Hedge funds and mutual funds are among bondholders that could lose $2 billion as a consequence of U.S. lawmakers' letting millions of homeowners delay mortgage payments during the coronavirus pandemic.
At stake are so-called credit-risk-transfer securities whose owners include fixed-income funds run by Franklin Resources and AllianceBernstein. The securities, which threaten to lead to estimated losses of $1 billion to $2 billion, are intended to shift the risk of borrower defaults on Fannie Mae and Freddie Mac mortgages to private investors.
The issue is an unintended side effect of the response to the global health crisis. As the U.S. economy shut down in March, Congress rushed to pass the $2 trillion CARES Act, which included a provision that allowed forbearance on loans backed by Fannie and Freddie for as long as one year if borrowers were impacted by the pandemic.
The postponed mortgage payments will hurt investors in certain credit-transfer securities even if homeowners resume payments and Fannie and Freddie never suffer losses, a predicament that's prompted bondholders to lobby lawmakers and federal officials for a fix. The situation has also soured some investors on CRT securities, a $50 billion market that was created in part to protect taxpayers from ever again having to bail out Fannie and Freddie.
"This is not supposed to be a transaction where Fannie and Freddie walk away with a windfall and do not have losses," said Michael Canter, director of securitized assets and U.S. multisector fixed income at AllianceBernstein. "Such a result would be contrary to the spirit of the economic arrangement."