Bond Investors Question Pilot Program for Mortgage Insurers

  • AllianceBernstein, others say risk-share plan may hurt system
  • U.S. looking to dial back mortgage exposure at Fannie, Freddie

Bond investors including AllianceBernstein Holding LP are criticizing proposals from Fannie Mae and Freddie Mac designed to transfer more of their risk to insurance companies.

The money managers have raised concerns about pilot programs by the two U.S.-controlled mortgage companies to share more risk with the guarantors, and are pressing trade groups to lobby against components of the plans. They say mortgage insurers have a history of failing during downturns, and that the industry might not be strong enough to withstand future calamities. The programs also could cut into supply for a relatively new type of bond that Fannie Mae and Freddie Mac issue, they say.

“Why would Fannie and Freddie want to be more exposed to mortgage insurers? It isn’t a dependable source of insurance, and I question their ability and willingness to pay claims during a crisis,” said Michael Canter, who oversees securitized assets at AllianceBernstein in New York.

The Securities Industry and Financial Markets Association, Wall Street’s main trade group, expressed similar concerns this week in a letter to the chief U.S. housing regulator. 

“People have memories of the crisis, when state regulators shut down monolines," Chris Killian, head of Sifma’s securitization group, said in a telephone interview on Thursday. Any housing reform proposals under the next administration will likely draw from whatever groundwork that regulators lay today, said Killian, whose group formed its position after convening with bond funds, dealers and lenders.

“Enough Risk”

The mortgage insurers say that the pilot programs don’t go far enough, and that their coverage is a critical part of fixing the mortgage market after the crisis. The U.S. government is trying to reduce its role in supporting home loans, and is trying to find ways to reduce the risk taken by Fannie Mae and Freddie Mac.

Investors have been taking on some of the companies’ risk, but may not be willing to do so when bond markets weaken, said Lindsey Johnson, president of industry trade group U.S. Mortgage Insurers. Giving Fannie Mae and Freddie Mac more outlets for shedding risk makes the system safer, she said.

“There’s enough credit risk to be transferred that no one entity is able to absorb it all,” Johnson said.

The mortgage insurer association says that new capital standards have made insurers stronger counterparties to Fannie Mae and Freddie Mac and that even before the standards were put in place, insurers paid billions of dollars in claims after the mortgage companies were taken under government control.

Freddie Mac agrees that it needs to consider all possible avenues, said Kevin Palmer, the company’s senior vice president of credit risk transfer. 

“We need to have a variety of different risk-transfer markets out there,” he said. “Each of those needs to develop into a mature business.”

Next President

Insurers’ and investors’ clashing views underscore how hard it is for the U.S. to dial back its involvement in the housing market after having provided extraordinary support for mortgages during and after the financial crisis. The U.S. government backs about 98 percent of home loans that get bundled into bonds and sold to investors. In 2006, mortgage giants Fannie Mae, Freddie Mac and Ginnie Mae backed closer to 44 percent.

Much of how housing reform proceeds from here depends on the next president, said Jim Parrott, a consultant to financial institutions and a former senior adviser to President Barack Obama’s National Economic Council. “Risk-sharing volume should go up over time,” Parrott said. “Fannie Mae and Freddie Mac get that.” Still, it may make sense for the two companies to look for more ways to reduce their risk, and bond markets alone probably are not the entire solution, he said.

Crowding Out?

Part of the government’s plan for reducing its exposure is to sell to investors bonds that pay higher yields than regular mortgage bonds, but force fund managers to sustain losses when homeowners default on their loans. Now, Fannie Mae and Freddie Mac take most of that risk. Since 2013, the two government companies have sold close to $36 billion of these credit-risk-transfer securities.

AllianceBernstein and other investors fear that if mortgage insurers end up being part of the government’s plan, Fannie Mae and Freddie Mac could issue fewer credit-risk-transfer bonds. “We want to continue to grow credit risk-transfer structures” in the bond markets, said Dave Lyle, who oversees residential mortgage investment strategies at Invesco Mortgage Capital Inc. Investors including TIAA-CREF, Prudential Financial Inc., BlackRock Inc., AllianceBernstein and Loomis Sayles & Co. have bought the bonds, according to data compiled by Bloomberg.

Mortgage insurers make most of their money from guaranteeing home loans against default, when the borrower’s loan is greater than 80 percent of the value of the house. The industry guarantees around $185 billion of risk on about $725 billion of mortgages, a small fraction of the more than $10 trillion of U.S. home loan debt outstanding.

Under the pilot program that Bloomberg first reported last month, Freddie Mac will allow mortgage insurers to take some of the default risk on nearly $4 billion of loans. The program is smaller than some insurers had expected, but could grow over time. Fannie Mae is working on a similar program.

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