(Bloomberg) - The loans that are bundled into government-backed mortgage bonds are getting supersized as homes grow more expensive, a change that could weigh on the performance of the securities next year.
The Federal Housing Finance Agency said last week that loans that can be bundled into agency mortgage bonds can be as big as $647,200, an increase of nearly $100,000 from the year before. While that limit rises annually based on average U.S. home prices, it’s the largest ever increase in absolute and relative terms.
“Home price appreciation is the foundation of why loan sizes are getting larger, mostly underpinned by lower rates, as well as the strong economy,” Michael Khankin, head of MBS research at Barclays, said in an interview.
But there are other factors contributing to the larger average loan sizes. For one thing, the Fed has started tapering its buying in the mortgage-backed securities market, already reducing its outright monthly purchases to $35 billion from $40 million.
The Fed tended to buy securities with higher average loan sizes compared with the rest of the market, so as it scales back purchases, the mortgage sizes in bonds available to investors will probably grow, Erica Adelberg, an analyst at Bloomberg Intelligence, said in a Dec. 3 report.
Lastly, with economists and markets broadly anticipating higher interest rates next year, refinancing will likely account for a lower percentage of lending volume in the near term, and loans for home purchases will probably account for more.
“Unlike refis, purchase loans are inherently tied to home prices, and they are quite a bit larger than refi loans now given the home price appreciation we’ve seen,” said Barclays’ Khankin. “If rates were to back up, you’d see the share of purchase loans grow in the market, and the loan sizes would grow as well.”
There have been torrid home-price gains in the U.S. this year, even though the growth rate is starting to slow a bit. Nationwide, prices climbed 19.5% in September from a year earlier, according to the most recent data available from the S&P CoreLogic Case-Shiller index. Completed purchases of existing homes are on track to exceed 6 million in 2021, the most in 15 years, according to the National Association of Realtors.
Prepayment Risk
Bigger loans make mortgage bonds riskier for investors. When homeowners have larger loans, they become more likely to refinance even with relatively small declines in interest rates, because the monthly savings in dollar terms is greater than it would be for a smaller loan.
That tendency for borrowers to refinance sooner means that mortgage bond prices gain less when interest rates fall, compared with other, less convex notes like Treasuries. Higher average loan sizes could translate to wider spreads on mortgage backeds next year, BI’s Adelberg wrote. In other words, the securities might underperform Treasuries.
One byproduct of overall larger loan sizes is that smaller loans with better prepayment characteristics, such as loans for $275,000, may get carved out of pools that are based on generic characteristics like the coupon rate, known as TBA pools. They might instead be securitized in specified pools, Khankin said, where investors pay up to identify specific loan characteristics they want. That could result in TBA pools having even larger average loan sizes, he added.
Relative Value: Agency MBS
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With prospects for an accelerated Fed taper rising, Goldman Sachs Asset Management has increased its underweight exposure to the sector, strategists said in GSAM’s latest weekly research note
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Looking ahead, agency MBS issuance volumes in 2022 are likely to be lower relative to 2021, but not low. Still-high new supply coupled with reduced Fed buying informs the analysts’ underweight position, they noted
Quotable
“Multifamily housing continues to benefit from significant changes in terms of the increased demand for rental housing, coupled with a lack of supply, and demographic trends, such as the growing population of people over 80 years of age and their need for senior housing,” David Brickman, CEO of NewPoint Real Estate Capital and former CEO of Freddie Mac, said this week. “Multifamily is a hotspot, broadly, in commercial real estate.”
What’s Next
Deals in the queue include Santander (prime auto-linked ABS) and Cologix (data center ABS)
By Adam Tempkin
