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Recession Fears Hit Risky Mortgage Debt Amid Default Concerns

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Investors are unloading securities sold by

fannie mae

FNMA -2.35%



freddie mac

This moves the risk of mortgage defaults away from taxpayers and signals growing concern about defaults if rising interest rates trigger a deep recession.

Securities called credit risk-transfers could suffer losses if a default creeps up on the bulk of the mortgage debt backed by the big mortgage lenders.Federal Reserve interest rate rises showing signs of cooling pandemic soaring real estate market.

This has worried some investors who hold securities associated with riskier cash flows. Mortgage Guaranteed by Fanny and FreddieAsset managers, pension funds and hedge funds have all invested in the approximately $60 billion CRT market. This acts as an insurance policy for his two agencies against defaults on some of the approximately $4.5 trillion in mortgages that would otherwise cost US taxpayers a loss.

As dark clouds roll over the housing market and the economy as a whole, investors are pushing CRT prices down and demanding more compensation to keep them going. Until last week, typical junk-grade CRTs yielded 6.75 percent more than ultra-safe U.S. Treasuries, according to JP Morgan data.

Aside from the initial spike in the Covid-19 pandemic, this is about the highest level since CRT was introduced a decade ago. In January of this year, the relative spread to US Treasuries was just 3.42%.

Last week’s index data showed spreads on comparable single B rated junk corporate bonds fell 5.43 percentage points.

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This reflects the market perception that CRT is riskier.

Fanny and Freddie do not take loans. Instead, it bundles other lenders’ mortgages into securities and sells them to investors, guaranteeing payment if the underlying mortgage defaults.

Transfer of credit risk is not guaranteed. Instead, it appeals to investors who want higher returns in exchange for the risk of losing money should broader mortgage defaults reach relatively modest levels.

Mortgage interest rates soared 20 year high Last week it was 6.92%. Paul Norris, head of structured products at investment manager Conning, said the housing market was one of the first sectors of the economy to outperform other sectors of the bond market as affordability is under pressure. He believes prices could fall further from here.

“Housing is at the forefront of the current downturn,” said Norris. “I want to go to my clients and say that I really believe in this asset class, but I can’t prove it yet.” He said he prefers junk-rated structured finance securities.

Ben Hunsaker, portfolio manager at Beachpoint Capital Management, said CRT prices have fallen so much that, judging by spreads alone, the market appears to be preparing for a housing crisis as severe as the 2008 recession. , said.

Investors today generally agree that risks in the mortgage financial system are better contained than they were in the mid-2000s, sparked by some riskier mortgage bonds. The financial crisis of 2007-2008.

Since then, Fanny and Freddie operates under federal guardianship, the credit standards for guaranteed mortgages are getting stricter. Introduced in 2013, the CRT is one of efforts to shift some of the risk of mortgage default to retail investors.

A series of interest rate hikes has spilled over into the US economy and is expected to rise further. The WSJ analyzes the numbers hitting American wallets this year and beyond. Photo: Elise Amendola/Associated Press

Undaunted by the bleak outlook for the housing market, some of these investors are betting that the recent sale of CRTs has gone too far. Hunsaker said real estate could languish in the coming recession, but defaults are unlikely to reach levels seen 15 years ago. Instead, he blamed some of the steep declines in CRT prices as large asset managers sold securities as clients withdrew from bond funds during this year’s historic market crash. .

Beachpoint purchased CRTs this year with a focus on those related to mortgages signed by homeowners in 2020 and 2021. Despite the recent drop in home prices, prices are still rising from last year, easing the finances of those households, Hunsaker said. Additionally, the interest earned by CRT investors scales with market interest rates, unlike most junk bonds, protecting investors such as Beach Point from risk. Further rate hikes by the Federal Reserve.

“There’s no denying that the housing market today is worse than it was a year ago, but after digging into the market, we’ve had a hard time underwriting the bearish thesis,” Hunsaker said.

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Another potential benefit for CRT investors is that Fannie and Freddie last year offered to buy back billions of dollars in CRTs. Going into 2022, investors were anticipating a slew of new issuances that never fully materialized.

The two institutions pay CRT investors variable interest rates, while the interest payments from homeowners’ mortgages are fixed. So if interest rates rise, buying back CRT may be more economical for agencies than paying ever-higher interest rates.

That’s one reason why investment manager Brandywine Global also invested in CRT this year, said Tracy Chen, portfolio manager at the firm. She believes the decline was driven more by technical market factors than by underlying risks to the housing finance system.

“The credit quality is exceptional and the underwriting is very solid,” she said, pointing to healthy household balance sheets and high average credit scores typical of modern mortgage borrowers. CRT prices seem to reflect expectations of a severe housing crisis, which Mr Chen doesn’t think so.

“I don’t think spreads like this are sustainable,” she said.

Email to Matt Grossman [email protected]

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