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New FHFA proposal could slow the creation of specified pools
admin | November 8, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
The Federal Housing Finance Agency wants to narrow the range of prepayment behavior across Fannie Mae and Freddie Mac MBS by changing pooling practices. This is the implication of a November 4 agency request for input on a proposal that could slow the creation of specified pools.
The FHFA’s goal
The FHFA would like to eliminate the issuance of single-lender pools that trade with no price premium to TBA. These pools often include loans with potential to prepay worse than large multi-lender pools since smaller pools are more susceptible to anomalous prepayments. Certain lenders also may have business practices that encourage fast prepayments. Unusually fast or slow single-lender pools often become the cheapest-to-deliver for TBA, lowering the TBA price. Loans backing pools with no premium to TBA instead would go into the large multi-lender pools created monthly for each 15- and 30-year coupon. This would eliminate the cheapest-to-deliver tail of the market.
Issuers would still be able to create pools backed by loans that do command a price premium to TBA, such as loans with lower loan balances, lower FICOs or located in places such as New York, Texas or Puerto Rico. These single-lender pools presumably would be eligible for TBA, although the proposal is unclear.
If a lender’s pools performs significantly worse than average, the GSEs would have the ability to force that production into non-TBA-eligible single-lender pools. Freddie Mac already does this with their Alignment Overflow pool program. The RFI seeks input on how this should be quantified.
The FHFA proposal suggests a specific waterfall for pooling loans:
- Lenders would be incentivized or required to deliver the vast majority of production into generic multi-lender pools. FHFA anticipates 70% to 80% of each month’s TBA-eligible issuance would end up in these pools.
- The remaining 20% to 30% of TBA-eligible production would go into permitted specified pools. These pools would all have prepayment characteristics that cause the pools to trade at a pay-up to TBA and would pose little to no risk of polluting TBA pricing. It appears these pools would remain TBA-eligible, although the document is a little unclear.
- The GSEs, on a case-by-case basis, could require some or all of a lender’s production to be placed into non-TBA-eligible single-lender pools. This would permit addressing anomalous prepayment speeds that would be detrimental to TBA pricing when included in the multi-lender pool.
Definition of a specified pool
A significant difference in the proposal from current pooling practices is that the FHFA and GSEs would define the pool characteristics allowed into specified pools. The RFI mentions loans with a maximum loan size of less than $200,000 and other common specified pool types created today. However, the RFI does not discuss how new specified pool types would be added. For example, the market is already seeing the creation of pools with a maximum loan size of $225,000. These innovations can occur rapidly in the current mortgage market, and requiring pre-approval would likely slow or eliminate this type of innovation altogether.
Comparison to Ginnie Mae
The FHFA’s proposal has some similarities to the Ginnie Mae II program. Ginnie Mae issues one large multi-lender pool per-coupon and product each month. Only these pools are eligible for TBA delivery. Single-lender pools must be issued in the Ginnie Mae II custom program—although this can also be done through the infrequently used Ginnie Mae I program—but these pools are not TBA-eligible. This approach means Ginnie Mae does not need to prescribe what custom pools are permissible. Moreover, a lender is unlikely to create a bad pool since investors won’t buy it, and it cannot be delivered to satisfy a short TBA position.
There is a downside to this approach. Ginnie Mae’s specified pool volume is significantly lower than the GSEs’. The GSEs issue 30% to 40% of TBA-eligible pools as specified pools, but specified pools account for only 10% of Ginnie Mae’s production. This is because Ginnie Mae custom specified pools are not TBA-deliverable, which makes it more difficult for pool investors to own and hedge the pools.
The GSEs want to maintain TBA-eligibility for specified pools, but this means they would need to actively prevent the issuance of poor performing single-lender pools. They propose to do this by pre-approving only certain specified pool characteristics.
FHFA is taking comment on the proposal until December 19.
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