Category Archives: Investing

Credit risk transfer bonds rise to one of best performing debts of 2017

One of the top bond trades of this year is expected to continue, and even become more popular in 2018 as more and more traders bet that homeowners won’t default of their mortgages.

Earlier this year, at the Mortgage Bankers Association National Secondary Market Conference and Expo in New York City, panelists gathered to speak on the credit risk transfer market, predicting that the housing market would see more capital come into the space in the next three to five years.

In order to reduce risk for American taxpayers, Fannie Mae and Freddie Mac created programs that allow reinsurers to cover part of a loss in case of borrower defaults.

And these programs have performed well over 2017. In November, Fannie Mae closed its ninth and final risk transfer of the year, marking a total $5.3 billion of insurance coverage of about $220 billion in loans through its CIRT program.

And these investments will pay off for investors as the Federal Reserve continues to project three interest rate hikes in 2018, according to an article by Claire Boston for Bloomberg.

From the article:

Money managers piled into relatively new Fannie Mae and Freddie Mac bonds known as “credit risk transfer” securities in 2017 in part because they are floating rate, a boon when the Federal Reserve is projecting three rate hikes in the coming year. Investors who bought subprime mortgage bonds after the housing crisis for pennies on the dollar are now getting repaid about $80 billion of principal a year, and are looking to reinvest their funds somewhere.

“It’s been an incredible year for the space,” said Dave Goodson, who heads mortgage-backed securities and related bonds at Voya Investment Management, which manages $230 billion. “It’s becoming better and better established. We like that.”

Bank of America data shows the riskier credit-risk transfers returned more than 10% through December 1, 2017. Next year, portions of the bonds could return 3% on top of government debt, a Morgan Stanley analyst said, according to the article. These analysts say CRT bonds are the place to be in 2018.

From the article:

Investors buying these securities are among the first to suffer losses when homeowners fail to make their payments. But with unemployment at just 4.1 percent in November and the U.S. economy growing at an annualized rate faster than 3 percent, it seems reasonable to bet that prime borrowers will continue to pay their home loans, Goodson said. He prefers the securities to commercial real estate or corporate debt, which may face downturns sooner.

Article source:

Fannie Mae and Freddie Mac now allowed to hold $3B capital reserve

With tax reform set to go into effect next year, Fannie Mae and Freddie Mac faced a possible one-time Treasury draw due to the change in corporate tax rate and the zero-capital mandate.

The Federal Housing Finance Agency announced each government-sponsored enterprise is entitled to a $3 billion capital reserve. This can be used as a cushion against expenses, should they occur, such as the scenario listed above.

More details may be found in the agreement letter.

Here are the details as laid out in an announcement from the Treasury:

  • Fannie Mae and Freddie Mac will be allowed to maintain a capital buffer of $3 billion each.
  • The dividend payment owed to Treasury will be calculated each quarter using the $3 billion capital buffer as a baseline.
  • To compensate taxpayers for the dividends they would have received absent these letter agreements, Treasury’s liquidation preference for the Preferred Stock held in Fannie Mae and Freddie Mac will increase by $3 billion as of December 31, 2017.
  • Any failure by Fannie Mae or Freddie Mac to declare and pay a full quarterly dividend will result in the automatic, immediate termination of its capital buffer.

“The Federal Housing Finance Agency, as conservator of Fannie Mae and Freddie Mac, and the Department of the Treasury have agreed to reinstate a $3 billion capital reserve amount under the Senior Preferred Stock Purchase Agreements for each Enterprise beginning in the fourth quarter of 2017,” said FHFA Director Mel Watt. 

“While it is apparent that a draw will be necessary for each Enterprise if tax legislation results in a reduction to the corporate tax rate, FHFA considers the $3 billion capital reserve sufficient to cover other fluctuations in income in the normal course of each Enterprise’s business. We, therefore, contemplate that going forward Enterprise dividends will be declared and paid beyond the $3 billion capital reserve in the absence of exigent circumstances.”

Also in exchange for the capital cushion change, Treasury gets an additional $3 billion a piece in senior preferred stock as of December 31, 2017, according to Jim Vogel, analyst at FTN Financial.

“Bottom Line: This agreement delivers an acceptable win for both sides,” said Vogel. 

“FHFA gets some capital flexibility and reduces the potential headache of GAAP earnings fluctuations that could cause unnecessary, annoying draws that are likely to be repaid shortly thereafter,” he added. “Treasury moves this 2-yr, nagging issue off its agenda and gets to focus on newly stirring congressional efforts at GSE reform in 2018.”

Vogel isn’t alone in declaring the announcement as good news overall.

“The FHFA Director could have chosen to create a $3 billion capital buffer on his own. He had such authority in HERA. The fact that Secretary Mnuchin and the UST worked with him on this initiative is a big positive and a proactive statement that Treasury is now focused on the issue,” said Joshua Rosner, an analyst with Graham Fisher.

“The FHFA and Treasury just, jointly, told Congress: ‘We have heard you say the GSEs don’t need capital and argue that UST lines of credit are capital, we don’t agree. We are reversing the Obama Administration’s direction that they have zero capital beginning in 2018’.”

Article source:

Tax reform expected to go into effect immediately

The Trump administration tax reform package — just passed the House, on to the Senate — is widely expected to pass this week and the Treasury is indicating it will start accepting the new changes to paychecks in 2018.

“The president has said he is ready to sign tax reform legislation into law “within hours of passing,” touting tax cuts as a Christmas present for the American people,” predicts Lindsey Piegza, chief economist at Stifel.

Critics of the reform package say the burden will be too great to put the plan in place by the April deadline, but “Treasury Secretary Steven Mnuchin has suggested that the IRS will be ready to process the new tax forms in February and, in any case, the cuts will be back-dated to 1st January,” said Andrew Hunter, U.S. economist at Capital Economics, in an email to clients.

“Accordingly, our long-standing forecast that a fiscal stimulus would give a boost to GDP growth in early 2018 looks like it will prove to be correct,” he adds.

After 2018, Hunter predicts the economy will slow as the tax boost wears off and higher paid Americans chose to save their money instead of spending:

“Although there will be a modest stimulus in 2018, the bill could prove a drag on the economy further ahead. The 2019 repeal of the Obamacare individual mandate, which forces healthy people to buy insurance, would save the Federal government $340bn over a decade but also lead to higher premiums and a sharp rise in the number of uninsured Americans. The Republicans have promised accompanying legislation to stabilise the insurance markets but, with little progress so far, this could be a big drag on real health care spending over the coming years. This is further reason to think that, as the temporary boost from the tax cuts fades and higher interest rates start to take their toll, the economy will slow in 2019.”

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