How will Fannie and Freddie's buyout of severely deliquent loans impact your portfolio?

On February 10, 2010, Fannie and Freddie announced the repurchase of loans that were more than 120 days deliquent. FactSet Senior Financial Engineer, David Mieczkowski discusses how this will impact investors portfolios and the mortgage markets patterns at large. He examines whether the actions are unprecedented, how they will impact prepayment speeds, and more factors.

Read our show notes below for more details on our episode. 

You can also e-mail podcasts@factset.com to request David's white paper describing how FactSet modeled the potential impact of the repurchase program in detail.

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2:15 – Particularly the investors who were investing in Fannie and Freddie are used to higher credit quality products and less risk. There may be some backlash at this repurchase program.

3:25-4:00 – The action to repurchase serious deliquencies is not unprecedented. Ginnie Mae, for instance, has the option to buy back securities that become more than 90 days delinquent. What makes this action unusual is that it impacts prime borrowers and impacts a much wider pool  of mortgages.

5:45 – In the short term, investors could see a serious elevation of CPRs (conditional prepayment rate).

6:00-7:30 – Longer term this shortens the "conveyor belt." The new buyback program shortens the time it takes before a borrower is considered in default to just four months. Also, the economic incentive for Fannie and Freddie to repurchase 120-day deliquencies will continue into the future.

7:30 - Freddie says it will release its list of 90-day deliquencies so that investors could see the potential pool of severe deliquencies. Any new source of data is helpful to investors

8:00 – As the market recovers, the repurchase of 120-day deliquencies will cause prepayment speeds (due to involuntary causes) higher than they would have otherwise been. As cure rates rise, Fannie and Freddie will have even more reason to buy delinquent loans.

9:15 – For FactSet and investors, modeling the impact of the repurchase program is a difficult process. Essentially you're modeling a one time event. At FactSet, we were able to shock the prepayment speed vectors. For Freddie, who instituted buying throughout February, this showed higher CPRs.  Higher coupons were particularly affected.

10:40 – FactSet also projected CPRs for the next three months for Fannie Mae. The highest impact was predictably seen in the first month, with less and less impact over the next four months, after which time the impact to CPR would be essentially nothing.

13:00 – While there are many mortgages in default, for a index-level view or in a well diversified portfolio the impact of deliquency repurchases will be small. Duration will likely shift, based on FactSet's models, about one tenth of a year. Option-adjusted spread may adjust slightly as well.

14:45 – One positive impact of the repurchases by Fannie and Freddie will be that they will inject more than $100 billion of cash back into the MBS market. Managers will most likely want to reinvest quickly, injecting more money back into the market. This may effectively extend the impact of the Fed Agency MBS repurchase program, which was due to expire in March.