Move over, Fannie Mae and Freddie Mac. JPMorgan Chase wants in on the credit-risk-transfer action.
Over the past three years, Fannie and Freddie have been offloading the default risk of high-quality residential mortgages to a widespread and diverse base of investors. Now JPMorgan is marketing an unusual offering of mortgage-backed securities that would effectively accomplish the same thing, albeit through a different mechanism.
While the $1.9 billion of bonds are private-label, meaning they are not guaranteed by the government, most of the underlying loans could have been sold to Fannie and Freddie. Three-quarters of the 6,111 loans conform to underwriting standards set by the government-sponsored enterprises; the rest are just as safe, but too large to qualify.
The bank would hold 90% of the bonds to be issued; it is retaining the most senior tranches, and selling most of the riskier pieces to investors. The underlying assets would remain on JPMorgan's balance sheet, but investors would eat most of the losses if large numbers of borrowers fell behind on payments.
"They're offloading most of the credit risk from the mortgages and likely getting capital relief on the rest," said Grant Bailey, the head of U.S. residential mortgage-backed securities at Fitch Ratings.
Nearly a decade after the housing crash, Fannie and Freddie still dominate the market for mortgage finance, putting taxpayers on the hook for losses in the event of another downturn. This has spurred the use of derivatives such as Fannie's Connecticut Avenue Securities and Freddie's Structured Agency Credit Risk (or "stacker") programs to unload the risk of default on the mortgages they guarantee.
Concern about footing the bill for a future wave of defaults has also prompted the GSEs to charge higher fees for the guarantees that they provide; the high cost of this insurance is likely one of the things that make it attractive for JPMorgan to securitize conforming loans, rather than selling them to one of the housing finance agencies.
The deal, Chase Mortgage Trust 2016-1, is notable for several other reasons.
The securitization is JPMorgan's first "house" transaction since the financial crisis — one backed entirely by its own mortgages. More recently, the bank has securitized a mix of loans made in-house and mortgages acquired from other lenders.
It's also the first transaction to rely on the Federal Deposit Insurance Corp.'s 2010 safe harbor rule, which would isolate the loans from JPMorgan's creditors if the bank failed, according to Fitch Ratings and Moody's Investors Service. That's important because of a 2009 change in accounting rules; loans originated and serviced by banks are now treated as though they are still on a company's books, even after they are sold to a special purpose vehicle for securitization.
"For accounting purposes, this transaction is not treated as a sale for JPMorgan. It's a secured financing," Suzanne Mistretta, an analyst at Fitch Ratings, said on a conference call discussing the deal. "The FDIC's safe harbor provides clear guidance on what a bank needs to do to isolate securitized assets on its balance sheet for the benefit of investors should the bank fail and the FDIC step in as conservator."
Safe harbor rules introduce numerous requirements that provide additional protections for investors, according to Fitch and Moody's. JPMorgan Chase must retain 5% of each tranche, or class, of notes to be issued by the trust, even though all of the loans meet the standards of qualified mortgages and so would not be subject to risk-retention rules. The bank must also comply with disclosure and reporting requirements introduced for securitization under Regulation AB II — even though these rules have yet to take effect.
"We haven't seen many safe harbor deals outside of credit cards, which are mostly grandfathered, because of these stringent requirements and because the rule applies only to banks," said Kenneth Marin, a partner at the law firm Chapman and Cutler.
The deal comes as the private-label market has gone dormant. Since 2010, there have been just 106 private-label residential mortgage securitizations totaling $38.2 billion, according to data from Fitch and Bloomberg.
Even if pricing proves attractive, however, it is unclear how many banks might follow in JPMorgan Chase's footsteps.
"The FDIC safe harbor rule includes a number of requirements that may be considered burdensome for a bank to comply with, such as the requirement to provide investors with all of the information that would be required in an SEC-registered offering under Reg AB," Marin said. "For a small bank that does a one-off securitization, that may not be worth the effort and expense; for a bank that already does SEC-registered deals, it may be more palatable."
The deal is expected to price in the next two weeks.