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Instrumental change.

Instrumental CHANGE

On December 2, 1981, business concerns weighed on executives at Fannie Mae as heavily as the thick snowfall that blanketed the city. The United States was hobbled by the worst economic conditions since the Great Depression, the national real estate market was slumping, and the company was losing more than a million dollars each business day.

These realities charged the air inside a first-floor meeting room at Fannie Mae. There, top executives were edgy, presiding over the inauguration of a new business strategy on which the survival of the company would hinge - its first offering of mortgage-backed securities, or MBS.

"A conventional MBS program [on this scale] had never been done before. We didn't know whether it was going to work," recalled Stuart McFarland, who served as executive vice president and chief financial officer from October 1982 to May 1985. McFarland is currently president and CEO of GE Capital Asset Management Corporation, Alexandria, Virginia.

The company had dispatched Don Klink, who oversaw its negotiated transactions desk, to the New York headquarters of Salomon Brothers, the investment firm serving as lead underwriter of the MBS issue. He was wired to Fannie Mae by speakerphone, along with the rest of the investment firms participating in the underwriting syndicate. Back in Washington D.C., Fannie Mae's information systems department had set up a bank of computer monitors in the company's executive meeting room to allow executives to track the progress of the MBS auction.

Terry Wakefield, now managing director of Residential Services Corporation of America, Milwaukee, was at that time a consultant working with McFarland. Wakefield was stretched out on the floor to alleviate stress on his back, which had gone out that morning. Other executives were arrayed at tables, calculating prices and deciding which bids from financial institutions to accept. As the auction progressed, the noise level rose, with Fannie Mae executives shouting at each other in the conference room or shouting at Klink or syndicate members in New York, while shouts returned over the speakerphone from Klink or syndicate members.

In the midst of this bedlam, David O. Maxwell, chairman and chief executive officer, entered. He surveyed the room for a moment, then walked over to McFarland. "I can see things are going just as we planned," he deadpanned. "Pretty much," McFarland replied. A few minutes later, the MBS auction was completed successfully. The company sold $250 million of MBS with an 8.5 percent coupon. It was only after the proceedings ended that Fannie Mae executives noticed they were snowed in by one of Washington's worst storms. A few of the executives were stranded and spent the night at the company. McFarland, who lived nearby, trudged home on foot.

A success story

A decade later, the Fannie Mae MBS is considered a premier investment in the international capital markets. With more than $350 billion MBSs outstanding, Fannie Mae offers its customers an array of products and services certain to whet almost any investors' appetite. The menu includes fixed-rate and adjustable-rate MBS, Fannie Majors, balloons, strips and Megas, and of course, REMICs.

"The most striking thing is how enormous [the market for the Fannie Mae MBS] has become," said Caryl Bernstein, Fannie Mae's executive vice president, general counsel and secretary, who joined the company in the spring of 1981. "When we first created the MBS program we thought we could run it by hand. A list of mortgages in each pool were kept in the general counsel's office and a secretary kept track of them."

In 1981, the first year Fannie Mae issued MBS, the company closed 10 pools, representing a grand total of $717 million. By contrast in 1991, its record year, Fannie Mae closed more than 38,000 pools for more than $100 billion.

"If you look at the larger implications of the secondary market, it has brought down the cost of housing, eliminated disintermediation and made the mortgage-backed security the second largest fixed-income security in the world. It's given financial flexibility to depository institutions. It allows them to be aggressive in local markets without concentrated credit risks," said Robert Sahadi, Fannie Mae's vice president for housing initiatives.

On the drawing board

Warren Lasko, formerly the executive vice president of GNMA and current executive vice president of the Mortgage Bankers Association of America, was hired by David Maxwell in 1981 to set up Fannie Mae's MBS program. He largely patterned it after GNMA's MBS program. A few key features immediately distinguished it from its competitors.

Lasko and his team established the 25th of the month as the payment date to investors. GNMA securities pay investors on the 15th. This small detail led to an important efficiency: it allowed Fannie Mae to collect from various lenders and to issue one check to investors regardless of the number of pools they owned, thus soothing the administrative headaches investors had endured from the receipt of multiple checks with other securities.

