Bank of America/Merrill Lynch (BAML) is cautioning its institutional investors against being unsettled by the announcement last week of development of a potential common securitization platform for Fannie Mae and Freddie Mac mortgage loans.  In an Agency MBS Alert the Bank said that the decision by the Federal Housing Finance Agency (FHFA) to begin work on such a structure appears to have sparked investor fears about potential market disruptions but instead could be useful "in a wide variety of future frameworks."

FHFA's Acting Director Edward J. DeMarco announced in a speech on Monday that the agency, which acts as conservator for Fannie Mae and Freddie Mac (the GSEs) would be establishing an independent entity to implement a new securitization structure to replace the existing GSE platforms.  The new entity, which would be initially funded and owned by the GSEs, is an outgrowth of the agency's 2012 Strategic Plan for the GSEs.

BAML said the initial headlines about the new entity aroused fears that there might be a near-term phase-out of existing agency MBS securities in favor of some new universal MBS security or that the two GSEs might be merged with potential negative results for MBS and debt markets.  The bank said these fears, in their view are unwarranted.  "We do not expect any changes in the next several years to the securitization framework or to the structure of Fannie and Freddie. And in fact, we believe there is a significant probability that a common securitization platform may not materialize at any time in the future."  The Alert however said it does see "a vision for the future of housing finance which shifts away from the guarantor-centric model that has so far prevailed."

Congress has taken no action on GSE reform so FHFA has taken steps to determine how best it can define its own mission as conservator.  In 2010 DeMarco identified loss mitigation as the central purpose along with reducing the retained portfolios as mandated in the stock purchase agreements with the Treasury Department.  By early 2012 this had evolved into the Strategic Plan with a "Build, Contract, Maintain" theme.  The "Build" component included developing a new infrastructure for the secondary mortgage market; a need which had become clear because implementing new programs was both costly and time, especially as each GSE had its own system with its own time frames, costs, and challenges.  With the GSEs still at the center of mortgage finance for the foreseeable future it was clear that developing a single system would be more cost effective than separate systems and it made financial sense to modernize the structure in a manner that could be used into the future even if the GSEs were no longer around.

BAML says the development of a single securitization platform does not imply the development of a single MBS security. The markets and the press came to this conclusion but it is not part of the Strategic Plan, "and in fact contradicts the purpose of the Build component, in our view."

The bank says that a merger of the GSEs might well be part of a reform package from Congress but it is not part of the FHFA Strategic Plan, and a single MBS security is not what FHFA aims to achieve.

The "Contract" goal of the Strategic Plan was aimed at reducing the retained portfolio and the dominant GSE footprint in the market and is being achieved by slowly raising the guarantee fees to encourage private participation in the market.  Bringing private capital back is a bipartisan goal.  Banks might also decide to retain loans to share in the profits the GSEs currently earn and a single securitization platform could aid in this shift, especially if it allows the GSEs to sell parts of their credit risk.

The "Maintain" goal represents the core focus on loss mitigation and foreclosure prevention, but also includes credit availability.  This may result in an extension of the HARP expiration date beyond 31 December 2013.

The Alert says that the Build, Contract, and Maintain sections of the February 2012 plan have become parts of strategic goals to establish standards for a safer and more efficient housing finance system and maintaining stability, liquidity, and access to mortgage credit.  Thus, disrupting the mortgage market by eliminating one of the GSE issuers would defy several of these strategic goals and  the task of building new infrastructure is now explicitly categorized as preparation for future housing finance, rather than a plan to potentially change or disrupt today's mortgage markets.

The Bank cautions that there are many reasons why the new structure may not even happen.  The Strategic Plan has been developed by the current FHFA acting director of the FHFA and is not law.  If or when a new director takes over, the more ambiguous interpretations of FHFA's role, such as designing a Common Securitization Platform, could be scrapped.  As the CSP plan is still in its earliest stage, eliminating it could be considered a cost cutting move; alternatively the government could create incentives for the private market to develop one, or enter into a joint venture with the private side to do so.

There are many questions about the CSP such as ways to set uniform standards without impacting competitiveness and how a CSP will balance between the interests of the government, borrowers, securitizers, rating agencies and investors?

BAML concludes that even if work continues on the CSP the goal is not to create a single security or disrupt the market.  Any merger of the two GSEs would likely be at the discretion of Congress and would be, at this stage, both complex and costly