a recent Moody's Investors Service report.

The mortgages, known as "conforming jumbos," exceed the standard $453,100 GSE conforming loan limit, but are still eligible for purchase because they're originated in high-cost areas where Fannie and Freddie's limits are higher.

So while the GSEs will buy conforming jumbo mortgages, private-label investors can often offer better pricing because of the loan-level price adjustments Fannie and Freddie must charge to account for their higher risk profile.

This is especially true when a lender has more conforming jumbos to sell than the 10% cap that the Securities Industry and Financial Markets Association puts on GSE to-be-announced loan pools, Moody's added.

For those loans, "you can definitely see private-label execution for the very high-quality loan being better than the GSEs," Millon said.

Lenders such as HomeBridge Financial Services, loanDepot and Flagstar Bank are preparing to or have already done deals consisting of agency-eligible high-balance loans in the private-label market. In 2016, JPMorgan Chase did two securitizations of traditional conforming loans.

The Flagstar deal consisted entirely of GSE-eligible loans. Because of the adjustments for investment properties on top of the agency execution, doing a private-label deal here makes sense, Millon said.

"The credit quality of GSE-eligible mortgages included in private-label RMBS collateral pools has thus far resembled that of prime jumbo loans more than that of GSE-owned loans," Moody's Senior Vice President Yehudah Forster said in a press release. "The inclusion of the GSE-eligible loans in private-label RMBS is therefore mainly credit neutral."

Those loans included in the private-label deals done between 2015 and 2017 have higher credit scores and lower loan-to-value ratios, and include fewer cash-out refinances than mortgages owned by the GSEs.

Fannie Mae and Freddie Mac own $79.2 billion of high-balance loans originated during that period. The average balance was $532,321 with a weighted average LTV of 71.1%, weighted average credit score of 753, with 46.1% being purchase loans, 16.0% cash-out refis and 92.7% owner-occupied.

Over the same period, $20.9 billion of prime jumbo loans were securitized, with an average balance of $611,754, a weighted average LTV of 70.4% and a weighted average credit score of 770. Purchase loans made up 61.8% of these deals, while 14.0% were cash-out refis and 96.7% were owner-occupied.

The dollar volume of high-balance agency-eligible MBS over the three-year period was less than 10% of those included in jumbo private-label deals, just $2.0 billion, but the weighted average LTV was lower, at 68.6%, and the weighted average credit score was similar at 768. The average balance of these loans was $539,199, slightly higher than that of the GSE high-balance loans originated during the three-year period.

The percentage of purchase loans, 61.4%, the percentage of cash-out refis, 13.9%, and the percentage of owner-occupied properties, 96.7%, was also similar to the jumbo deals.

The Moody's report mentioned several other categories of traditional conforming loans where a private-label execution might get better pricing than from Fannie Mae and Freddie Mac. These included high credit score loans with low LTVs; loans with lower debt-to-income ratios; and cash-out refis with strong credit quality.

But unlike the high-balance conforming and the investor loans, the pricing differences between private-label and GSE deals would be more marginal, Millon said.

The private-label execution for those products has become more viable in the past year than previously, added David Battany, currently the vice chairman of the Mortgage Bankers Association's residential production committee and the immediate past chairman of its secondary and capital markets committee.

Part of the reason is that the GSE risk-based pricing structure intentionally overprices the credit risk on these categories of loans in order to subsidize the pricing of loans for first-time home buyers who have high LTVs, low credit scores and high DTIs.

"When the GSE are the only game in town, it doesn't matter so much because everything is going to the same source," said Battany, who is the executive vice president, capital markets at Guild Mortgage Co. But now, private-label execution is becoming more viable and that brings up another problem — the potential of adverse selection of loans being sold to the GSEs. That is already starting to occur, Battany says.

Some of the larger banks have already adjusted their consumer-facing rate sheets to reflect the real risk of the loan made to those first-time home buyers rather than cross-subsidize them, with these loans kept on balance sheet or being held for future private-label securitization, he said.

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Jumbo mortgages RMBS prime jumbo Private-label GSEs Underwriting Secondary market Securitization Fannie Mae Freddie Mac Moody's