A $50 billion bond market once heralded as the future of housing finance has been stuck in limbo since the start of the coronavirus crisis, and now proposed regulatory changes have left investors worrying that they might be left holding the bag.
At issue are so-called credit-risk-transfer securities offered by Fannie Mae and Freddie Mac. They are tied to Fannie and Freddie’s mortgage-backed securities and pay investors principal and interest as long as the borrowers don’t default.
Fannie hasn’t issued the bonds since the pandemic began, and the company’s executives are privately telling some investors that it has doubts about the market’s longterm viability. Freddie, meanwhile, has resumed issuing the bonds after a pause near the start of the pandemic. The lack of activity is starting to worry investors that they will be saddled with securities that are akin to museum pieces that no one is interested in buying.
The uncertainty stems from a proposal by Federal Housing Finance Agency Director Mark Calabria that many say would make it uneconomic in some cases for Fannie and Freddie to keep issuing the securities. Calabria’s plan would reduce the capital relief the companies get by issuing CRT by about half in some circumstances, according to Chris Helwig, a managing director at Amherst Pierpont Securities.
“There are pretty substantial, existential risks to credit-risk transfers if Calabria goes through with these plans,” said Structured Finance Association Chief Executive Officer Michael Bright, whose trade group includes CRT investors.
Business Models
The credit-risk-transfer market was the result of an effort to change the business models of Fannie and Freddie after they failed and were taken under U.S. control during the 2008 financial crisis.
The two companies don’t originate mortgages. They buy them from lenders, wrap them into securities and guarantee the repayment of principal and interest to investors. Before the birth of the CRT market in 2013, Fannie and Freddie largely bore the brunt of losses when borrowers defaulted. CRT securities pay investors only if borrowers keep paying their mortgages, which protects Fannie and Freddie.
CRT bonds have a market capitalization of about $45 billion, according to data from market research firm Mark Fontanilla & Co. That’s still small relative to the $5 trillion in bonds guaranteed by Fannie and Freddie, but many analysts expected it to mature into a staple of the mortgage-bond market.
All that was thrown into question in May, when Calabria’s FHFA released a proposal for what capital the mortgage giants would have to hold when they exit federal conservatorship.