Fannie notes hint at future of mortgage market

JPMorgan Chase Co.’s sale of a new type of mortgage-linked bonds is the best glimpse yet into a possible future of the $9.4 trillion U.S. home-loan market.

The $47 million of securities raised cash from investors this week that can be used to offset some of Fannie Mae’s losses on its mortgage guarantees. The transferring of risk from almost $1 billion of loans packaged into separate Fannie Mae bonds resembles a model envisioned by bipartisan legislation passed by a Senate committee this year and endorsed by the Obama administration.

While government-backed Fannie Mae and Freddie Mac have sold about $11 billion of their own risk-sharing notes since introducing them last year, the JPMorgan securities give a larger role to private capital. Unlike the case with the mortgage giants’ own offerings, Fannie Mae won’t need to wait for homeowner defaults to reach a threshold before getting payments to cover losses, according to Fitch Ratings.

“They’re really taking on only the catastrophic risk,” Suzanne Mistretta, a senior director at Fitch, said Oct. 29 in a telephone interview.

That’s the model for taxpayers’ backing of the mortgage market sought in the legislation by Sen. Tim Johnson, a Democrat from South Dakota, and Sen. Mike Crapo, an Idaho Republican. Their bill would replace Fannie Mae and Freddie Mac with a government reinsurer that would bear losses only after private capital — potentially insurers or bond investors — covers the first 10 percent.

First defaults

Brian Marchiony, a spokesman for New York-based JPMorgan, and Andrew Wilson, a spokesman for Washington-based Fannie Mae, declined to comment on the deal. The transaction settled yesterday, according to data compiled by Bloomberg.

Cash raised from bond investors will be placed into an account that gets depleted as borrowers default over the first 10 years of their loans, offering Fannie Mae payments equal to as much as 4.75 percent of the starting balances. Fitch is assigning BBB- ratings to the safest $19.8 million of the debt.

Those notes carry a floating coupon that pays 2.25 percentage points more than a borrowing benchmark, compared with 4.25 percentage point for rest of the securities, which are first in line for losses, Bloomberg data show.

Market pricing

In Fannie Mae and Freddie Mac’s own deals, they haven’t gotten relief on initial defaults, and shared in losses on the next ones up to the point that bond investors get wiped out. Investors may not solely bear the losses on individual loan defaults in both types because they use fixed recovery rates and the actual costs of foreclosures may be higher.

The JPMorgan offering also may represent a way for banks to involve the market’s pricing of risk in their loan rates or profits and negotiations over Fannie Mae guarantee fees, by having the risk-sharing come sooner and leaving its distribution in the hands of loan originators.

Another difference is that the new debt doesn’t represent corporate obligations of Fannie Mae, according to Fitch. Tax rules have limited the ability of real-estate investment trusts to invest in the earlier risk-sharing notes.

“Maybe you will see some of the other larger banks” create the new kind of Fannie Mae-tied securities, “but that remains to be seen,” Fitch’s Mistretta said.


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