The forecasted ripple effects from the collapse of Equity Programs Investment Corp. (EPIC) have begun to materialize, as investors reassess private mortgage-backed securities that financed the real estate investment group's purchase of new homes.
The most tangible manifestation of this nervousness is that thrifts and mortgage bankers have been forced to pay higher interest rates to attract investors in private mortgage-backed securities, Wall Street analysts say. These higher rates ultimately will be passed on to the small portion of home buyers who obtain mortgages financed through these types of securities, mortgage finance officials said.
"Whenever there's a default or potential loss of the size of EPIC, the market tends to overreact," said Stephen Pasko, managing director in charge of mortgage finance at Drexel Burnham Lambert. "The primary reason is that the investors, because of the EPIC situation, are concerned about the risk with private mortgage insurance."
"There is concern in the mortgage-backed security market about the quality of certain mortgage-backed securities. There is certainly no panic, but there is caution," added Richard Dorfman, a managing director at Shearson Lehman Brothers.
Evidence of concern over the private issues can be seen in the widening spreads brokerage houses are reporting between the yields on Treasury securities and those demanded by investors in private-mortgage backed securities.
Typically, yields on Government National Mortgage Association (Ginnie Mae) issues are about 1 1/4 percentage points higher than yields on Treasury securities, said Gary Lieberman, national sales manager for mortgage securities at Merrill Lynch. Ten-year Treasury securities were trading at about 10.4 percent this week.
Lieberman said the private issues usually return about another quarter of a percentage point above the Ginnie Maes. In the wake of the EPIC debacle, however, this spread has widened by about another quarter of a percentage point, Wall Street sources said, evidence of skittishness about the reliability of these types of issues.
Although the private secondary mortgage market is still far smaller than the public market, it has grown in recent years as a source of funds for mortgage-seekers who cannot obtain mortgages backed by government agencies. Wall Street officials who have pushed the growth of this market said they are worried the shakeout from EPIC in the mortgage insurance industry could impinge on this growth.
Those insurance companies are currently facing losses that could reach $400 million as a result of the default of EPIC partnerships on $1.4 billion worth of mortgages and mortgage-backed securities. The companies are trying to restructure the EPIC mortgages to avert the worst-case losses, which would be the industry's biggest ever.
Yesterday, however, a group of eight major investors in EPIC mortgages and mortgage-backed securities announced that it had rejected a plan developed by the insurer with the most to lose at EPIC, Ticor Mortgage Insurance Co. The plan calls for a reduction of the monthly interest payments owed by the partnerships, as well as a cash contribution by the insurance companies to meet those payments.
A statement issued by the Federal National Mortgage Association, one of the investors, said that after a meeting yesterday the investors agreed the Ticor plan "does not constitute the basis for an equitable solution to the problem," and that they instructed their lawyers to draw up another plan.
The ultimate resolution of the EPIC situation will have a major impact on the mortgage insurance industry, which plays a crucial role in the market for private mortgage-backed securities. A mortgage-backed security is created when a lender pools a group of mortgages and sells them to investors, to whom monthly mortgage payments are then passed on.
The vast majority of the market, in the neighborhood of $350 billion, is composed of mortgage securities guaranteed by the quasi-governmental agencies: the Government National Mortgage Association, the Federal Home Loan Mortgage Corp. and the Federal National Mortgage Association.
A smaller, but growing, market has emerged through the private sale of mortgage-backed securities. Totaling between an estimated $15 billion and $30 billion, this market is dependent on private mortgage insurance, because that is the only protection afforded investors beyond the actual value of the properties underlying the mortgages.
Although the public market has come through the EPIC disaster unscathed, mortgage finance officials say, a feeling of unease has drifted through the private market as a result of the potential damage EPIC holds out for the mortgage insurance companies with exposure from the partnerships.