SECURITIZATION IS EVERYTHING for the government-sponsored enterprises. Investor interest in the Fannie Mae Mortgage Backed Securities (MBS) program continues to heat up, lowering spreads and driving more competition between the agencies.

Fannie Mae won a sizable amount of fixed-rate business through the MBS program in the first half of '09, with pricing on standard 10-year deals hovering in the midto high-5 percent range. But Fannie Mae's adjustable rate program is less competitive. Freddie Mac's adjustable rate deals have featured rates well inside of Fannie's for most of the year. Though rates on Freddie's adjustable deals climbed in June—from a start rate of 3.5 percent to a start rate of 4.25 percent (with a 7 percent cap), the pricing still remained inside of Fannie by about 65 basis points as of mid-July.

And Fannie may see more competition on the fixed-rate side, as Freddie Mac's Capital Markets Execution program— which pools loans for securitization— continues to gain steam. In fact, Freddie is working on a single-loan securitization strategy to battle Fannie's now-popular MBS execution. (For additional information on the strategy, see news article on page 2). On fixed-rate loans, Freddie is picking its spots. For deals the agency likes, it can offer more competitive rates than Fannie, but many standard deals are still going Fannie's way due to the lower spreads resulting from MBS investor demand.

“Fannie spent a lot of time and effort building that product over the last six months, and it's become a better and better execution,” says Michael Berman, president and CEO of Boston-based CWCapital. “But the Freddie CME program has come on very strong in the last few months, and it's really balanced out.”

Through the first half of the year, more than 71 percent of Fannie's production has been through the MBS execution, compared to just 17 percent in the first half of 2008. As the investor base of MBS improves, the pricing on MBS loans has continued to drop each month.

“If you go back to January, the MBS spreads were about 280 to 300 [basis points] over, and today they're down to about 100 over,” says Manny Menendez, vice president of multifamily product development and business management for the Washington D.C.-based Fannie Mae.

The company will continue to migrate many of its portfolio-based products into the securitized realm. Earlier this year, Fannie Mae turned its fixed-rate credit facility product into an MBS execution, and the second half will see similar transitions. “The next product that we're probably going to make MBS-eligible is the structured ARM, an adjustable-rate execution,” Menendez says.

Ten-Year Floors, Less IO

Fannie Mae also released another round of underwriting changes heading into the second half of 2009, further tightening their credit standards yet again.

The changes included a reduction in the availability of Interest-Only (IO) periods. “They pretty much almost entirely went away with IO,” says John Barbie, a vice president at Pittsburgh-based PNC ARCS. “You can get maybe two years of IO on a 10-year deal, but only if you're low leverage at a 1.35x debt service coverage or better.”

Another change: Ten-year deals now have an underwriting floor of 5.75 percent for loans of above 65 percent loan-to-value. The floor is used only as a means for sizing the loan, and borrowers can still get an all-in rate below 5.75 percent. But this new floor will likely constrain proceeds for many borrowers.

“The change is starting to have an effect, especially if the Treasury keeps coming down,” says Will Baker, a vice president at Bethesda, Md.-based Walker & Dunlop.

The underwriting floor on five-year loans is 7.25 percent, and for seven-year loans it's 6.5 percent, making shorter-term executions less attractive. “Now more than ever, the exit strategy is forefront in Fannie Mae's mind,” Barbie says. “They're pushing you to longer-term debt.”

By adding a floor on 10-year deals, Fannie Mae is effectively changing its loan-tovalue and debt-service coverage ratios. The combination of the floor and today's rising cap rates further tightens the underwriting approach of agency lenders.

“What ends up happening is that instead of 80 percent LTV and 1.25 DSC being your minimums, they will turn into 75 percent LTV and 1.30 DSC, effectively,” says Phil Melton, a senior vice president at Charlotte, N.C.-based Grandbridge Real Estate Capital.

Tougher All Around

Fannie Mae also recently toughened up on supplemental loans. In the past, borrowers could get two supplemental loans during the loan term, and then an additional supplemental loan would be available for whoever assumed the loan. But Fannie now holds the line at one supplemental loan per original borrower, and one more with an assumption.

“You're going to see the DUS lenders increasing their minimum loan amount for a supplemental loan as well,” Barbie says. PNC ARCS once set the loan minimum for a supplemental at $250,000, but have recently raised it to $500,000. “It's underwritten the same way as a cash-out refi, so you're not going to get the same leverage level as you did in the past.”

Fannie is also taking a much closer look at collections trends. Measuring the collection levels of the trailing three months, six months, and 12 months has always been par for the course, but the relationship between those figures is being scrutinized.

If the trailing three months show declines, the agency is now projecting income based on the lowest of the trailing 12, six, three, or more recent months. When especially severe declines are seen, Fannie Mae underwriters automatically add a minimum 2 percent additional vacancy to the figure.