To enhance the marketability of Fannie Mae's security, the corporation promised the full guarantee of timely payment of principal and interest to its investors, thus assuming full risk for the loans it securitized.

In its full first year of MBS, 1982, Fannie Mae issued $14 billion.

"Fannie Mae was a lot more experienced in the MBS business than the timeline would indicate," said Jayne Shontell, citing the corporation's long-term experience as administrator of the GNMA program. Shontell, who helped pioneer Fannie Mae's MBS, is now Fannie Mae's president for business development.

"When we adopted GNMA's forms and their process, it made it easy to do business with us. There was no learning curve for our customers. If they knew how to do Ginnies, they could do Fannies."

In addition to creating new products, particularly ARMs in the mid-1980s, Fannie Mae was "flexible," according to Shontell. The corporation also contributed to the industry by setting standards in the conforming market that resulted in giving the "whole market wider acceptability," Shontell said.

"The beauty of the secondary market was that a lender no longer had to have a personal relationship with other lenders. A lender in Florida no longer had to get to know a lender in New York or one on the West Coast. Fannie Mae said the loans were a good buy."

"One of our greatest challenges was to convince the investor public - mainly pension funds - to buy Fannie Mae securities, in spite of losses the company was enduring," recalled Klink. Klink is currently assistant director, asset marketing of the southeast consolidated office of the Resolution Trust Corporation in Tampa.

Price was another crucial link. Fannie Mae's MBS were designed to pass payments through faster than Freddie Mac's original participation certificate (PC). As a result, Fannie Mae's investors gained greater yield with the MBS as it allowed investors to reinvest the monthly cash flow for an additional 20 days.

"This was the single biggest feature that moved us," said Klink. We were able to show the market would pay more for the extra cash flow."

Explosive growth

What began as a swap program, the exchange of portfolio loans primarily from thrifts for MBS, quickly evolved into a business that accommodated mortgage-bankers, commercial banks and other institutions.

Fannie Mae's swap program "set the stage for explosive growth in the secondary market," explained Joseph Hu, senior vice president and head of mortgage research at Nomura Securities, New York.

"Between 1970 and 1980, annual production [of total MBS] rarely exceeded $20 billion and was closer to $5 billion to $10 billion annually."

In 1981, the company began purchasing adjustable-rate mortgages (ARMs) for its portfolio, first buying whole loans and later initiating a program to purchase loans on a participation basis. Two years later, Fannie Mae issued its first ARM MBS.

And, by the fourth anniversary of Fannie Mae's entree into the MBS market, in December 1985, the company's MBS issuances for the year exceeded its portfolio purchases for the first time.

One of the most important developments for lenders, especially small and medium size companies, was the creation of the customer service trading desk in the summer of 1984. Janet Shatz, now Fannie Mae's vice president for marketing, was hired to set up and run the desk.

The trading desk allowed Fannie Mae to help the customer better understand the MBS program, explained Shatz. "We would walk the customer through every step of the process - the pools being delivered, closed and wired - all the things and more that we transmit to the lender via MORNET today."

Fannie Mae's customer service trading desk made its first trade of $1 million in September 1984. When regional managers started to "sell" the desk by marketing it to their customers, Shatz said it "made all the difference in the world... In the early days, $5 million a month was very good; now, $1 billion per month is the norm."

In January 1987, the company introduced a product that leveled the playing field and made it possible for thousands of new participants to enter the MBS arena.

Fannie Majors enhanced the conventional MBS program by allowing lenders to include their current production mortgages in a pool with other lenders' loans. By consolidating the single-lender pools as small as $250,000 into multiple-lender issues, the value of the securities increased. Also, trading costs were reduced, and small and large lenders alike had more opportunity to pool mortgages.

"We were finally cracking the big nut...doing less than a million dollar security," said Shatz.

"For smaller lenders, Fannie Majors were a breakthrough to MBS market participation. It allowed them to get million dollar pricing for as little as $250,000. In my opinion, Fannie Majors really revolutionized the market because it opened it up to any player," said Shatz.

REMICs emerge

By 1987, the REMIC story had also unfolded. "The REMIC legislation was most significant in creating a large market of investors eager to invest in mortgage-backed securities," said Fannie Mae's Bernstein.

