By Ben Eisen
Private investors are directly buying a small but growing share of loans that have long been the domain of Fannie Mae and Freddie Mac, a sign of the changing dynamics in the $11 trillion mortgage industry.
More mortgages that meet the standards for Fannie and Freddie to buy are instead flowing into the private market, where banks and other financial institutions pool them into bonds and sell them to investors without government backing. Firms that have recently issued these so-called private-label securities with a significant amount of such loans in them -- some up to 100% -- include Chimera Investment Corp. and Redwood Trust Inc., both real-estate investment trusts, as well as JPMorgan Chase & Co. and Flagstar Bancorp Inc.
Fannie and Freddie perform a similar middleman role in moving mortgages from lenders to investors, though in those instances the government takes on some of the risk. In the last year or so, investors have proven increasingly willing to forgo the government backstop and buy private mortgage bonds, indicating they have grown more comfortable taking risk for more potential return. The fact that more investors want to buy these securities means banks and other firms can package these deals more profitably, which in some cases lets them offer better bids than the agencies.
"I think there's a number of investors interested in playing and engaging in this market," said Kristy Fercho, president of the mortgage business at Flagstar. The company put together two deals last year made up largely of conforming loans -- or loans that meet Fannie and Freddie's standards -- for investor properties.
Though the proportion of loans securitized by private buyers remains just a speck in the broader market, it is growing. Last year, $3.9 billion of Fannie- and Freddie-eligible loans went into private-label securities, and the year before $4 billion did, both roughly tripling 2016 levels, according to broker-dealer Amherst Pierpont Securities LLC.
Don Layton, chief executive of Freddie Mac, said in a recent interview that the agency is watching the trend, but that it doesn't affect most of the loans the agency guarantees. "It's stuff at the margins for us," Mr. Layton said.
The private market was a formidable rival to Fannie and Freddie before the financial crisis, but efforts to restart it since then have largely failed. If the latest activity is the start of a bigger shift, then Fannie and Freddie's role in housing finance could shrink through market forces rather than congressional action.
Shrinking Fannie and Freddie is the goal of some lawmakers and policy makers, including Republicans who want government to play a smaller role in housing. Lawmakers have tried unsuccessfully to remake the agencies since the financial crisis more than a decade ago. Some industry watchers think Mark Calabria, a sometime critic of the agencies who has been nominated to run their regulator, the Federal Housing Finance Agency, could try to encourage the private market's growth as a backdoor way to diminish the government entities, which guarantee nearly half of mortgages issued in the U.S.
"In effect, this effort to reduce the footprint is well under way," said Mark Zandi, chief economist at Moody's Analytics. "It's happening and it is consequential."
About 45% of mortgages originated in the January-to-September period last year went into Fannie and Freddie securities, according to the Urban Institute, a think tank. At its most recent peak in 2008, that proportion was 65%.
In the first nine months of last year, 1.9% of mortgage originations went into private-label securities, according to the Urban Institute. At the trough in 2009, essentially zero did. The rest are held by the lenders who made them or securitized by Ginnie Mae, the government-owned mortgage corporation that guarantees loans to many first-time buyers and veterans.
The recent moves stem from the changing calculus for lenders deciding where to sell their loans. Fannie and Freddie charge guarantee fees that erode lenders' haul from selling loans. When the fees are high enough, it can be more efficient to sell to the private market, which can be more nimble in its pricing.
When San Diego-based Guild Mortgage Co., for example, wants to sell Fannie- and Freddie-eligible loans, it collects bids from about a dozen private-market buyers and then compares those options with pricing offered by the agencies. Recently, private buyers have offered better deals on some loans. Like many lenders, Guild has found private-market pricing particularly attractive for loans where the agencies charge higher guarantee fees, including those financing investment properties, as well as loans with high balances.
It isn't certain to stay this way. The growth in private buyers has forced them to also compete with one another, analysts say, and the share of private-label securities made of agency-eligible loans dropped at the end of last year.
Some lenders say Fannie and Freddie have flagged to them the recent market dynamics, reminding them that a lender is supposed to sell a representative sample of its loans to the agencies. They have interpreted that as a directive to not to sell their highest-quality loans to the private market while handing lower-quality ones to the government entities.
"They will fire a friendly shot across the bow" for lenders around the market, said David Battany, who oversees capital markets at Guild Mortgage.
In some instances, those in the market have noticed Fannie and Freddie adjusting their pricing, making them more competitive with the private market.
Amherst Pierpont estimated that about 10% of Fannie- and Freddie-eligible loans issued in September 2018 could be more cheaply pooled into private-label deals.
"Ultimately mortgage originators are in the business of best execution," said Chris Helwig, a managing director at Amherst Pierpont.
Write to Ben Eisen at email@example.com