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Mortgage Market Needs $250 Billion Capital Infusion

FBR report analyzes deleveraging

August 23, 2007

By MortgageDaily.com staff

The mortgage market needs an infusion of up to a quarter trillion dollars to return back to normal, according to an investment banking report.

The comments were made by FBR Research in a note yesterday.

"With the unusual amount of balance sheet de-leveraging occurring in companies that hold mortgages, we believe that roughly $150 to $250 billion of permanent capital is needed to normalize pricing in the mortgage market," the investment banking firm said in Mortgage Market Overview: De-Leveraging Destroying Value--New Capital Needed released Wednesday.

Rate cuts by the Federal Reserve will only bring temporary relief and won't bring permanent capital to the market, FBR analyst Paul J. Miller Jr. wrote in the report. An adjustment of the prices being paid for mortgage products is what is required for the necessary capital infusion.

"This price adjustment will take time and will be very painful, with many existing portfolios and mortgage originators feeling the pain.," the report said. "We have already experienced the aftermath of the adjustment with mortgage holding companies and originators going out of business or taking large write-downs across their balance sheets; it's not going to stop anytime soon."

Miller forecasts it will take up to a year for prices to adjust and for capital to flow back into the business, adding that there is no quick fix.

The mortgage market is seeing lower leverage, prices paid for non-agency assets has fallen to an abnormally low level, FBR explained. One major cause for the activity is investor expectations that home prices will fall and impair collateral.

While the capital crunch was initially limited to investors of subprime securities, it subsequently spread to the jumbo mortgage market and the asset-backed commercial paper market, the report indicated.

"As the credit crunch spread throughout the entire market, financial institutions began to focus on deleveraging their balance sheets," FBR said.

It will take at least $100 billion in new capital to compensate for the deleveraging, while a total of $150 billion to $250 billion will be needed to maintain the $6.5 trillion to $7.5 trillion in mortgage assets. The estimate was based on a current leverage ratio of 20:1 and the expectation that it will drop to around 13:1 to 15:1.

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