30 Seconds or Less…

To get a jumbo mortgage (over $510K & up to $3M) in this market, your best chance is to go directly to a big mortgage bank like Wells Fargo, Bank of America or Chase, (just to name a few.)  What happened to the thriving jumbo market? Lack of Liquidity!

• Only 1 out of every 10 mortgages can be a high cost loan (up to $ 765,500) in an Agency Bond
• Demand for non-Agency Bonds is way down with the Flight-to-Safety
• Prudent portfolio management puts limits on how much of each asset type can go on balance sheet
• Traditional jumbo loans and non-Agency bond investors like REITs and Hedge Funds are facing major liquidity problems and even bankruptcy so their demand is gone

Wells Fargo announced last week that they have stopped buying jumbo loans originated by others in a move to ensure they have enough portfolio capacity to support their clients.

IN THE WEEDs –

Let’s step back and digest what this means…

When the talking heads on TV say the U.S. Mortgage Market is working they are typically talking about agency residential mortgage-backed bonds (Agency Bonds or Agency RMBS). We touched on this a bit last week. These bonds carry either an implicit or explicit government guarantee. Under Federal Housing Authority (FHA) which is an arm of the U.S. Government, Ginnie Mae explicitly guarantees the timely repayment of principal & interest of the mortgage-backed bonds with the full faith and credit of the U.S. Government. Ginnie Mae focuses their support on low-income, 1^st time home, and Veteran homebuyers. Freddie Mac, Fannie Mae, and the Federal Home Loan Banks who support the broader mortgage market within the GSE limits carry an implicit guarantee as they are Government-sponsored enterprises (GSEs) chartered by the U.S. Department of the Treasury and are specifically limited in their scope of business in exchange for access to Treasury lines of credit. Since the Financial Crisis of ‘08, both Freddie Mac and Fannie Mae have been controlled by the Treasury. Based on past actions, the market expects that Fannie Mae, Freddie Mac, and the Federal Home Loan Banks will pay the investors timely who have bought their bonds and will be supported by the Treasury as needed.

For loans to be agency eligible or conforming loans, the loan size can only go up to $ 510,000 or $765,600 in certain high-cost areas like Hawaii, parts of California, New York City, etc.  BUT, and it’s an important BUT! Only 10% of an agency bond can include these high-cost mortgages loans. That is only 1 out of 10 loans can be high-cost. That’s not much when you are looking at major metropolitan areas!

Consequently, the Jumbo Mortgage Market was created.  Here are the basics of that market:  

What is a jumbo mortgage? Jumbos are defined as any loan above the standard GSE limit which changes annually based on home prices. Typically, the jumbos are between $510K and $3M. Super Jumbo loans refer to loans in the $10M to $20M range. 

What does a borrower of a jumbo look like?  These borrowers are high quality borrowers with a fair amount of disposable wealth. They have high credit scores, are required to put down at least 20% or more of the total property value, have other assets and generally have a high number of months cash reserves to draw on in times of stress. 

What happens to jumbo mortgages after origination?  Most originators sell the jumbos to be securitized or held in portfolio.

Who invests in jumbos? Real Estate Investment Trusts (REITs), Hedge Funds, Investment Portfolio Managers, Big Banks and Large Servicers.  (And let’s not forget that many of the REITs and Hedge Funds have major liquidity issues and have been selling everything!)

What do the buyers do with the loans?  A few investors simply hold these loans in portfolio and collect the monthly principal & interest (P&I) payments. Some banks hold them in portfolio, opportunistically. That means they like the returns of P&I payments while the loans sit in their portfolio and then when the credit markets are favorable, they will sell pools of the jumbo loans or issue a non-agency bond. These sales or bond originations free up balance sheets or portfolio capacity to originate more jumbo loans. 

Many players in the jumbo market buy pools of jumbos with the sole intention to create their own Residential Mortgage-backed Bonds (non-Agency bonds or RMBS). These non-Agency bonds are like Agency Bonds in that they pay principal & interest based on the underlying mortgage collateral except they don’t carry the guarantee of repayment. In most of these bonds, the company servicing the loans (collecting payments and holding the mortgage note) is required to pay principal and interest (P&I) based on expected cash flows which is called a servicing advance. Advances are to be made by the servicer until it’s clear that the loan can’t be collected and is heading for foreclosure. Therefore, all of this talk of forbearance plans hits the servicer’s pockets as they have to advance the P&I because the payments will be collect at some point. This reduces the value of the servicing asset as well as causes potential liquidity concerns. The mandatory state stops on foreclosures hit the investors’ pockets as they will be out the interest for the delay period and are subject to the increased risk of principal loss from poor house sales.

So before you get too worried about the bond investors, non-Agency bonds are generally structured from AAA, AA, A to BBB. The lower bonds (BBB or even BB) are intended to take the losses and protect the AAA and AA bond holders. Even so, these bonds are not designed for an Economic Shut Down, as we’ve never seen it before. Consequently, we saw a Flight-To-Safety where investors are shunning non-government bonds for Treasuries and Agency Bonds. The few remaining investors are demanding very low prices to take the extra risk to buy these bonds.

Where’s the Fed in all this?  Up to this point, they have been silent on this piece of the market. It is believed that 25% to 50% of all mortgage borrowers (Agency & NonAgency) may apply for forbearance plans.  (American Action Forum 4/1) The Federal Reserve is clearly aware of non-bank servicer liquidity concerns across the entire mortgage market (not just jumbos) and is monitoring the situation. (Servicers owned by banks have already been given access to liquidity.) A special taskforce called the Financial Stability Oversight Council (FSOC) has just been established to tackle these non-bank liquidity concerns.

What to do if you need a jumbo mortgage? Call around!

Final note: While this article focuses at jumbo mortgages, the same is true for anything that’s not considered a plain vanilla mortgage like High Balance Loans (very low down payments) etc.

I hope this helps explain what’s up. It was a specific request so please send in more requests or questions!

As always, stay healthy, help those around you, and be your amazing self!  We will get through this crisis. We will lead our families and our teams calmly through this.  #BeTheCalm!!! #Leadership!!!

Stay Healthy! Susie

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