It would seem that Federal Housing Finance Agency chief Edward DeMarco has given up hope that Congress will get around to permanently fixing Fannie Mae and Freddie Mac.
How do I know that? Actually, I don't, but by allowing the GSEs to start pilot programs to create nongovernment-guaranteed MBS tranches that will take the first-loss position he's basically trying to “derisk” Fannie and Freddie.
Why would the FHFA director do that? As one MBS investor told me, “This is de facto GSE reform. Congress can't agree on anything. This could be a solution to the GSE issue.”
To date, DeMarco has said little publicly about the concept of what are being called “credit securities” though he's alluded to the idea in Congressional testimony and speeches by using the phrase “risk sharing.”
Under the credit security concept, Freddie Mac, for instance, would securitize a pool of loans with 5% of the deal being sold in the form of a higher yielding tranche that takes the first losses. In return for the coverage the bondholder would be paid an above-market rate on the tranche because Uncle Sam isn't backstopping the credit security.
At this point in time the big question—as you might've guessed—boils down to yield. In short, how much would Freddie have to pay to get investors to buy this “first loss” piece? Some analysts have suggested 10%, while others, citing today's pristine credit quality, say that figure is a bit high.
As for who ultimately pays for the higher-yielding tranche, that's simple—the consumer will, in the form of higher upfront fees. A recent Barclays Capital report on GSE credit securities notes, “The coupon of this tranche comes from the guarantee fee of the referenced collateral.”
As for when the market might see the first GSE credit security, the general thinking is that the first deal might appear some time in the first quarter of 2012.
Freddie Mac is said to be farther along on the project than Fannie, though the latter is working on a similar structure. (Although DeMarco has made veiled references to risk sharing, Freddie CEO Charles Haldeman and Fannie chief Michael J. Williams have said little.)
Wall Street, of course, would love to see credit securities hit the market because it would give investment bankers a high-yielding bond they can peddle, and might set the stage for an eventual revival in private-label bonds. But don't hold your breath on the latter.
The Street likes certainty and as Barclays noted in its research paper the GSEs will need “to commit to a series of deals at the outset and provide loan level data” mandated by regulations.
To get this party started Barclays suggests one of the GSEs “start selling the credit risk of an existing cohort, say a large one such as the 2009 4.5s.”
Despite what Barclays is suggesting, the idea is to securitize new production and not seasoned or “reperforming” loans that have been modified.
So, will GSE credit securities get off the ground? Right now it looks like all systems are go. Investment bankers working on the first bond have signed nondisclosure agreements, so obviously this is being taken seriously.
Then again, if Congress gets wind of the idea it might want to find a way to kill it.
