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It was only a matter of time. On the heels of a comeback in U.S. housing, there are signs of life in the market for private-label mortgage bonds. These securities slice and dice home loans but are not guaranteed by Freddie Mac, Fannie Mae or other government-related bodies. Since the mortgage boom – when more than $1-trillion (U.S.) of bonds were issued in 2005 and in 2006, according to Inside Mortgage Finance – and the subsequent bust, there have been just a smattering of private deals. But this week, two sales have surfaced back-to-back, including a $616-million deal from JPMorgan.
Even if this market will never retest its peaks (and here's hoping), it is unsustainable for the U.S. government to support 95 per cent of the U.S. mortgage market, as it has since the housing meltdown. Several factors have set the stage for more private issuance. The fees that Fannie and Freddie charge to guarantee loans have gone up, while the size of the loans eligible for them to finance has fallen. On top of the housing rebound, add investors' thirst for yield. After several years of near zero rates, many asset classes – even subprime bonds from the boom years – have been picked over.
But already some concerns are arising about the new deals. In JPMorgan's deal, the underlying loans meet tight underwriting standards: prime borrowers that have an average of 35 per cent of equity in their homes, according to Fitch. But the rating agency warned that "representations and warranties" (R&W) – protections for investors if the underlying loans become delinquent or default – are weaker than those seen in earlier post-crisis deals.
The private deals since the crisis do not have the insane underwriting that proliferated during the boom. But the question is whether even a little loosening of R&Ws is a bad precedent for a deterioration of credit as demand continues to grow.