Private MBS market may soon crawl out of bunker

March 11, 2010

The U.S. private-label mortgage bond market may be about to crawl out of its bunker. The housing-induced credit crisis bombarded it into hiding almost two years ago. But a handful of firms, independently of each other, are working on deals that could hit the market by June.

Any new issue of mortgage bonds lacking guarantees from government-run agencies Fannie MaeĀ  and Freddie Mac will need to be squeaky clean — and the seller may lose money.

The bonds in the works would probably be backed by jumbo mortgages — loans mostly bigger than about $730,000, depending on location, that Fannie Mae and Freddie Mac won’t accept. If successful, it would mark the first such deal since May 2008.

Buyers seem to be willing to consider moving away from standardized paper guaranteed by Freddie and Fannie, partly because those instruments now offer the lowest returns on record. Bonds backed by troubled loans made by failed institutions that the Federal Deposit Insurance Corp just sold were popular with investors. Admittedly they came with a guarantee, but investors including banks are starting to look for places to invest the capital they have raised or earned.

Prospective investors in the new round of jumbo mortgage-backed securities will want assurances that all the loans are in order, with all the proper documents and proof of income. They’ll probably want borrowers to have put as much as 40 percent of their own money down when buying their properties. And they’ll expect that, even if house prices have dropped since the mortgage was made, the average loan balance is still no more than, say, 60 percent of the property’s value.

What’s more, any deal will have to be over-collateralized so that it can withstand losses on the underlying mortgages of, say, 15 percent or more before investors in even the lowest-rated slug of bonds take any hit at all. New bonds might still need to be priced at a discount to entice buyers.

That poses a dilemma for the institutions working on the deals: under those conditions, they’re likely to lose money. But the cost of reopening a key market could be worth it. While banks might not rush to securitize non-standard mortgages right now, that should change as the market rediscovers its equilibrium. Those who pioneer its rehabilitation will get the kudos to help bring in future deals.

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