Unstructured Finance

The amazing shrinking pile of non-agency mortgage debt

March 8, 2013

By Matthew Goldstein

Many cash-strapped, unemployed or underemployed people are still struggling with too much consumer and household debt. But there is one kind of debt that is getting smaller and smaller–mortgage bonds issued during the U.S. housing bubble by Wall Street banks and finance firms that isn’t guaranteed by either Fannie Mae of Freddie Mac.

The outstanding dollar value of  so-called private label residential mortgage bonds, or non-agency mortgage debt, is $909 million, according to stats compiled by CoreLogic and mutual fund firm Doubleline Capital. At its peak in July 2007, the total of private label mortgage debt was $2.2 trillion.

In July 2007, the financial crisis began in earnest as ever-so-late-to-game rating agencies began downgrading en massse a whole range of private label mortgage debt, much of which was backed by mortgages taken out by borrowers with either iffy credit histories or who put almost no money down for a home. As we all know the market for private mortgage debt shut-down and only now is beginning to show the first signs of coming to life–or green shoots as some might say.

For now, however, the issuance of private mortgage debt is just a trickle and represents roughly 2 percent of all new mortgage bonds brought to market. Mortgage debt issued with a guarantee from Fannie, Freddie, Ginnie Mae or FHA still accounts for all of the mortgage bond activity in the U.S.

Hedge fund reporter Katya Wachtel reported Thursday that the diminishing pool of private label mortgage is creating a quandry for hedge funds that specialize in mortgage debt. Those funds posted 20 percent or better returns by feasting on private label mortgage debt that kept rising in price all of last year both before and after the Federal Reserve, in September, began buying $45 billion of agency mortgage debt a month. The Feds move to keep interest rates low has pushed investors into riskier and better yielding assets, like private label mortgage debt.

The thing is, the remaining stockpile of private label mortgage debt isn’t seen as risky as it once was because of the early recovery in the housing market and the cold reality that the worst of the private label debt has disappeared largely due to foreclosures, short sales and prepayments on the underlying mortgages.

So, mortgage debt investors are left chasing after a ever smaller supply of private debt that keeps increasing in price as the yields go down–remember, price moves inversely to yield.  So while the Fed bond-buying binge and the housing recovery clearly are the main drivers of the recovery in private label debt prices, there’s a little bit of a supply-and-demand issue at work here too. (For a good story on just what the Fed will do with all the bonds it is buying, read this story by  Fed reporter Jonathan Spicer).

But there’s a bigger issue here: whether credit hedge funds, or bond funds for that matter, can find attractively price mortgage debt to invest in to generate solid returns for their investors, and that’s the best way of seeing a return of the private label mortgage market. Since federal policymakers are determined to reduce the footprint of Fannie and Freddie in the mortgage market, clearly there will be a need for private label securities to return to the market.

There’s nothing wrong with the private market taking a more active role in the mortgage bond issuance market. But it will be important for everyone to avoid the gross excesses of the past everyone from the banks, mortgage firms, brokers and yes, borrowers themselves engaged in.  So with the first signs of private securitization beginning to take off in various asset classes including mortgages, the time is now to be vigilant in avoiding the mistakes that brought about the financial crisis.

Securitization in and of itself isn’t bad. But as money manager told me the other day, a blowup of some sort is almost given with every new kind of securitization. You just don’t know when and where.

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