JPM JP Morgan Chase and Co

By Sam Goldfarb 

A recent move by JPMorgan Chase & Co. to shed risk on some of its mortgage loans is stirring hope that the tactic could help reduce the government's role in the $11 trillion mortgage market.

JPMorgan last month became the first U.S. bank to issue credit-risk transfers tied to a pool of mortgages. The bondlike instruments have been embraced by the government-controlled mortgage guarantors Fannie Mae and Freddie Mac since their introduction in 2013.

Like the credit-risk transfers issued by Fannie and Freddie, those sold by JPMorgan pay investors a stream of income. In exchange, investors will shoulder losses up to a certain level if homeowners default on loans in the underlying pool of mortgages.

In essence, JPMorgan has bought a type of insurance on loans it had already made to borrowers with high credit scores. That, in turn, should allow it to hold less capital against those loans.

The deal is notable because some analysts think that a new market for credit-risk transfers issued by banks could make it at least a little more likely that banks would hold mortgages rather than selling them to Fannie and Freddie. By extension, such an outcome would make taxpayers less exposed to mortgage defaults.

Fannie and Freddie don't make loans but buy them from lenders and bundle them into securities. They typically carry a guarantee that Fannie and Freddie will pay investors if the underlying mortgages default, leaving investors with only the risk that the bonds will lose value if interest rates rise.

As it stands, nearly half of U.S. mortgages are guaranteed by Fannie and Freddie. Under government control since the start of the 2008 financial crisis, Fannie and Freddie have always carried at least the implicit backing of the government, which has been critical to preserving America's popular 30-year fixed-rate mortgage.

For years, both Republicans and Democrats have considered options for replacing the mortgage giants or introducing more competition in the housing finance market in an effort to protect taxpayers.

In September, the Trump administration outlined a plan to return Fannie and Freddie to the private market and reduce their market share while continuing to provide them with a government backstop. Among its ideas: reducing the amount of capital that banks would need to hold against a pool of mortgages if they issue credit-risk transfers.

James Dimon, the chief executive of JPMorgan, has for many years been critical of government regulations that he says have made it overly difficult for banks to hold mortgages. He has, though, offered praise for the Trump administration's proposals.

In the specific case of last month's deal, the roughly $750 million of mortgages linked to JPMorgan's credit-risk transfers were likely never going to be sold to Fannie and Freddie, in part because the average loan in the pool was too large, analysts said.

The loans, in general, were made to borrowers with high credit scores and low leverage, making defaults relatively unlikely. The maturities of the risk-transfer securities matched those of the underlying mortgages.

Investors in credit-risk transfers issued by banks are taking an additional risk that the banks themselves could become insolvent, analysts said. That could make it uneconomical for all but the largest and most creditworthy banks to issue the securities.

Still, some have welcomed JPMorgan's deal as a step in a positive direction.

Credit-risk transfers could be "the next little big thing" for banks, said Chris Helwig, a managing director at Amherst Pierpont Securities.

At a minimum, it could help some banks shed risk and free up capital that they can allocate elsewhere, he said. It also "opens the door for banks to put more loans on their balance sheets."

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--Ben Eisen contributed to this article.

Write to Sam Goldfarb at sam.goldfarb@wsj.com

(END) Dow Jones Newswires

November 08, 2019 08:14 ET (13:14 GMT)

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