Combining Freddie Mac and Fannie Mae’s MBS in the TBA market sounds like it is not impossible, but is much easier said than done. There would be several operational and other differences that “would have to be harmonized” if the two agencies’ securities were to be combined as recently proposed, such as their differing remittance schedules and buyout policies, Credit Suisse managing director Mahesh Swaminathan said when asked about this.
A research report he wrote with Qumber Hassan and Vikram Rao last week explains further. It warns that investor perceptions would have to be addressed first to avoid negative unintended consequences.
Key steps the report suggests taking include establishing consistent g-fees and eliminating Freddie Mac Gold/Fannie Mae swap-based discounts, reconciling differences in the two’s streamline refinancing as well as their third-party originator share.
Another key need that may take longer to bring about would be increasing Fannie Mae disclosures to Freddie Mac’s levels.
While there has been talk of creating multilender Freddie Mac and Fannie Mae pools and the report suggests this is could be helpful, there would be some hurdles to overcome to get there. While Ginnie Mae IIs in the TBA market, for example, are solely multilender pools, the conventional market’s equivalent is not entirely multilender. The report suggests starting with Freddie pools to address concerns about their speeds but ensuring Fannie also makes the change at some point so as not to skew the market.
The report suggests four possible ways to create a single security.
One would involve allowing the two agencies to issue pools independently, allowing either to be delivered into the TBA market.
This sounds to me to be a little more in line with the GSE regulator’s plan and comments the GSE executives made at the Mortgage Bankers Association’s National Secondary Market Conference last month, suggesting that plan is more about having a common platform for multiple types of MBS than creating single security, per se. The report identifies this as the most practical way to go given the infrastructure and potential charter hurdles to other plans. But it notes that it does not address investor concerns about prepayment differences between the two agencies.
A proposal that would address the prepayment difference concern but have infrastructure and charter hurdles, as well as potential investor concerns related to issuer liability, would be a situation where the two deliver loans into a common TBA in which both GSEs are severally liable for timely principal and interest payments.
Perhaps addressing the prepayment concern and reducing the infrastructure needs a bit could be a situation with similar liability, but where the both agencies’ separate securities are combined as in a mega in the TBA market.
Finally the report suggests that if that mega model had a third-party/government wrap it could both address the prepayment concerns and head off some liability concerns. The main hurdle would be that this would require congressional action/housing reform.
It all sounds daunting, but the report suggests it seriously needs to be considered given the way things have been going.
In noting the potential challenge of Wall Street and investors’ single-issuer/security exposure in the case of a combined TBA model, the researchers note that it might be a problem even without one if Freddie Mac market share declines don’t reverse.
