Hot U.S. Housing Bonds Are Getting Riskier as Investors Pile In

By Anthony B. Sanders

Examples Of Fannie Mae Credit Risk Transfer Notes

(Bloomberg) — Riskier U.S. mortgages are creeping back into the bond market again.
The loans in question are nowhere near the toxic mortgages that brought down the financial system last decade. But they’re being made to people with lower credit scores and with more debt relative to their income. And in separate transactions tied to rental homes, Wall Street banks are putting together securities with fewer safeguards for investors — a potentially worrying sign of complacency.

If the housing market weakens, and unemployment starts rising, mortgage bond investors could find their securities losing value, money managers warn.

“Underwriting starts out very strict and as time goes on, it’s kind of the proverbial frog in the pot of boiling water,” said John Kerschner, head of securitized products at Janus Henderson Group Plc, which manages $372 billion. “The heat keeps going up and up and then you realize, oh, this is really not good.”

The bonds linked to increasingly risky loans are known as credit-risk transfer securities. They are tied to mortgages that don’t have government guarantees, but that meet the minimum standards from U.S. backed-Fannie Mae or Freddie Mac, including down-payment requirements for borrowers.

riskybusiness

The borrowers are prime, and Fannie Mae and Freddie Mac essentially bundle the risk of the homeowners defaulting into the bonds so taxpayers don’t have to bear it. Measures of borrowers’ strength can decline due to changes in demand and banks’ and lenders’ underwriting, separate factors from Freddie Mac’s and Fannie Mae’s credit decisions.

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