Mortgage bonds at heart of crisis dwindle in supply as new breeds take root


Old mortgage bonds at the heart of the 2008 global financial market crisis are on the road to becoming extinct.

Like baby boomers eclipsed by millennials, older housing bonds soon will be outnumbered by newer ones that came of age during the past decade.

Mortgage bonds packed with crisis-era home loans have dwindled to just $431.5bn from their 2007 peak of more than $2.3 trillion as home foreclosures, borrower defaults and loan repayments have trickled through the system, according to Bank of America Merrill Lynch data.

“Half way through 2019, it appears non-agency RMBS may be at a turning point in terms of issuance,” Bank of America analysts led by Chris Flanagan wrote in a note to clients.

Mortgage bonds were dubbed “residential mortgage-backed securities” after 1968 when the first set of home loans were pooled into tradable bonds. The industry uses “non-agency” as a catch-all for mortgage bonds sold without government guarantees.

Flanagan’s team at Bank of America assembled a chart showing the near even split between the amount of outstanding pre- and postcrisis mortgage bonds without government backing.

Bank of America

Crisis-era mortgage bonds are just 56.5% of the market

Precrisis mortgage bonds, and the derivative products that amplified losses after home prices plummeted, were likened to an “invisible virus” that infected people and communities and spread in ways that “raised concerns about liquidity and solvency elsewhere,” in a 2008 International Monetary Fund report on the U.S. subprime contagion.

The damage spread far and wide, with an estimated $600 billion lost just from the near $3 trillion of non-agency mortgage bonds issued between 2005 and 2008, according to data from bond analytics provider Intex.

That tally does not include losses from synthetic exposure to soured mortgages through what was the proliferation of exotic Wall Street products, including collateralized debt obligations.

“We’ve had a pretty good laboratory to see what can go wrong,” said Jody Shenn, vice president and senior analyst at Moody’s Investors Service. “And the market is taking those lessons and moving forward.”

Since the 2008 crash, the bulk of all new home loans have been packaged and sold to Freddie Mac

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Fannie Mae

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and other U.S. housing agencies that issue bonds with guarantees. The agencies require mortgages to follow much stricter standards than the “no-income, job or assets” or “ninja” loans to unqualified borrowers that were popular in the mid-2000s.

But recent efforts to lure private capital back into U.S. housing finance have been gaining traction. And newer breeds of housing bonds, which boast enhanced investor protections, now are on the rise.

Shenn pointed out that most loans in new RMBS deals are 30-year fixed-rate mortgages, with payments over the life of the loan clearly spelled out to borrowers.

“Unlike in the past, when there were loans with very low initial payments that often spiked higher, and in some cases by as much as 200% to 300%,” Shenn said.

Many new mortgage safeguards follow the rise of the Consumer Financial Protection Bureau, which was set up in the wake of the financial crisis to help shield consumers from abusive lending practices. It set new standards that make home loans safer and easier for borrowers to understand, while requiring lenders to verify that a borrower can actually afford their mortgage payments.

“Ironically, we needed a rule that requires lenders to verify a borrower’s ability to repay,” said Sam Dunlap, a senior portfolio manager at Angel Oak Capital Advisors.

Angel Oak has been an issuer of newer mortgage bonds that pool home loans of borrowers with nontraditional income sources, such as self-employed business owners. These loans are part of a small, but growing niche of loans that rely on bank statements to vet a borrowers’ creditworthiness, rather than full income documentation.

“Generally, credit guidelines are still historically tight in the residential market,” Dunlap said.

This year Bank of America expects $102 billion of mortgage bonds to be issued outside of those with government-backing. While still a drop in the bucket when compared with the market heyday, it is roughly double the volumes seen in 2016.

To be sure, older mortgage bonds gained a following in the aftermath of the crash, particularly among hedge funds and other managers who scooped up toxic mortgage debt at cents on the dollar and made double-digit returns as home prices rebounded.

“Coming out of the crisis, there were a lot of cheap bonds out there and a lot of capital raised to take advantage of that,” said John Kerschner, a portfolio manager at Janus Henderson’s multisector Income Fund

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Yet, the sector still has a certain taint. Millions of borrowers lost homes to foreclosure and central banks that were called upon to shore up the global financial system, more than a decade on still are providing monetary stimulus.

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“There are people who will argue that investors were big girls and boys,” Kerschner said of fallout from the mortgage crisis. “But at the very least, it didn’t leave the market in the best light.”

Source : MTV