By the Numbers
The impact of higher agency loan limits on PLS issuance
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.
Growth in the prime private-label MBS market should get a challenge next year from substantially higher conforming loan limits. Nearly unprecedented year-over-year home price appreciation may lift conforming and jumbo conforming limits by nearly 20% next year, giving Fannie Mae and Freddie Mac purview to purchase loans with balances close to $1 million in certain high-cost areas. The potentially new reach of the enterprises could weigh on private issuance, although that will likely hinge on how the GSEs choose to price guarantee fees for larger loans.
The growth in private-label issuance this year has been fueled in no small part by a flow of agency-eligible loans into private-label trusts. But the GSEs could be taking some of that share back next year. FHFA has already lifted the caps on the amount of non-owner-occupied loans that the GSEs can purchase and will likely use risk-based pricing on those loans rather than hard limits on purchases to govern GSE originations going forward. A big bump in the original balance of loans that the GSEs can purchase may further encroach on private-label issuance next year.
As of June, FHFA’s Home Price Index was up roughly 12% over the prior June reading. A more recent CoreLogic reading has home values up 18.1% year-over-year through August. Assuming FHFA’s measurement is roughly in-line with Core Logic estimates, conforming and jumbo conforming loan balances could rise close to 20% next year. An 19% increase in balances would push the conforming limit next year to nearly $650,000 and the limit for high-cost areas, which is 150% of the conforming balance, to nearly $1 million.
Exhibit 1: Home price appreciation may push limits on GSE eligible loans to nearly $1 million
Source: FHFA, Bloomberg LP
There is a very small possibility that FHFA may not raise loan limits to the full extent allowed. The impetus for a smaller increase would be primarily due to safety and soundness concerns, which historically has been an area of focus for acting Director Thompson. However, the higher probability event appears to be that FHFA will increase loan limits in accordance with the rise in home values.
Sizing the impact of loan size changes
The headline impact of increasing loan limits on the $30 billion of prime loans securitized in private trusts this year would be massive. Over two-thirds of loans securitized in PLS trusts this year had balances less than $1 million. However, the real impact is likely far more subtle as this does not consider whether the loans would qualify for the high-cost limit. Sponsors of securitizations do not uniformly disclose whether loans are agency-eligible, and ZIP code data is often not available at the loan level. Classifying a loan as conforming or conforming jumbo relies on some higher-level assumptions. Based solely on original loan balance, the number of units and state-level geography, some assumptions can be made as to whether a loan would qualify for a conforming jumbo balance. However, this methodology will likely overstate the amount of loans that would qualify for the higher limit as the home may not be a high-cost area of a given state.
A 19% increase in both conforming and conforming jumbo limits would unsurprisingly shift the mix of conforming, jumbo conforming and non-conforming loans securitized in private trusts this year somewhat materially. Based on existing limits, over two-thirds of loans securitized in private trusts were non-conforming. A 19% increase in GSE loan limits would reduce that number to just below 50% (Exhibit 2).
Exhibit 2: Higher loan limits shift the mix of agency-eligible loans in PLS trusts
Note: Data show prime jumbo private-label securitizations YTD for 2021. The “2021 Limit” shows the current mix. The “2022 Estimated Limit” shows the mix that would prevail if projected higher agency loan limits applied to 2021 YTD production.
Source: CoreLogic, Intex, Amherst Pierpont
FHFA and the administration by proxy will likely face a balancing act between the negative optics that come with providing financing for million-dollar single-family homes and the valuable guarantee fee income associated with those loans, which could be used to cross-subsidize affordable housing. One potential solution would be to increase guarantee fees on higher cost homes either in the form of a broad-based incremental delivery charge or a loan level pricing adjustment. The question of whether to raise charges on higher balance loans does not appear to be a front-burner issue but could come into focus early next year. And increasing fees on higher balance loans would itself be somewhat of a balancing act. A material uptick in the cost of financing for more creditworthy borrowers would likely push more of those loans to private-label channels especially among larger originators with existing ability to tap the private-label market.
Most jumbo conforming loans still get better private-label execution
While the population of loans eligible for GSE delivery looks poised to grow, better private-label execution may stem the flow of higher balance loans to the GSEs to some extent. Assuming a 2.5% pass through execution at $1-16/32s behind the UMBS benchmark, nearly 80% of conforming jumbo loans delivered to the GSEs in August of this year would have fetched at least a quarter-point higher price through private-label execution. If private-label pass through spreads were to widen by an additional half point it would only change best execution economics for 8% of those loans as nearly 70% of August’s conforming jumbo production would have still achieved a higher price, had they been delivered into private-label execution (Exhibit 3).
Exhibit 3: Conforming jumbo loans may still get better private-label execution
Source: eMBS, Fannie Mae, Freddie Mac, Amherst Pierpont
Recently spreads across lower coupon conforming jumbo specified pools have tightened dramatically against TBA benchmarks, driven by a lack of supply as originators are likely holding back production to deliver into higher limits for forward delivery next year. And as a result, GSE execution may be moderately better than the analysis may suggest. However, as the supply technical abates, spreads on conforming jumbo pools should widen back out, and if they do, many conforming jumbo loans may still achieve better prices by being sold to private-label conduits.
GSE pricing will also weigh heavily on the impact of higher limits on private-label supply. One of the big drivers of private-label execution this year was the 50 bp Adverse Market Delivery Charge that the GSEs applied to all refinances. That blanket charge expired earlier this year. However, the removal of that charge did little to impact best execution on conforming jumbo loans as the above analysis shows. Additionally, and potentially more significantly, the jumbo conforming loans analyzed already carry an average of one point of LLPAs. If FHFA were to apply a broad-based LLPA increase to all conforming jumbo loans that would further improve private-label execution on a cohort of loans where most of them are already better executed in the private-label market. As a result, higher LLPAs on these loans would likely be the biggest reason why private-label volumes may remain elevated next year despite higher GSE loan limits.
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