Hedge Funds Drawn to Fannie-Freddie Risk-Sharing Plan
Bond buyers are vying with insurers to strike deals with Fannie Mae (FNMA) and Freddie Mac as their regulator seeks to draw private capital to the government- dominated mortgage market.
The taxpayer-supported companies, which own or guarantee $5 trillion of residential debt, have held discussions with NMI Holdings Inc., a new mortgage insurer that raised $500 million in April, as they explore new ways of sharing risks. American International Group Inc. (AIG) is also interested, while Angelo Gordon & Co. and Pine River Capital Management LP are among fixed- income investors that could jump on the opportunity.
Fannie Mae and Freddie Mac, which help finance about two- thirds of new U.S. home loans, are seeking to shrink their footprint and reduce the danger to taxpayers four years after being rescued. While no deals have been announced, the Federal Housing Finance Agency says progress is underway. The regulator in March set a target of last month for their initiation.
“It’s been a really long time coming,” said Merrill Ross, a Wunderlich Securities Inc. analyst who covers real estate investment trusts that could be participants.
Fannie Mae and Freddie Mac (FMCC) have been backed by the U.S. after being seized in 2008 following the housing collapse. While the FHFA said in an Oct. 26 statement the companies won’t require any support after this year in most scenarios, they’ve received $137 billion of aid to help the recovery.
“The taxpayer is directly on the hook for nine out of every 10 loans getting made,” Michael Heid, president of Wells Fargo & Co.’s home-loan unit said at the Mortgage Bankers Association annual conference last week. That includes loans backed by the Federal Housing Administration, and other agencies.
While there are a lot of similarities between proposals to replace Fannie Mae and Freddie Mac, there’s been little urgency among policy makers, he said. The plans would involve government insurance that guards against catastrophic losses.
FHFA Acting Director Edward J. DeMarco is seeking to reduce Fannie Mae and Freddie Mac’s role in the market as lawmakers fail to take action. One measure has been to increase the fees they charge to guarantee mortgage securities.
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He’s also looking to have insurers or bond investors bear losses before or along with the companies on pools of loans.
“We are moving forward steadily and expect to continue making progress in the coming months,” Denise Dunckel, an FHFA spokeswoman, said last week in an e-mailed statement. “Risk sharing is a complex process that requires time to assess market opportunities, structural considerations, make operational changes and develop proper risk metrics and controls,” she said.
Brad German, a spokesman for McLean, Virginia-based Freddie Mac, and Andrew Wilson, a spokesman for Washington-based Fannie Mae, declined to comment.
The companies may turn to investors in the $1 trillion market for home-loan bonds without government backing, who are seeking high-yielding debt after the market shrunk by $1.3 trillion since 2007. While some mortgage insurers are facing financial challenges, “others may have the capital capacity to insure a portion of the mortgage credit risk currently retained” by Fannie Mae and Freddie Mac, the FHFA said in a February report about their future before a broader overhaul.
All but one of the mortgage insurers writing coverage before foreclosures began soaring in 2007 have stopped paying claims in full or been downgraded to speculative-grade ratings, potentially limiting the pool. The other is United Guaranty, a unit of AIG. The parent was also rescued by the U.S. in 2008.
NMI is seeking to join Essent Guaranty Inc. in entering the business. Essent, whose backers included Goldman Sachs Group Inc. (GS) and reinsurer PartnerRe Ltd., began writing traditional policies for Fannie Mae and Freddie Mac last year.
Janice Daue Walker, a spokeswoman for Essent, declined to comment.
NMI, which is seeking approval to write policies through a unit called National MI, signaled to one of the companies the potential premiums it might charge on a specific pool of home loans, Chief Executive Officer Bradley Shuster said in an interview at the mortgage conference.
‘It’s a potential way for us to really jump-start the ramp up of our business,” said Shuster, who’s seeking to register Emeryville, California-based NMI’s shares for public trading next year.
The discussions involve recent mortgages with loan-to-value ratios, or LTVs, of less than 80 percent, he said. Insurers typically focus on debt with higher ratios because Fannie Mae and Freddie Mac’s federal charters only require such protection when homebuyers use downpayments of less than 20 percent.
The guarantors, which usually take the initial losses after foreclosures, mostly write policies on a loan-by-loan basis, rather than in bulk. The FHFA has said that Fannie Mae and Freddie Mac should also consider getting insurance on individual loans that covers more of the losses after foreclosure.
“United Guaranty welcomes the chance to discuss these opportunities,” CEO Kim Garland said in a statement. “Having private mortgage insurers insure loans with less than 80 percent LTV would put more private capital at risk in a non-disruptive manner while increasing the safety of mortgage system.”
Reinsurers may also be interested in participating in the bulk insurance deals, which would expand NMI’s capacity for them, said Shuster. Investors in NMI’s initial private share sale have the right to withdraw their money if it doesn’t receive approval to do traditional business with Fannie Mae or Freddie Mac by Jan. 17.
In the bond market, Freddie Mac already sells securities backed by apartment-building loans that it doesn’t guarantee, instead transferring to investors some of the risk from defaults on the underlying mortgages.
It also sells notes tied to the same pools of loans that it does guarantee. Those bonds are senior to the non-guaranteed debt, meaning they would only bear losses after the first securities are wiped out.
Fannie Mae and Freddie Mac could use that “senior- subordinated structure” as a template, Andrew Davidson, head of consulting and analytics firm Andrew Davidson & Co., said. They could also bundle credit-default swaps offering them protection on mortgage pools into bonds and sell those to investors.
Deals involving either bonds or credit derivatives could be “a very compelling opportunity for our investors,” said Jonathan Lieberman, head of residential-mortgage securities at New York-based Angelo Gordon, which oversees about $24 billion in private-equity funds, hedge funds and a REIT. “When they come to market, we will certainly be ready to look,” he said.
The transactions may be attractive because the housing market is recovering and there’s “much, much stronger underwriting” of mortgages being done, he said. Only 0.11 percent of loans guaranteed by Fannie Mae in 2011 were more than 90 days delinquent as of June 30, compared with 12.3 percent for 2008 debt, according to the company’s disclosures.
Hurdles include whether and how to structure deals to meet accounting and tax rules for REITs, according to Davidson.
Commodity Futures Trading Commission rules effective Oct. 12 also pose a challenge to the effort, Dow Jones reported this month. The CTFC later said it would exempt at least some securitizations using derivatives from the regulations, which could require new disclosures meant for so-called commodity pool operators.
Pine River and Metacapital Management LP, managers of two of the best-performing hedge funds in 2012, have told their investors they could be interested, according to a person familiar with the matter, who declined to be identified because the communications were private.
Deepak Narula, head of Metacapital and Patrick Clifford, a spokesman for Pine River, which oversees about $10 billion including through a publicly traded mortgage REIT called Two Harbors Investment Corp. (TWO), declined to comment.