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August 30, 2021

Policy Shifts Impact Agency MBS

By Benjamin Birnbaum

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With Democratic control of the White House and Congress, the course of Fannie Mae, Freddie Mac and Ginnie Mae policy is being reshaped. While former President Trump and Treasury Secretary Mnuchin were moving toward the “recap and release”1 of Fannie and Freddie, under the Biden administration these efforts were replaced by housing affordability policy. The focus has been on minimizing Covid-related foreclosures and expanding credit to lower-income and minority borrowers. Fannie, Freddie and Ginnie have all implemented new programs in recent months that align with the administration’s goals, carrying notable implications for investors.

Given that scores of borrowers will soon see their loan forbearance (due to COVID-19 hardship) period end, it is no surprise that policy developments are targeted at keeping delinquent borrowers in their homes. Eviction restrictions and loan forbearance timelines have been extended. Meanwhile, the Federal Housing Administration (FHA), which guarantees the majority of Ginnie Mae loans, has announced a streamlined modification program for delinquent borrowers with loans above current market rates.2 Borrowers who qualify will be able to modify their mortgage rate3 and extend their mortgage final due date, resulting in a meaningfully lower monthly payment. The process can be completed with minimal effort from the borrower, requiring only their signature.

Similarly, the Federal Housing Finance Authority (FHFA), which governs Fannie and Freddie, has expanded its existing modification program, making it available to a wider range of delinquent borrowers.4 The FHFA modification program also allows borrowers to modify their loans to a lower rate and gives them more flexibility in extending their mortgage due dates out to 40 years.

These options are clearly a boon for struggling homeowners, but they cause prepayment indigestion for mortgage investors. Loans that are modified will be bought out of mortgage pools, resulting in prepayments and reducing carry for bond holders.

Some market participants have been sanguine about these risks. After all, the new policies only affect delinquent loans, which are likely to be bought out eventually. But we feel there are still reasons to be cautious. The new programs will pull forward the timing of buyouts and increase the risk of incremental buyouts from borrowers who might have otherwise caught up with their missed payments.

The following chart shows the percentage of loans that have missed payments for more than 90 days. We expect that 50% of the conventional (Fannie and Freddie) delinquencies and 75% of the Ginnie Mae delinquencies will be eventually bought out, resulting in prepayments.

Exhibit 1: Share of Loans with 90+ Days of Delinquencies
Explore Share of Loans with 90+ Days of Delinquencies
Source: EMBS. As of 01 Aug 21. Select the image to expand the view.

These loan modification programs have not been the only policy development. In January, President Biden appointed Marcia Fudge to lead the Department of Housing and Urban Development. In June former FHFA director Mark Calabria (a Trump appointee) was replaced with acting director Sandra Thompson. Shortly thereafter, on July 16, the FHFA removed the Adverse Market Refinance Fee.5 This fee was put in place during 2020 to protect Fannie and Freddie from Covid-related losses. With the fee removed consumers could realize an estimated 12.5 basis point drop in mortgage rates.

Given the large amount of policy changes over a short time period, we feel investors need to be particularly thoughtful. We have pared exposure to pools that are most at risk to increased buyouts and are mindful of the potential for more policy changes, potentially around the costs for Ginnie and Fannie/Freddie to insure loans as likely to be targeted by the Biden administration to expand housing affordability. These higher fees (instituted during the Trump presidency) have room to be reduced, providing additional incentive for borrowers to refinance at the cost of bondholders. Consequently, we believe active investors in the agency MBS market have significant opportunities to generate alpha from sector rotation, security selection and duration management relative to the benchmark.

1. Recapitalization of Fannie Mae and Freddie Mac, and their release from government conservatorship.
3. The new rate will be very close to the Freddie Mac Primary Mortgage Market Survey (PMMS) rate, often one of the lowest rates available for 30-year conforming loans.

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