Image: iStock
Image: iStock

Seems like old times for the nation's housing finance agencies.

A few years ago, these agencies avoided tax-exempt bond issuance in favor of secondary market sales to fund mortgages. Now they appear ready to return to traditional housing bond financing.

The reason is clear. Falling mortgage rates greatly hampered HFAs' usual tactic of offering discounted rates to their clients, mainly low- to moderate-income and first-time buyers. When the 30-year fixed-rate mortgage was at 3.5%, these agencies were squeezed between their cost of funds and the rates they could offer. So, they turned to the secondary markets to sell mortgages and mortgage-backed securities to raise cash for new loans.

While that might have been a good short-term strategy, a new report from Moody's Investors Service says there are long-term negative implications for the agencies. Specifically, by selling off their production, they have reduced their balance sheets considerably.

Total assets for all of the state agencies combined shrank to $113 billion in 2014, down from $142 billion just since 2010, according to Ping Hsieh, vice president and senior analyst at the ratings agency, the report’s author.

But now, writes Hsieh, "As HFAs seek to rebuild their balance sheets amid a favorable bond market, we expect bond financings to become a more significant part of HFAs mortgage funding sources, reversing the downward trend since 2011."

That trend was significant, as HFA bond financings slipped to a third of their total fundings, down from basically 100%, in just a few years. But they managed to keep volumes up in absolute terms during this transition (they finance affordable single-family through mortgage revenue bonds and multifamily housing through the Low Income Housing Tax Credit) despite the bumpy finance environment, according to the National Council of State Housing Agencies.

In 2011, when secondary deals began to increase, mortgage revenue bond issuance still grew 13.5%. "While the capital markets continued to struggle, HFAs issued $8.4 billion in MRBs in 2011, compared to $7.4 billion in 2010." The agencies raised "more than $1.2 billion from alternative financing sources" in that year, according to the council.

No doubt upward-trending mortgage rates will lessen the margin pinch on the state agencies (called mortgage finance agencies or MFAs in some states). Moody's says the secondary markets will remain "an important funding source" but that bonds will provide "a more profitable long-term revenue stream."

According to a 2012 Moody's report on secondary financings, HFAs employed three options: cash window sales of whole loans to Freddie Mac and Fannie Mae; cash sales of mortgage-backed securities; and financings in the TBA (to be announced) arena for the forward sale of MBS. The federal government also helped the HFAs by buying mortgage bonds from them in the aftermath of the meltdown (keeping rates lower just as they did in the conventional single-family market) but that program ran out, causing the shift to secondary deals.

Hsieh writes that bonds provide "a more profitable long-term revenue stream" for HFAs. Secondary market financings are more volatile, and expose the agencies to reinvestment risks, her report says.

Bonds are more profitable, and drive long-term revenue growth, she writes. And since the agencies retain bond-financed mortgages on their balance sheets, using this type of funding will boost their assets. Moody's expects the asset shrinkage to temper this year and begin reversing next year.

HFAs can also use "excess spread" — profits on bond deals above what is allowed by tax laws — to subsidize new mortgages. This spread is created when old, high-rate mortgages from repaid bond deals are transferred to new issues, providing additional collateral that allows an agency to offer lower rates to new borrowers.

If they don't use it for this purpose, the agencies have to rebate the excess spread to the federal government. That choice sounds like a no-brainer.

Mark Fogarty, Editor at Large at National Mortgage News, writes analysis and commentary based on his 30 years covering the mortgage industry.