Secondary Mortgage Market: In Trouble
The secondary market that supports a big part of the U.S. mortgage industry has ground to a halt in recent days, a development that dramatically could increase the cost of home loans in expensive regions, experts said Thursday.
“Unlike past private secondary mortgage market disruptions, which have lasted a few weeks or so … our industry and IndyMac have to be prudent and assume that this present disruption, which appears broader and more serious, might take longer to correct itself,” said Mike Perry, chief executive of home loan specialist IndyMac Bancorp Inc.
After mortgage lenders such as IndyMac offer loans, they often package them for sale to institutional investors as mortgage-backed securities. If the loans conform to the standards of government-sponsored enterprises such as Fannie Mae, those organizations can buy them. If the loans don’t conform, they are sold in the private, secondary market to other investors such as hedge funds and insurers.
The private, secondary mortgage market “is not functioning,” Perry wrote in an email to IndyMac staff, which was posted Thursday on a site run by the company.
It’s currently difficult to trade even AAA-rated parts of private mortgage- backed securities. Only mortgages that conform to the standards of government- sponsored enterprises, or GSEs, like Fannie currently are trading, Perry said.
That account was confirmed by Scott Valentin, a mortgage company analyst at Friedman, Billings, Ramsey.
“We’re hearing securitizations have frozen up,” he said. “No one wants to bid on these things and then find out that the loans are worthless tomorrow.”
Down Dramatically
The private, secondary mortgage market has not totally shut down, according to Andy Chow, portfolio manager at SCM Advisors LLC, a $14 billion San Francisco investment firm specializing in fixed-income and structured-finance markets.
The spread between bids and offers has widened in the past week, but trading still is occurring for AAA-rated parts of mortgage-backed securities, Chow said.
However, the volume of activity is down dramatically, and it’s currently not possible to complete a securitization of so-called Alt-A mortgages, Chow also said. The largest, AAA-rated parts of Alt-A securitizations can be sold, but there are no buyers for the lower-rated bits, he explained.
“That’s 5% to 7% of the capital structure that you can’t sell,” Chow noted.
That’s a big problem for mortgage originators, because they rely partly on the securitization process to replenish the cash they need to keep making new loans.
Mortgage originators instead can hold onto the loans. But that requires lots of cash, and the big investment banks that have provided the so-called warehouse financing have been pulling back in recent months, Valentin explained.
Congressional Call
That’s a problem currently facing IndyMac, Perry said Thursday.
“We cannot continue to fund $80 to $100 billion of loans through a $33 billion balance sheet unless we know we can sell a significant portion of these loans into the secondary market,” Perry wrote. “And right now, other than the GSEs and Ginne Mae … the private secondary market is not functioning.”
In response, IndyMac is originating more loans that conform to the standards of Fannie Mae and the other GSEs, Perry noted.
Higher Interest Rates
The mortgage market disruption likely will mean some home buyers will pay much higher interest rates to get a mortgage, Perry and SCM’s Chow said.
The cost of making non-agency mortgage loans is about 102 cents for every 100 cents of the loan, Chow estimated. But right now, mortgage originators can’t sell the loans at 103, he noted. To get selling prices up, loans will have to have much higher interest rates.
“So that will feed through to a very substantial increase in the interest rates that home buyers will pay,” Chow explained. “If home buyers are in loans that don’t conform with Fannie or Freddie, given present market circumstances, they will have to pay at least 100 basis points more.”
That will have a big impact on the California and Florida housing markets, along with other places where home prices are very high, he said.
“In these areas, if home buyers don’t have much money as a down payment, their loans will be too large to conform with Fannie and Freddie’s standards,” Chow explained. “That means people will pay much higher interest rates.”