An ambitious, risky plan to let mortgage originators shift more of their risk to Wall Street has suffered a potentially fatal setback.
The Public Securities Association has said the proposal - to securitize a larger proportion of interest payments on home loans - would not meet bond-industry criteria.
That opinion, from the industry's standard-setting body, has at least one mortgage banker delaying participation in the program. Stewart Fleming, head of secondary marketing at Standard Federal Bank, Troy, Mich., said that although he was still eager to proceed, he was putting on hold his thrift's plans to securitize a pool of $500 million of loans through Fannie Mae until matters with the PSA are straightened out.
Others also are growing doubtful that the new securities will gain acceptance. An executive on Wall Street pooh-poohed efforts by Freddie Mac to work out the problems by hosting a June 5 meeting for industry representatives, including the PSA and Fannie Mae.
"It's a little bit presumptuous of Freddie to think that by getting everyone together, there would be a meeting of the minds," said the executive, who declined to be identified.
At issue is a plan for lenders to securitize and sell on Wall Street interest payments that are charged to perform administrative chores for mortgage loans. Right now, lenders retain these interest payments, which typically amount to one-quarter of 1%.
Under proposals by Fannie Mae and Freddie Mac, mortgage banks would continue to do the servicing for a smaller fee, while the bulk of the cash flow is securitized and sold on Wall Street.
But the PSA believes the structure could encourage prepayments that would make the bonds too volatile. The less-than-favorable opinion is indeed a serious blow to the agencies, industry observers said.
Representatives of Fannie Mae and Freddie Mac acknowledge the PSA's position could have an impact on their efforts, but they do not appear prepared to abandon the idea.
Fannie Mae will evaluate the PSA's sentiments before coming out with any products, said Gene A. Spencer, a vice president involved with securitizations at Fannie Mae.
"I'm confident we will develop a product that will meet dealers', investors', and lenders' needs," Mr. Spencer said.
Freddie Mac, in a statement, labeled the PSA's concerns reasonable and said it would "reevaluate" its position based on what happens at the June 5 meeting. A spokesman for Freddie Mac declined to elaborate.
Fannie Mae and Freddie Mac developed the concept for the bonds in response to a ruling last year - FASB 122 - that allows mortgage banks to change the way they account for servicing. The housing agencies said securitizing the servicing revenues would help protect mortgage bankers from the consequences of interest rate swings.
But the PSA believes the bonds could pay off early because mortgage bankers, no longer having to carry servicing assets on their books, would approach borrowers about refinancing the loans.
"There needs to be more empirical evidence upon which to base judgments of how the bonds would prepay," said George Miller, associate counsel for the PSA.
Because of these reservations, the bonds would not be considered "good delivery for to-be-announced transactions," as other mortgage securities are, he said. Without the PSA's nod, the securities would face a difficult time, with both trading and liquidity limited, traders said.
If Fannie Mae and Freddie Mac go ahead with their plans, the PSA would likely vote on formalizing its position, Mr. Miller said.
Snigdha Prakash contributed to this article.
