Market Pros Set Their Sights on GSEs

Securitization professionals are already gearing up for the next battle in Washington - the overhauls of Fannie Mae and Freddie Mac.

With the Dodd-Frank Wall Street Reform and Consumer Protection Act on the verge of final passage, there has been increased speculation about whether lawmakers' next project will be setting a course for the troubled mortgage agencies. The thought is that a big opportunity for private-label players could be in the making.

Why? There's a good chance Congress will reduce the maximum size of government-guaranteed Fannie and Freddie loans from the current limit of $729,750. That would reclassify a large swath of would-be agency loans as jumbo credits, which when securitized provide higher yields for investors and bigger fees for investment banks.

While they have taken little if any action yet, investment banks that issue and manage jumbo-loan deals would have the most to gain - and thus are seen as likely to play leading roles in lobbying for lower loan limits. Such a possibility is particularly intriguing in light of a provision in the Dodd-Frank bill that would allow banks to sidestep new risk-retention requirements if they use "qualified residential mortgages" as collateral in their securitizations.

The exact specifications for such loans will be determined by a new regulatory panel established under the act, which President Obama is expected to sign later this month. However, it's already clear that qualified mortgages won't require the imprimatur of Fannie or Freddie.

For banks, that raises the possibility of assembling non-agency securitizations backed by qualified loans - a win-win that would mean higher profits without having to keep "skin in the game." But first, banks have to convince Congress to downsize Fannie and Freddie, and thereby increase the supply of non-agency collateral.

Currently, 90-95% of all U.S. mortgages are backed by Fannie or Freddie. Rep. Barney Frank (D-Mass.), who is spearheading financial-reform efforts in the House, has suggested that the government-sponsored enterprises have become too big.

Reducing the maximum sizes of agency loans would be one way to scale down the operations, while forcing originators to finance larger portions of their credits via private-label securitizations. Steven Abrahams, who heads mortgage-bond research at Deutsche Bank, said non-agency loans that meet the standards of qualified mortgages under the Dodd-Frank bill would be particularly attractive collateral.

It's unclear when Congress plans to tackle the GSEs. Some see it happening next year, while others don't expect lawmakers to act for another two years - after the 2012 presidential election. But even before the legislation materializes, there could be a shift in emphasis from the agency to the non-agency market.

That's because Fannie and Freddie realize it's just a matter of time before they're taken to task for their collapse during the credit crisis and subsequent taxpayer bailouts. As a result, said Morrison & Foerster attorney Jerry Marlatt, the agencies will probably begin to curtail their mortgage-financing activity well ahead of any Congressional action. That, coupled with a recent uptick in mortgage originations, could "facilitate the comeback of a primary mortgage-securitization market," Marlatt said.

When it comes to lobbying Congress to shrink the agency-mortgage market, banks' securitization groups could encounter resistance from an unlikely source: their colleagues on agency-bond desks. Marlatt said while it's true banks stand to earn big fees from underwriting more non-agency issues, the institutions also pocket big profits by arranging and trading agency securities.

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