Closing the Pricing Gap

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closing the gapThe American Securitization Forum has detailed possible ways regulators could merge mortgage-backed securities offered by Fannie Mae and Freddie Mac in order to close the pricing gap between the two.

The market discounts Freddie securities on the belief these bonds prepay faster because of differences in underwriting and other guidelines. The government-sponsored enterprises always held smaller market share compared to its twin Fannie, but the spread between the two widened sharply since the fall of 2011.

Freddie Mac 4.5 bonds traded 48 cents cheaper than comparable Fannie securities as of June 12, meaning an originator delivering to Freddie loses $4.8 million for every $1 billion of new mortgages sold, according to the paper. Market share dropped from a historic 40 percent for Freddie to 19 percent in December.

Freddie closes the gap itself by lowering its guarantee fee for the originator or paying concessions, both at a cost to the taxpayer.

Many trade groups began advocating the Federal Housing Finance Agency to merge the two securities.
“For this to occur, both perceptions about and features of Fannie Mae MBS and Freddie Mac PCs, which contribute to the current pricing differential, must be eliminated,” ASF said in the white paper.

To begin, the trade group suggested moving the payment date for Freddie securities to match Fannie to the 25th of each month. Developing and implementing a brand-new platform for originators to deliver these loans for a single securitization could take years, but ASF suggested sending the mortgages to Fannie Mae as a short-term solution.

“Fannie Mae would accept Fannie Mae assets as principal, and Freddie Mac assets on behalf of Freddie Mac,” according to the paper. “Internally, the assets could be “credited” to one GSE versus the other, or subdivided between the two, but the security issued in exchange for the assets would be a Single Agency Security.”

Concerns abound. ASF said its originator members would urge the GSEs to keep separate guarantee fee pricing to maintain competition. Investor members, however, said the two separate bonds would never be interchangeable as long as different fees were issued.

Originators were also against identifying which GSE issues and guarantees the single security as it would only perpetuate the pricing discrepancies among investors. It would trade under a new ticker and have no identifiers linking back to a particular entity.

But the investors themselves said beginning next year, they will need to discern between the two because the Treasury Department will cap the amount of support given.

“Investors keep a close eye on the financial position of both GSEs, assuming that unlimited Treasury support will end after this year, leaving only specified amounts of support Without further unlimited support having been pledged, investors need to make calculated decisions on how much exposure they can have to each GSE,” ASF said in the paper.

The ASF did also suggest offering a voluntary exchange to replace existing securities, but it must remain voluntary for investors who crafted these complex instruments to suit their tax or accounting needs.
The technical achievement required to merge the two securities could require years of planning. In response to the paper, analysts at Barclays Capital ($18.43 0 percent) said such a launch “is likely to be a long drawn affair.”

“Implemented correctly,” ASF wrote, “a Single Agency Security could benefit all participants in the mortgage market, including borrowers, originators, investors and the US government, which owns the controlling stake in the GSEs. Eliminating market inefficiencies through a Single Agency Security should result in lower mortgage interest rates for borrowers.”

By Jon Prior

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