By Dan Abdill, Senior Investment Officer (retired)
Mortgages and MBS in the COVID-19 Era
For decades, Fannie Mae and Freddie Mac have helped keep the mortgage markets functioning. Enter COVID-19: the global pandemic that slowed, and even shut down,
wide swaths of the economy. Parts of the mortgage market seized up, but Fannie and Freddie stepped in to keep mortgage financing flowing.
Their conservator, the Federal Housing Finance Authority (FHFA), allowed the two mortgage giants to adapt their policies to cope with the unique circumstances caused by the pandemic. These changes include buying loans in forbearance, flexible appraisal guidelines, alternate employment verification, and remote notarization at closings. They also implemented moratoriums on foreclosures and evictions, including eviction of tenants.
The changes are good news for borrowers and lenders, but what do they mean for investors in the agencies’ debt and mortgage-backed securities (MBS)? And, how do possible changes to the FHFA’s continued conservatorship of Fannie and Freddie factor into the safety of agency securities?
Keep calm and invest
A global pandemic of this magnitude is unprecedented, but for Fannie and Freddie, managing disaster scenarios is nothing new – think hurricanes, such as Harvey and Maria, or the California wildfires. So, while forbearance will change cashflows for the agencies, the impact on investors who own MBS should be minimal, as both agencies guarantee principal and interest payments to investors.
Older Fannie Mae MBS guarantee “ultimate” (or eventual) payment, but Fannie Mae MBS issued after the June 3, 2019 launch of the Common Securitization Platform (CSP) guarantee “timely” (or scheduled) payment. Freddie also uses the CSP to create Uniform Mortgage Backed Securities (UMBS) that follow Freddie’s long-standing “timely" payment guarantee. Additionally, shortly after conservatorship in 2008, the FHFA arranged unlimited lines of credit with the U.S. Department of Treasury. There should also be no impact to investors that own agency bullet (fixed rate, fixed term) and callable (agency’s option to redeem prior to maturity) bonds.
Conservatorship: will they stay, or will they go?
Since their conservatorship in 2008, the fate of Fannie and Freddie has remained unclear. At one point, it even appeared the enterprises would be wound down and liquidated. Although chartered by Congress as federal agencies in 1938 and 1970, respectively, and often referred to as “agencies,” their status changed long ago. Fannie converted into a publicly traded company in 1968, and Freddie followed suit in 1989. Both are now known as government-sponsored enterprises (GSEs).
Essentially, all net income from the enterprises is now paid as a quarterly dividend to the Treasury in a so-called “net-worth sweep.” The FHFA kept their combined capital at roughly $3 billion. However, the current administration wants to see the enterprises returned to shareholders, and in September 2019, allowed the agencies to start building more capital through retained earnings. Although they are now allowed to keep $45 billion in combined capital, the FHFA wants them to have around $200 billion before releasing them from conservatorship. To complicate matters, shareholders of their publicly traded stock mounted a legal challenge to the net worth sweep that is now before the Supreme Court.
The bottom line? Fannie and Freddie are not going away anytime soon.
Impact on credit unions
The enterprises’ policy changes to cope with COVID-19 will allow credit unions to continue selling mortgages during this challenging time, and credit union investors should remain comfortable buying their securities. Current market indicators and key economic and market metrics, such as those available in our monthly Market Overview & Data Report, can provide additional insight when evaluating such investment options in the coming months.
Under the guidance of the FHFA, and its agreement with the U.S. Treasury, the agency debt and mortgage market will likely remain an active and safe place for credit union investors – no matter what the future holds for the enterprises.
The Catalyst Corporate Brokerage Team can help your credit union navigate the current economic environment and prepare for future liquidity needs. For a comprehensive portfolio review, or to speak with an Investment Officer, contact us today!
All securities are offered through CU Investment Solutions, LLC. The home office is located at 8500 W 110th St, Suite 650, Overland Park, KS 66210. CU Investment Solutions, LLC registered with the Securities and Exchange Commission (SEC) as a broker-dealer under the Securities Exchange Act of 1934. CU Investment Solutions, LLC is registered in the state of Kansas as an investment advisor. Member of FINRA and SIPC. All investments carry risk; please speak with your representative to gain a full understanding of said risks. Securities offered are not insured by the FDIC or NCUSIF and may lose value. All opinions, prices and yields are subject to change without notice.