Mortgage-Bond Revival Cut Short as Wall Street Sidelined

Royal Bank of Scotland Group Plc banker Trez Moore says the firm’s U.S. securities arm recently created a group to buy home loans from other lenders. He’s just not seeing much opportunity for what used to come next.

The post-crisis revival in the business of bundling new mortgages into bonds without government backing and then selling them to investors is petering out. Issuance has dropped to $1.6 billion this year from more than $6 billion in the first five months of 2013 and is a speck of the $1.2 trillion that was sold annually during the U.S. housing boom of the 2000s.

“It’s just barely alive,” Moore, who worked at First Boston Corp. in the 1980s as the market was being created, told an audience of mortgage executives in New York last week.

Six years after the private mortgage-backed securities market came to a halt as it sparked a global seizure in credit, Wall Street hasn’t figured out how to regain its place in a $9.4 trillion housing-finance system lawmakers are trying to rebuild. While home buyers are being served by government programs and bank lending, a fuller revival of the market may eventually be needed to keep borrowing costs low and expand credit.

Lack of Optimism

Moore’s lack of optimism about the current state of a business known as non-agency mortgage securitization was echoed widely at the Mortgage Bankers Association conference last week that focused on the secondary market for home loans.

While lenders are hoping the market can rebound in the near-future, “Vegas is taking odds on that,” said Eric Kaplan, a managing director at mortgage company Shellpoint Partners LP, which is backed by Lewis Ranieri, a pioneer of home-loan securities.

The Federal Housing Finance Agency’s acting inspector general, Michael P. Stephens, said the non-agency market is “almost totally dormant,” citing a failure to restore investor trust after an era of “fraud and deceit.”

A dearth of confidence in the securities from bond buyers is compounding two potentially bigger roadblocks to sales.

Taxpayer-backed programs are still offering stiff competition while banks flush with record deposits are hungry for the growing share of new mortgages known as jumbo loans that are too big to qualify for government support and are even taking on more that could be packaged into U.S.-backed bonds.

Government Guarantees

U.S. agencies and government-backed firms such as Fannie Mae guaranteed about 76 percent of new home loans in the first two months of 2014, the least since 2007 and down from more than 90 percent in early 2010, according to data firm Black Knight Financial Services. Bank lending accounted for about 20 percent, the most since at least 2003.

JPMorgan Chase & Co. is one of the lenders being wooed to retain lower-balance loans after housing stabilized and Fannie Mae and Freddie Mac almost doubled the fees they charge for their guarantees.

“Private capital has re-entered, but in the shape of bank portfolios,” Garry Cipponeri, director of capital markets at JPMorgan’s mortgage unit, said at the conference.

About 10 percent of home loans that JPMorgan put on its balance sheet in the fourth quarter could have been sold to Fannie Mae and Freddie Mac, the bank’s mortgage head, Kevin Watters, told analysts in February. That share and the portion of loans eligible for the firms’ guarantees the bank is retaining are higher since then, according to spokesman Jason Lobo, who declined to provide more specifics.

Jumbo Loans

The reduced taxpayer-backed share in the market is partly tied to the greater proportion of loans that are too big to qualify. Applications for jumbo mortgages of at least $729,000 for home purchases fell only 6 percent in April from a year earlier, while requests for loans of less than $150,000 fell by 21 percent, according to the Mortgage Bankers Association.

The rising jumbo share is being fueled both by a jump in home prices while Fannie Mae and Freddie Mac loan limits go unchanged, as well as the healthier state of the high-end housing market, said Tom Wind, head of EverBank Financial Corp.’s mortgage unit.

His bank, which last quarter cut down-payment requirements for loans of up to $850,000 to 10 percent from 20 percent, retains only the adjustable-rate jumbo mortgages it makes, he said. After the lender completed two securitizations of fixed-rate jumbo loans last year, other banks are now the buyers because they pay more, he said.

‘Getting Closer’

The prices offered by bond investors are “getting closer,” as relative yields demanded on new sales partially reverse a surge that occurred as last year wore on, he said in an interview.

The jump in those yields was spurred in part by the Federal Reserve’s move last May toward slowing its monthly bond purchases. Also contributing was a lack of confidence that bondholders are being adequately protected by contracts governing the deals. Market participants are seeking to address those concerns through a Structured Finance Industry Group project called RMBS 3.0.

Bond investors are getting a chance to buy housing debt without government backing, though those offerings are coming through Fannie Mae and Freddie Mac. Issuance of a new type of risk-sharing debt that the companies began selling in 2013 totals about $3.6 billion this year.

‘Roaring Success’

“They’ve been nothing less than a roaring success on every possible metric,” said Moore, a managing director at RBS in Stamford, Connecticut. The appetite shows there’s demand for taking on mortgage credit risk at higher yields, and instead “the place where all of us struggle is at the AAA level, where there’s not a very wide and deep market at all.”

Moore, whose firm this week announced plans to cut its mortgage-trading business by two-thirds within 18 months, said he expects securitization to eventually return.

“But it will not dominate the market like it did,” he said. In the meantime, he said, potential issuers will focus on selling unpackaged loans, and such sales may even persist as a large part of what they do, as “was the norm” in the 1980s and 1990s.

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