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geodesic
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Joined: September 12th, 2005, 4:41 am

What Does FRMC and FNMA implicitly guarantee?

January 25th, 2021, 6:59 pm

I just watched a video on YouTube that said when FRMC or FNMA buy a mortgage, they implicitly guarantee the mortgage.

However, it was my understanding that they do NOT guarantee the underlying collateral -- my understanding is that they guarantee the the debt: the bonds issued on the collateral.

It's an important distinction because through credit enhancement, a bunch of mortgages can default, and yet, the bond holders won't lose a dime because of excess spread, subordination, over-collateralizations, reserve accounts, surety bonds, etc.  It's only when a sufficient number of mortgages default and the P&I collections are sufficiently disrupted from the scheduled collections, when an issued bond doesn't pay its scheduled cash flow to the bond holders.  My understanding is that these two GSEs protect the bond holders, not the individual mortgages themselves.

By the same token, the so-called "credit risk transfer deals" transfer credit risk from the American taxpayer directly to the RMBS bond holder, not the holder of the mortgage (which in this case would be the trustee, I guess).

Am I completely wrong?
 
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bearish
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Joined: February 3rd, 2011, 2:19 pm

Re: What Does FRMC and FNMA implicitly guarantee?

January 26th, 2021, 12:07 am

In a word, yes. Unless some radical change took place while I wasn’t paying attention, the agencies will make a payment of principal to the trust upon a default, making an individual loan default functionally equivalent to a prepayment as far as bond investors are concerned. This is different from the (now quaint) practice of monoline financial guarantee insurance applied to the bonds, which worked more or less as you describe. Until it didn’t, but that’s a different story.
 
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geodesic
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Joined: September 12th, 2005, 4:41 am

Re: What Does FRMC and FNMA implicitly guarantee?

January 26th, 2021, 2:39 am

Ahhh.  OK, thank you for that.  You jogged my memory from my old FE program days.  What I described was the monoline insurers like Ambac.   Can't believe I forgot.
Now the description of CRT deals make more sense.  Agency purchased mortgages which are not guaranteed.
Thank you!