Freddie Mac Announces $534 Million NPL Sale
Freddie Mac was chartered by Congress in 1970 to keep money flowing to the US housing market. Today, they continue to build a more sustainable and affordable US housing finance system by providing lenders with liquidity, and investors with innovative ways to invest in the US housing market; they purchase mortgages from lenders daily, bundle these mortgages into securities, and sell them to investors globally. If a homeowner defaults on their mortgage loan, investors are still paid, and Freddie Mac shifts the risk of default away from themselves and US taxpayers through their Credit Risk Transfer programs. These programs are supported by an advanced risk management framework, and effectively sell mortgage credit risk to investors by structuring the risk into securities and insurance offerings.
A recent article posted on Freddie Mac’s website discusses their announcement of a $534 million nonperforming loan (NPL) sale. Freddie Mac periodically sells NPL’s in its mortgage-related investment portfolio through competitive auctions in order reduce its less-liquid assets. The NPL’s in this auction are broken down into four Standard Pool Offerings (SPO), and one Extended Timeline Pool Offering (EXPO) which targets smaller, more diverse investors. Qualified bidders submitted bids for the SPO pools on October 1 and will be required to submit their bids for the EXPO pools by October 15.
The NPL sale is structured as a second-price auction in which winners are chosen on the basis of price, subject to Freddie Mac’s reserve price. As we have discussed in class, second-price auctions with reserve prices award the winner of the auction with a maximum price of the second-highest bid and reserve price. For example, in a 2016 NPL sale to Upland Mortgage Acquisition Company, Freddie Mac sold an SPO pool of $227.2 million at the second-highest bid of around 70% of the total unpaid principal balance included in the pool. Using the language of game theory, the dominant strategy of a bidder in this auction is to bid their true value, as this will guarantee a non-negative payoff if they win. Although Freddie Mac’s internal reserve level sets a minimum price at which they will sell to a bidder, this does not affect the dominant strategy of a bidder. This reserve price can be thought of as an additional bidder, and the behavior of other bidders do not influence the optimal strategy of bidding truthfully in a second-price auction.
During such an unprecedented time when millions of homeowners throughout the United States are struggling to make their mortgage payments on time, this is certainly an interesting auction to analyze. On one hand, mortgage rates are hovering around all-time lows, and this has caused mortgage refinancing and overall loan activity to surge. In fact, we are currently seeing the highest sales pace in homes since right before the Great Recession in 2006. However, the unemployment rate remains high at 8.4%, which is believed to be understated by many, and the possibility of our divided Congress issuing a new stimulus package in the near future looks dim. At a time when millions of Americans remain under severe economic distress, evictions continue to rise, and mortgage delinquency rates remain high, it is refreshing that Freddie Mac continues to tap the capital markets.
Sources:
https://freddiemac.gcs–web.com/news–releases/news–release–details/freddie–mac–announces–534million–
https://freddiemac.gcs–web.com/news–releases/news–release–details/freddie–mac–sells–1–billionseriously–