JPMorgan Deal Shows Possible Path to Smaller Fannie and Freddie
November 08 2019 - 8:29AM
Dow Jones News
By Sam Goldfarb
A recent move by JPMorgan Chase & Co. to shed risk on some
of its mortgage loans is stirring hope that the tactic could help
reduce the government's role in the $11 trillion mortgage
market.
JPMorgan last month became the first U.S. bank to issue
credit-risk transfers tied to a pool of mortgages. The bondlike
instruments have been embraced by the government-controlled
mortgage guarantors Fannie Mae and Freddie Mac since their
introduction in 2013.
Like the credit-risk transfers issued by Fannie and Freddie,
those sold by JPMorgan pay investors a stream of income. In
exchange, investors will shoulder losses up to a certain level if
homeowners default on loans in the underlying pool of
mortgages.
In essence, JPMorgan has bought a type of insurance on loans it
had already made to borrowers with high credit scores. That, in
turn, should allow it to hold less capital against those loans.
The deal is notable because some analysts think that a new
market for credit-risk transfers issued by banks could make it at
least a little more likely that banks would hold mortgages rather
than selling them to Fannie and Freddie. By extension, such an
outcome would make taxpayers less exposed to mortgage defaults.
Fannie and Freddie don't make loans but buy them from lenders
and bundle them into securities. They typically carry a guarantee
that Fannie and Freddie will pay investors if the underlying
mortgages default, leaving investors with only the risk that the
bonds will lose value if interest rates rise.
As it stands, nearly half of U.S. mortgages are guaranteed by
Fannie and Freddie. Under government control since the start of the
2008 financial crisis, Fannie and Freddie have always carried at
least the implicit backing of the government, which has been
critical to preserving America's popular 30-year fixed-rate
mortgage.
For years, both Republicans and Democrats have considered
options for replacing the mortgage giants or introducing more
competition in the housing finance market in an effort to protect
taxpayers.
In September, the Trump administration outlined a plan to return
Fannie and Freddie to the private market and reduce their market
share while continuing to provide them with a government backstop.
Among its ideas: reducing the amount of capital that banks would
need to hold against a pool of mortgages if they issue credit-risk
transfers.
James Dimon, the chief executive of JPMorgan, has for many years
been critical of government regulations that he says have made it
overly difficult for banks to hold mortgages. He has, though,
offered praise for the Trump administration's proposals.
In the specific case of last month's deal, the roughly $750
million of mortgages linked to JPMorgan's credit-risk transfers
were likely never going to be sold to Fannie and Freddie, in part
because the average loan in the pool was too large, analysts
said.
The loans, in general, were made to borrowers with high credit
scores and low leverage, making defaults relatively unlikely. The
maturities of the risk-transfer securities matched those of the
underlying mortgages.
Investors in credit-risk transfers issued by banks are taking an
additional risk that the banks themselves could become insolvent,
analysts said. That could make it uneconomical for all but the
largest and most creditworthy banks to issue the securities.
Still, some have welcomed JPMorgan's deal as a step in a
positive direction.
Credit-risk transfers could be "the next little big thing" for
banks, said Chris Helwig, a managing director at Amherst Pierpont
Securities.
At a minimum, it could help some banks shed risk and free up
capital that they can allocate elsewhere, he said. It also "opens
the door for banks to put more loans on their balance sheets."
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--Ben Eisen contributed to this article.
Write to Sam Goldfarb at sam.goldfarb@wsj.com
(END) Dow Jones Newswires
November 08, 2019 08:14 ET (13:14 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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