In April 1987, HUD Secretary Samuel Pierce approved Fannie Mae's request, granting Fannie Mae the authority to issue up to $15 billion of REMICs backed by conventional mortgages with a sunset of July 20, 1988. On August 18, 1987, the corporation announced its first conventional REMIC offering, a $500 million issue backed by fixed-rate mortgages sold to Fannie Mae by 157 lenders through a special purchase program. HUD granted Fannie Mae permanent and unlimited authority to issue REMIC securities in October 1988. In December of 1991, the company settled its 500th REMIC offering.

International interest

Foreign interest and investment in the MBS market fueled another significant growth spurt in the late 1980s. Since 1984, Fannie Mae has looked to the Far East and Europe to tap a new pool of capital for American homebuyers and renters.

"It was the next step," says Fannie Mae's manager of MBS investor marketing, John The Losen.

"Our biggest challenge was educating people about how the products work and allaying concerns of managing the prepayment risk as well as the operational aspects. We had to convince investors we had a wide range of products that would fit their asset and liability needs or yield objectives."

Approximately 15 percent of Fannie Mae's MBS production is now being sold to foreign investors.

"What's occurred in mortgage finance, in general, over the last decade is an increasing ability for institutions in the business to specialize," explained Tim Howard, executive vice president and chief financial officer of Fannie Mae.

"You can break up the mortgage lending process into four pieces: origination, servicing, packaging and investing. Where the real changes have occurred in the past several years have been in the last two categories. And that has been due to activities on the packaging side and Wall Street's activities in making it more possible for investors to take on large positions in what had previously been a not very interesting or liquid security type.

"A couple of things seem to have occurred to make that possible. One is the achievement of what might be called a critical mass of mortgage-backed securities in the market that convinced investors that these securities were liquid and easily tradeable.

"The second thing is the development by the Wall Street firms not only of superior market-making abilities but also of broad-based and widely disseminated analytic tools and evaluation conventions that allowed a number of so-called nontraditional investors to make major investment commitments into mortgages. These include pricing models and means to evaluate mortgages versus other securities. Absent those two things - liquidity and analytic techniques - you wouldn't have had anything like the explosion in mortgage finance that you had," Howard said.

Meeting housing's needs

The nearly $500 billion of MBS that Fannie Mae has issued in the past decade has helped more than six million American families finance their homes. As the company moves into its second decade of MBS, Fannie Mae will continue to serve as the link between homebuyers and renters to the capital markets, thus helping low-moderate and middle-income Americans find decent housing.

Fannie Mae will also continue to look for innovative ways to serve its customers. "I think we'll be offering lenders tremendous power in the 1990s," said Shatz. "In the future, we'll give lenders, large and small, the tools to manage their business loan by loan so that they can get the most money out of each loan.

"There's nothing like the mortgage-backed security. It's incredibly liquid. Lenders can sell an unlimited quantity of MBS and always have a buyer. There's a well-greased network of dealers, who provide competitive pricing. Mortgage-backed securities are the vehicle that help provide stability in the mortgage market," Shatz said.

On a mild December day, 10 years after Fannie Mae introduced its MBS program, McFarland recalled the days when he and his colleagues engineered the Fannie Mae MBS.

"We knew the product was absolutely right then and that it was the right time for it," McFarland said, explaining that the economy and market conditions were ripe for the MBS program. "But I don't think anyone knew that the MBS market would grow to these numbers this quickly."

So like the light snow that fell on the day of the first Fannie Mae MBS auction, Fannie Mae's MBS has turned into a blizzard, blanketing the market, creating liquidity for investors and providing opportunities for millions of American homebuyers.

Donna Callejon is Fannie Mae's senior vice president-marketing and mortgage-backed securities. She is responsible for single-family product acquisition, product development and program management, marketing, MBS capital markets and MBS investor marketing.
COPYRIGHT 1992 Mortgage Bankers Association of America
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Title Annotation:Secondary Marketing; Federal National Mortgage Association's mortgage-backed securities
Author:Callejon, Donna
Publication:Mortgage Banking
Date:Jan 1, 1992
Words:2414
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