New Appetite for Mortgage Bonds That Sidestep Fannie and Freddie - WSJ

Wall Street is diving back into the business of turning home loans into bonds, injecting new competition into a market long dominated by government-backed mortgage giants Fannie Mae and Freddie Mac .

The so-called private-label mortgage market—in which financial firms serve the middleman role of creating giant pools of loans and selling them to investors—had more than $42 billion of issuance in the second quarter. That is the most since the pandemic started and almost the most for any quarter since the last financial crisis, according to Inside Mortgage Finance, an industry research firm.

This market still made up a mere 4% of all mortgage bonds issued last quarter. Fannie Mae and Freddie Mac, which issue bonds that come with a federal guarantee that investors will get paid, remain the industry’s dominant players.

But mortgage investors expect the private market to keep growing as a repository of loans that Fannie and Freddie can’t or won’t purchase, such as those tied to investment properties, super-expensive homes or self-employed borrowers. Recent issuers include Goldman Sachs Group Inc., Morgan Stanley and JPMorgan Chase & Co., as well as a growing array of banks and real-estate firms.

As it has become more liquid in recent months, the private-label market has piqued the interest of more money managers, who are searching for yield in an era of rock-bottom rates. Private-label securities typically offer higher yields than those issued by Fannie and Freddie since they don’t come with a government guarantee that investors get paid.

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“Because of the growth in the market and the growth of issuance, they view it as a viable market,” said Mike Fania, head of residential credit at Annaly Capital Management Inc., the largest mortgage real-estate investment trust by market value. The firm has issued five private-label bond deals this year and has logged higher demand for them than in the past.

There also has been more supply of new loans, partly because Fannie and Freddie have curtailed some business. Earlier this year, they capped their purchases of mortgages tied to second homes and investment properties. That has made it tougher for lenders to sell these loans to the government-backed giants. Instead, many lenders are selling them to Wall Street firms or creating their own mortgage bonds instead.

Lenders also have restarted making loans that don’t conform to the standards Fannie and Freddie require. Some use alternative documentation, such as bank statements instead of pay stubs, to verify borrowers’ income.

These kinds of loans are sometimes used by self-employed people and small-business owners whose incomes can’t be verified using standard measures. Michael Buck, who owns a wallpaper-hanging company in Hurst, Texas, completed a refinance last month with Griffin Funding Inc., which used his bank statements to approve him.

The mortgage firm looked at 24 months of his banking history, which showed income going into his account even though he doesn’t draw a regular paycheck. He closed on a loan with an interest rate of 3.625%, down from the nearly 7% he was paying previously on a bank-statement loan he had taken out before the pandemic. He said it will save him hundreds of dollars a month.

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“You still have to earn it just like a traditional loan. If you don’t have those deposits and you can’t prove it, they are not going to give you the loan,” Mr. Buck said. “If you can prove it, you can get a piece of the pie just like I did.”

Such loans were hard to come by in the wake of the financial crisis of 2008-09. When mortgages soured across the country and tanked the economy, investors took heavy losses on loans with alternative documentation. For years afterward, many deemed the loans too risky.

nascent revival in 2019 and early 2020 came to a halt when the pandemic hit and investors retreated from risk.

Delinquencies among these unconventional loans rose in spring 2020 along with other types of mortgages, but fell as time wore on. Less than 6% of mortgages that use alternative documentation were delinquent as of last month, not much higher than pre-pandemic levels, according to Chris Helwig, managing director at Amherst Pierpont Securities LLC.

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Their performance has given investors confidence that the loans are higher-quality than the type issued before the 2008-09 crisis, analysts say.

Investors’ increased willingness to invest in the market has channeled more capital to lenders such as San Diego-based Griffin Funding. The firm stopped making loans that use alternative documentation in spring 2020 and stuck to government-backed mortgages instead, according to Chief Executive Bill Lyons.

But Griffin restarted alternative-documentation loans recently; now they are about one-third of its business. “We finally caught momentum,” Mr. Lyons said.

Write to Ben Eisen at ben.eisen@wsj.com

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