The market for “private-label” mortgage-backed securities stopped two years ago when rising defaults destroyed investors’ appetite for the bonds. But is sentiment starting to shift?

The answer may come soon. According to securities analysts, some underwriters on Wall Street are discussing the possibility of bringing small quantities of private-label mortgage securities to market within a few months. The first such sales are likely to consist of securities backed by high-quality jumbo mortgages, loans too big to be backed by government agencies.

The securitization market “for newly originated mortgage loans is getting closer to reopening” says Tom Deutsch, executive director of the American Securitization Forum, an industry group. Bryan Whalen, a managing director at Trust Co. of the West, says Wall Street dealers have been having “hypothetical” chats with investors about possible deals. Mr. Whalen estimates that the first offering could perhaps total $250 million to $500 million and debut during the first quarter of this year.

Historically, most mortgage securities were issued or backed by Fannie Mae, Freddie Mac and the Federal Housing Administration. But during the housing boom, investment banks and mortgage banks dove into the market and began issuing their own brand of mortgage-backed securities. These private-label mortgage securities were often backed by riskier loans, including subprime mortgages and loans made to borrowers who didn’t not fully document their income and assets.

At the peak of the housing boom in 2006, private-label mortgage securities accounted for 56% of the $2 trillion in mortgage securities sold to investors, according to Inside Mortgage Finance, an industry publication. But the private-label market has been almost dead since the third quarter of 2007. Virtually all mortgage securities now offered are those backed by government agencies, and demand for those securities has been so tepid that the Federal Reserve has become the largest buyer.

But there are indications that some investors are ready to take a second look. Tom Capasse, a principal with Waterfall Asset Management LLC, notes that there is a dwindling inventory of private-label securities in the secondary market that sets the stage for new issues. Any deal would mark a milestone for efforts to reduce the mortgage market’s current dependence on government coverage of default risks.

Credit-rating firms say they have been requested to review several potential deals, which comprise of fixed-rate loans and mortgages that carry a fixed-rate for the first few years. “People are trying to test the waters,” says Linda Stesney, a managing director at Moody’s Investors Service, who says there has been an increase in inquiries from potential issuers of mortgage securities, including big banks and Wall Street firms.

Even if the market’s first offering is successful, it isn’t likely to trigger an instant flood of new issues. One limiting factor is that lenders aren’t originating large numbers of nongovernment-backed mortgages. The maximum size of “conforming” loans—those that can be sold to Fannie Mae or Freddie Mac—has risen to $729,750 in the priciest housing markets, up from $417,000 during the housing boom. That means that most home buyers can get a conforming loan rather than a jumbo mortgage, which carry higher interest rates. Sales of higher-end homes in many markets have been sluggish, further reducing the supply of mortgages tied to the homes.

In addition, investors are likely to demand “super-clean credit,” further lowering the supply of loans eligible for packaging, says Chandrajit Bhattacharya, a mortgage strategist at Credit Suisse Securities. He expects average credit scores to be around 750 and borrowers to have 30% to 40% equity in the property.

Another obstacle is pricing. Some analysts believe the yields needed to attract buyers will possibly be too high to make the transactions profitable for lenders. At current rates, “you can’t profitably originate new jumbo mortgages … sell off the pieces and securitize it profitably,” says Laurie Goodman, a senior managing director at Amherst Securities Group. Rates on jumbo loans currently average 6%, according to HSH Associates.

To be eligible for purchase by many insurers, pension funds and mutual funds, any new deal would need a big slice of bonds with triple-A ratings.

But ratings firms are still facing some key questions. One is “has there been a psychological change in the U.S. borrower that will make them more readily walk away [from their mortgage] in the future,” says Huxley Somerville, a group managing director with Fitch Ratings. If borrowers are more likely to walk away, any deal would have to be structured to protect against higher expected losses. Another open question is how much more home prices are likely to drop over the next few years.

In reviewing new deals, Standard & Poor’s says it will also look at the lender’s past performance, management and organization. Pools will also be sampled by third-party quality-control experts.

While a triple-A rating may be necessary to get a deal off the ground, investors are also seeking more details on the quality of underlying loans. “In the old days, the ratings agencies drove the looks of those deals,” said Edward Gainor, a securities lawyer in Washington, D.C. “In the post-collapse world, the investors will very much be at the table.”

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jumbo mortgage · subprime mortgages

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