While the FHFA’s conservatorships of Fannie Mae and Freddie Mac are unlikely to end before 2017, the Enterprises continue to transfer more credit risk from their single-family residential mortgages to private insurers. Both GSEs have exceeded their credit-risk transfer goals for calendar year 2015, largely because of Fannie Mae’s CAS series and Freddie Mac’s Structured Agency Credit Risk (STACR) series. Fannie Mae has transferred credit risk on $205 billion in single-family mortgages as of October 2015 (the goal was $150 billion), and Freddie Mac has transferred credit risk on $126 billion in single-family mortgages for that same period (the goal was $120 billion).
Credit-risk transfer is now a regular part of the Enterprises’ business, as cited in FHFA’s Performance and Accountability Report for FY 2015. In all credit-risk transfers, the Enterprises and FHFA have been strategic about which loans to target. Instead of using a random sample of Enterprise loans, the transactions focus on new loan purchases with the greatest credit risk. The targeted loans include new acquisitions of 30-year fixed-rate mortgages that have loan-to-value ratios exceeding 60 percent, excluding HARP (Home Affordable Refinance Program) refinances. The Enterprises are currently transferring significant credit risk on approximately 90 percent of these targeted loans, the mainstay of their single-family purchases. This approach has made the transactions easier to scale-up and more economical, benefitting the Enterprises and taxpayers.
FHFA said that going forward it will set specific goals in the annual conservatorship scorecard and work closely with staff members at Fannie Mae and Freddie Mac to help the GSEs develop and evaluate their credit-risk transfer structures. FHFA is encouraging the GSEs to continue engaging in large volumes of meaningful credit-risk transfer. More than 150 investors have participated in the STACR and CAS programs; any given transaction will typically feature anywhere from 50 to 70 investors, according to FHFA. Asset managers make up the largest share of participating investors with 53 percent; hedge funds have the next largest share with 31 percent.
However, some in the industry, like the Mortgage Bankers Association (“MBA”), are suggesting that the GSEs’ use of multiple forms of up-front risk sharing be piloted, including deeper cover mortgage insurance, lender recourse, and structured finance. Moreover, the thinking is that multiple forms of up-front risk sharing should be approached in a manner that maximizes the opportunity for the market broadly, and should not advantage certain lenders relative to others. That is, approved sellers to the enterprises of all sizes and business models should be eligible to participate in such a program, and would be in keeping with FHFA’s policy of leveling the playing field between larger and smaller lenders.
Up-front transactions are defined as those that de-risk loans before they are acquired by the GSEs, as opposed to back-end CRTs that require the Enterprises to warehouse risk for a period of time, making them subject to swings in credit spreads, and having them retain substantial risk for the life of the loans. Many believe this up-front transaction approach will further reduce taxpayer risk, maintain a liquid and dynamic market, and help to build toward the new system by increasing the amount of private capital in front of the Enterprises and their federal backstop. Additionally, the MBA has raised concerns about retained risk practices involving mortgage insurance by the GSEs.
Notwithstanding the success of the Enterprises’ credit-risk transfer programs in their first three years, much is yet to be determined.
Because the programs have not been implemented through an entire housing price cycle, it is too soon to say whether the credit-risk transfer transactions currently ongoing will make economic sense in all stages of the cycle. Specifically, we cannot know the extent to which investors will continue to participate through a housing downturn. Additionally, the investor base and pricing for these transactions could be affected by a higher interest rate environment in which other fixed-income securities may be more attractive alternatives. Given this uncertainty, some within the industry, like the National Mortgage Banker’s Association and the Mortgage Insurance Industry, are recommending in a recent letter that more should be done, such as incorporating additional explicit, up-front, risk-sharing targets.
Conclusion: While there may be many benefits to pursuing “multiple forms” of up-front risk sharing, it should only be “considered” in terms of conversation - as it is too early to immediately move forward with that concept. Rather, the best course is to see whether investors will continue to participate in the current “up-front” risk-sharing program through the housing recovery cycle: if the current credit-risk transfer transactions program does not continue to yield very positive returns for taxpayers, then the GSE’s should consider the multi-risk sharing concept.