Jumbo loans appear increasingly likely to be the first part of the nonagency secondary mortgage market to make a comeback.
"There definitely has to be something that's going to break loose on the jumbo side," said Guy Taylor, the chief executive of Equi-Trax Asset Solutions LP, a Santa Barbara, Calif., company that provides loan valuations.
Defined as loans too big for Fannie Mae and Freddie Mac to buy or guarantee (the cutoff is $417,000 in most places and up to $729,000 in certain high-cost areas), jumbos have historically been considered the least risky nonagency product. Ideally they are sold to rich borrowers with strong credit, and with the exception of their size, they are supposed to meet most traditional underwriting standards. But like all nonagency products, jumbos were affected by the widespread loose underwriting during the housing boom and by the resulting downturn.
Recently jumbo rates have been as much as 2 percentage points higher than conforming rates, and that is a concern when in the past they might have been only half a percent higher, Taylor said.
With private-label securitization largely absent, the secondary market options for jumbos today largely consist of banks that want the loans for their portfolios.
Selling participations in a pool of jumbo whole loans is another option and could be a "baby step" back toward securitization, said Tom Millon, the president and CEO of Capital Markets Cooperative in Ponte Vedra Beach, Fla.
The participation deals are not actual securitizations, in which loans are pooled into an off-balance-sheet trust and their cash flows are divvied up into officially rated tranches. However, participation deals are similar to the "senior-subordinate" structures of the securitized market in that the senior participations are protected by others that absorb losses first.
"It's old school," Millon said. "It's the way things were done way back before the securities market existed for this sort of thing."
Efforts to sell participations in jumbo pools have been "slow-going," Millon said. But he said his cooperative, which helps depositories with secondary marketing, is "cautiously optimistic" about the structure. "Banks are interested, and I would not have said that six months ago."
Other means through which the demand for liquidity in the jumbo market might be met could include extending government involvement to higher loan balances, said David Adamo, the CEO of Luxury Mortgage in Stamford, Conn. However, the Obama administration has shown reluctance to get involved in supporting housing loans for higher-income individuals.
More bank use of European-style covered bond programs could be another way to help restore jumbo financing, Adamo said. These offer what investors may perceive as an attractive combination of relatively strong credit and relatively high yield, as well as more "skin in the game," since they are kept on issuers' balance sheets, he said.
Securitizations have reached the point where they funded only about 2% of jumbo originations in 2008, Adamo noted. Investors might take to covered bonds faster than they would return to securitization, he said.
Millon said covered bonds would not be enough to revitalize jumbo lending, because current balance-sheet capacity is not enough to meet loan demand. But he agreed that having some skin in the game, in terms of issuers holding at least the first-loss piece from deals, will probably be one element of securitization's return.
Washington officials have been thinking along the same lines. In June, as part of the administration's broad plan for regulatory reform, the Treasury Department circulated a proposal to require originators to retain 5% of a loan's credit risk when selling it into the secondary market.