Will Stable Home Prices Make Investors Buy Mortgage Securities?


Stabilizing home prices in many markets has investors pouring money into distressed properties—largely to turn into rentals—but it’s likely to be many years before there will be any major return of private capital in the mortgage market.

For now, investors' appetite for residential mortgage-backed securities (RMBS) is nearly gone. There have been only a handful of RMBS issues since the market’s collapse in 2008. In 2011, there were $22.2 billion of private label RMBS issued, down 96.9% from the 2006 peak of $723.3 billion. (Click here for an explanation of what a mortgage-backed security is.)

The housing bust and financial crisis are the main causes of the market’s demise, but other factors—including the uncertainty surrounding government's role—will likely keep the private money from coming back soon.

Financial institutions simply don’t know the rules of the road and what role the government will play. The federal government, through Fannie Mae, Freddie Mac, and FHA are backing 90% of new mortgages.

“The biggest challenge to reviving the private mortgage market is the radically underpriced government guarantees that the GSE’s provide, which makes private competition impossible with taxpayer funded support,” says Tom Deutsch, who heads the American Securitization Forum, which represents market participants.

But any serious effort to address the future of Fannie and Freddie is on hold until after the presidential election.

Redwood Trust has done 6 of the 8 RMBS deals that have occurred since the market collapse, made up of prime jumbo mortgages, which are outside the bounds of government limits. The triple A yield on its most recent deal was around 3.5%.

With banks’ cost of capital low and the reserves ratios high “there’s no economic incentive to securitize,” says Redwood Trust Managing Director Mike McMahon. Banks are holding the bulk of loans that can’t be sold to government sponsored agencies.

And then there’s an alphabet soup of regulations being written. The Consumer Financial Protection Bureau has proposed rules to standardize how lenders calculate a borrower’s ability to repay a loan, known as the Qualified Mortgage Rule or QM. There is much wrangling over how the rules should be written, with a key point of contention being how much lenders will be shielded from liability when a loan goes bad. Just about the only area of agreement is that the rules need to be clear.

Deborah Still, Chairman-elect of the Mortgage Bankers Association told lawmakers this week that access to credit will be limited without legal protection, "The issue is how extensive and expensive the legal proceedings will be. Uncertain and unbounded legal exposure runs counter to the availability of affordable credit to qualified borrowers.”

A final Qualified Mortgage rule is due early in 2013. After that’s done, rules governing which mortgages would qualify to be sold in the secondary market—known as QRM for Qualified Residential Mortgage—are next.

Creative solutions to address underwater loans add another layer of uncertainty. San Bernardino county has proposed using eminent domain to seize mortgages as way to keep more people in their homes and stabilize neighborhoods.

In a research note, Fitch Ratings says it believes the potential use of eminent domain by communities in California would negatively affect private label RMBS performance.

Of course, the industry hasn’t done itself any favors. The Libor (click here for an explanation of Libor) scandal stands as a reminder of the games that were played with mortgages at the peak of the market. The Cleveland Fed figures 45% of prime adjustable-rate mortgage and 80% of subprime ARMs are tied to the Libor index, giving regulators even more incentive to be cautious.