MReport September 2020

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M REPORT | 63 SECONDARY MARKET THE LATEST O R I G I NAT I O N S E R V I C I N G DATA G O V E R N M E N T S E C O N DA R Y M A R K E T The MBS Outlook: What's Driving the Dip to 'Negative?' Here's how Fannie and Freddie's responses to the COVID-19 pandemic have affected MBS. F itch Ratings is raising concern that the govern- ment-sponsored enter- prises' (GSEs) response to the COVID-19 pandemic is having a problematic impact on their mortgage-backed securities (MBS) issuances. Fitch noted that its rating ac- tions prior to the pandemic's onset were mostly positive for the GSEs' risk transfer deals. But on May 19, Fitch placed seven initial exchange- able classes on Rating Watch Negative and revised the Rating Outlook to Negative from Stable on five additional tranches from 15 Fannie Mae and Freddie Mac credit risk transfer (CRT) transac- tions issued between 2013 and 2015 and one private label CRT transac- tion issued in 2018. Suzanne Misretta, Senior Director at Fitch, explained this shift to pessimism was the result of the GSEs' acknowledgment of the pandemic. "Both GSEs have not responded to the coronavirus pandemic in the same manner they have for natural disasters such as hurricanes in the past," Mistretta said. Misretta highlighted Fannie Mae's Connecticut Avenue Securities (CAS) series from 2013 and 2014 (C01) and Freddie Mac's Structured Agency Credit Risk (STACR) series from 2013 and 2014 (DN1 and DN2) for failing to carry provi- sions for grace periods or credit event reversals, adding they lacked the flexibility to address natural disasters and, thus, were among the transactions most at risk given the current environment. "Some fixed severity deals have either a grace period or reverse credit event that lessens the impact of affected borrowers," Mistretta said. "That said, some bonds are at risk of permanent interest short- falls since the interest paid will be calculated off of the written down bond balance until the reference pool and bonds are written back up." Misretta added that the GSEs' lack of pandemic response and the rigidity of structure in their MBS issuances could result in downgrades of some tranches to speculative-grade, reflecting either an elevated vulnerability of default risk or that default risk is present. Fannie Mae: Economy Ready for Rebound After Historic Setback According to an economist for the GSE, however, the pace of economic recovery will be driven largely by factors related to the coronavirus. A ccording to the latest commentary from the Fannie Mae Economic and Strategic Research Group, America's economy is surprisingly poised to bounce back in the coming quarter. Although the U.S. economy ex- perienced a setback in the second quarter, contracting by 32.9% (an- nualized), all seems not to be lost according to experts. Even though this second quarter showing marked the largest decline since the demobilization efforts after World War II, experts point to the healthy rate of recovery in the economy that was seen this past May and June, a momentum which they say is perfectly setting up this coming third quarter for an equally healthy rebound. Specifically, experts predict that the third quarter GDP growth will be roughly 27.2% (annualized). Further support of this posi- tive outlook for the future of the economy is now-declining corona- virus case rate, as well as current support being offered by fiscal and monetary policy in the U.S. The experts have even pointed to the fact that many households have increased their savings while reining in spending during these uncertain times, thus creating an environment for future consumer spending throughout the year as people gain more confidence with the current state of affairs. Even though there are decided risks that could complicate this positive outlook, such as a surge in COVID-19 cases and further lock- downs, the experts from the ESR group still are staying optimistic. Doug Duncan, Fannie Mae SVP and Chief Economist, further elaborated on the group's economic forecast, particularly in how the pandemic will affect it: "The economy's climb back from the sudden and severe setback of the second quarter is fully underway, but we believe the future pace will be driven largely by the path of the novel coronavirus and how the public responds to coronavirus- related information." Duncan added: "Consumers have savings to draw on, but some are holding that savings in reserve until the economy and labor mar- kets improve. Others are spending on a discretionary basis as they await evidence that the virus has receded sustainably. Our base scenario assumes that Congress will agree upon additional fiscal stimulus in support of consum- ers and businesses, and that the economy will only shrink 3.1% in 2020 relative to 2019, measured on a fourth-quarter-over-fourth-quarter basis." Further details on what to expect were provided by Duncan: "We believe housing will continue to be a sector with relative strength amid the larger downturn, as long-running supply constraints exacerbate demographic and interest rate demand-side factors that are supporting home price growth. The recently observed increase in purchase demand is largely due to pent-up demand as buyers are acting now after delay- ing purchases in the spring. We are, however, seeing some early signs of shifting buyer preference to locate to lower density areas, potentially driving some addi- tional purchase activity. Here, our baseline forecast sees purchase volumes of $1.3 trillion in 2020."

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