Global Investing 411 Your #1 Source for Investing Info!

All Mortgages Aren't Created Equal

11/06/2007

An Interview with Didi Weinblatt

With the housing market in an extended slump and subprime mortgages causing a global credit crisis, it stands to reason that now would not be a good time to invest in mortgage-backed securities. However, some mortgage-backed securities such as Ginnie Maes more than held their own in the third quarter. To understand what is going on, we spoke to Didi Weinblatt, portfolio manager of the USAA GNMA Trust.
MarketWatch

Keep track of the latest market news.

USAA: Didi, if U.S. mortgage-backed securities are seen as one of the biggest problems facing global financial markets, causing a near meltdown in July and August, how was the USAA GNMA Trust up 2.51% in the third quarter?

Didi Weinblatt: To understand what happened, we need to distinguish between agency mortgage-backed securities and non-agency mortgages. Agency mortgage-backed securities are pools of mortgages issued and guaranteed by one of the housing agencies — Fannie Mae, Freddie Mac, or Ginnie Mae. Created by Congress many years ago to support home ownership, these organizations have done an excellent job.

These agencies all have strict underwriting standards for mortgages they will guarantee. For instance, homeowners must:

* Verify their income
* Payments can't be more than a certain percentage of income
* There has to be a down payment
* Taxes and insurance payments are escrowed
* There are no pre-payment penalties
* If they are adjustable rate, there is a cap on how much the payment can adjust upward.

Because these are government-sponsored agencies, they can borrow from the capital markets at very low rates, and hence they tend to offer homeowners lower rates.

In effect, agency securities are what most Americans would think of as traditional mortgages — you don't get one unless you prove you can pay it, and the terms are clear and fair.

And best of all, from an investor's point of view, the agencies pay the principal and interest payments even if the homeowner doesn't. In the event of a default, the investor receives the principal amount of the mortgage.

USAA: What about non-agency mortgages?

Didi Weinblatt: Well, being non-agency doesn't make a mortgage bad. For instance, there are caps on how big a loan the agencies will guarantee. If a prime borrower needs a mortgage for over $417,000, it would have to be what's called a jumbo loan. Then, there are loans to non-prime borrowers, or what’s called subprime loans. These grew from 6% of all mortgages issued in 1995 to 22% in 2006.

USAA: What's so bad about subprime?

Didi Weinblatt: Again, nothing is inherently wrong with a subprime loan – it's simply a loan made to a lower-income borrower. Unfortunately, during the housing boom many subprime lenders totally gave up on having any lending standards. There were investors waiting to buy the loans and people wanting to enter the home market.

Much of this demand was based on the belief that home prices would keep rising. Subprime lenders developed what they called "affordability" products for subprime borrowers. They gave mortgages to people who made no down payment and therefore had no investment in their homes. They did not require people to verify their income. Many of these mortgages had low initial teaser rates, which after some period would reset at much higher rates that the borrower would have no hope of paying. The only way that most of these mortgages could possibly be paid would be for housing prices to keep rising, which would allow the homeowners to refinance. Some mortgages were also given to investors who hoped to flip the homes for a profit.

As long as home prices kept rising, everyone was happy. As we now know, once housing prices stopped rising, these mortgages were doomed.

USAA: So if you're an investor in agency mortgage-backed securities, there's no problem in terms of your investment?

Didi Weinblatt: Right. The problem is with the subprime mortgages. There are also many adjustable-rate subprime mortgages that will reset in the coming months, and the homeowners won't be able to pay.

USAA: Why is this such a big problem? It seems like investors took on risk to get a higher interest rate, and people took on mortgages they couldn't afford.

Didi Weinblatt: Well, it's certainly frustrating for a lot of people. But the sheer volume of potentially problematic subprime mortgages could cause credit markets to seize up. No one is quite sure of exactly how much exposure big banks and other financial institutions have on their books. We need these institutions to be solvent and to continue making credit available to businesses and consumers. If credit stops being available, it could take the economy into recession.

USAA: Is there any other impact on Ginnie Maes and other agency mortgage-backed securities?

Didi Weinblatt: The issue facing the agency mortgage-backed securities market going forward is one of increased supply in the markets now that competing products have all but disappeared. We believe that the agency market will readily absorb the increased issuance since it is coming at the expense of the non-agency markets.

Congress is also in the act. They are looking at allowing Fannie Mae and Freddie Mac to buy more mortgages or guarantee larger loans. One program that’s set to go into effect soon is called FHASecure. FHASecure will assist homeowners who have made timely mortgage payments prior to an adjustable-rate reset, but are having problems after the reset. To qualify, homeowners must put 3% down or have 3% equity in their homes, a history of sustained employment, and sufficient income to make the mortgage payments. They will have to escrow tax and insurance payments. FHASecure loans will be packaged in a new program of GNMA securities.

USAA: Are you concerned the FHASecure loans could hurt the value of Ginnie Maes?

Didi Weinblatt: FHASecure loans will be in their own Ginnie Maes and clearly distinguishable from existing Ginnie Maes. And, the most important thing is, they will still have the government guarantee. The only real difference between these loans and existing Ginnie Maes may be that delinquency rates are higher. And remember that delinquency and foreclosures in agency mortgage-backed securities does not mean a loss for the investor but that you get your principal back. Until we see how they trade, we won't know if the price difference is enough to compensate us for the added prepayment risk. But it's not a question of credit quality.

USAA: It seems like the mortgage market is in flux.

Didi Weinblatt: Yes it is. With an election coming up next year and many people calling for government action to protect subprime borrowers, we are closely monitoring the situation. Investors in the GNMA Fund are protected, and we will continue to do our job to make sure it stays that way.

Investing resources for creating wealth!
Pet Supplies & Training needs. Global shipping.
Finest blue nose pitbulls in its breed!
Please visit: Coffee-Advice.com
Dog & Puppy resources, news, articles, and more.
Got acne? Cures, Treatments, articles, and more.
Restore that classic Pontiac musclecar. Click here.
Shop your favorite stores from across the country!
Looking for something? Google it here!
News & Technology headlines from around the globe.
Environment News, Information, resources!
Fishing News, Information, resources!