Tag Archives: MI

Fannie and Freddie’s Credit Risk Transfers

Posted on by

The Urban Institute’s Housing Finance Policy Center has released its February 2017 Housing Finance at a Glance Chartbook, always a great resource for housing geeks. Each Chartbook highlights one topic. This one focuses on GSE credit risk transfers, an important but technical subject:

The GSE’s credit risk transfer (CRT) program is growing and tapping into a more diverse investor base, reducing the costs of CRTs and improving liquidity in this market. At the same time, the continued reliance on back-end transactions is cause for concern
.
Freddie Mac‘s first two capital markets CRT transactions of 2017 have been different from previous Structured Agency Credit Risk (STACR) transactions in one important way. Unlike the pre-2017 deals, in which the first loss piece (Tranche B) was 100 basis points thick, the first loss piece (Tranche B2) in the latest transactions is only 50 basis points thick while second loss piece (B1) is also 50 basis points thick. Splitting the old B tranche more granularly in this manner is a noteworthy development for a few reasons.
Although this is hardly the first improvement the GSEs have made to their back-end CRT execution, it is an important one. Splitting the offering into more granular risk buckets will force investors to price the tranches more accurately, thus facilitating more precise price discovery of credit risk. More granular tranching will also help increase the demand for STACR securities. Investors who were previously willing, but unable to invest in the B tranche because investment guidelines prohibited them from taking first loss credit risk will now instead be able to invest in the second loss B1 tranche, which offers a higher expected returns than the previous second loss tranche (M2). Growing and diversifying the investor base is important because it makes the bidding process more efficient and minimizes the cost of risk transfer for Freddie Mac and the taxpayer. A larger, more diverse investor base also bodes well for the liquidity of the CRT market, which is still in its infancy.
Clearly, these innovations are important steps towards improving the efficiency of back-end CRT. But at the same time, they must be viewed in the context of the broader objectives of credit risk transfer and housing finance reform which have near unanimous support: reducing taxpayer risk, passing the benefits of CRT on to borrowers, facilitating broad availability of credit through the economic cycle, ensuring adequate access for lenders of all sizes, and promoting a variety of CRT executions, including at the front end to facilitate an understanding of which programs are most favorable under which circumstances.
Although the GSEs have experimented with front end mechanisms like lender recourse and deeper MI, these transactions have been few and far between, and with very little transparency about pricing and other terms. But more importantly, the GSEs’ continued and significant reliance on back-end capital markets transactions doesn’t put us on a path towards achieving some of the program objectives outlined above. This matters because it signals that the GSEs’ current strategy for credit risk transfer, which revolves largely around the success of back-end transactions, may ultimately keep the program from realizing its full potential. (5)
 So, all in all Fannie and Freddie are taking a step in the right direction, but it is just a small step on the road to housing finance reform.

Mortgage Bankers and GSE Reform

Posted on by

photo by Daniel Case

The Mortgage Bankers Association has released GSE Reform Principles and Guardrails. It opens,

This paper serves as an introduction to MBA’s recommended approach to GSE reform. Its purpose is to outline what MBA views as the key components of an end state, the principles that MBA believes should be incorporated in any future system, the “guardrails” we believe are necessary in our end state, as well as emphasize the need to ensure a smooth transition to the new secondary mortgage market. (1)

While there is very little that is new in this document, it is useful, nonetheless, as a statement of the industry’s position. The MBA has promulgated the following principles for housing finance reform:

  • The 30-year, fixed-rate, pre-payable single-family mortgage and longterm financing for multifamily mortgages should be preserved.
  • A deep, liquid TBA market for conventional single-family loans must be maintained. Eligible MBS backed by a well-defined pool of single-family mortgages or multifamily mortgages should receive an explicit government guarantee, funded by appropriately priced insurance premiums, to attract global capital and preserve liquidity during times of stress. The government guarantee should attach to the eligible MBS only, not to the guarantors or their debt.
  • The availability of affordable housing, both owned and rented, is vitally important; these needs should be addressed along a continuum, incorporating both single- and multifamily approaches for homeowners and renters.
  • The end-state system should facilitate equitable, transparent and direct access to secondary market programs for lenders of all sizes and business models.
  • A robust, innovative and purely private market should be able to co-exist alongside the government-backed market.
  • Existing multifamily financing executions should be preserved, and new options should be permitted.
  • The end-state system should rely on strong, transparent regulation and private capital (including primary-market credit enhancement such as mortgage insurance [MI] and lender recourse, or other available forms of credit risk transfer) primarily assuming most of the risk.
  • While the system will primarily rely on private capital, there should be a provision for a deeper level of government support in the event of a systemic crisis.
  • There should be a “bright line” between the primary and secondary mortgage markets, applying to both allowable activities and scope of regulation.
  • Transition risks to the new end-state model should be minimized, with special attention given to avoiding any operational disruptions. (3-4)

This set of principles reflect the bipartisan consensus that had been developing around the Johnson-Crapo and Corker-Warner housing reform bills. The ten trillion dollar question, of course, is whether the Trump Administration and Congressional leaders like Jeb Hensarling (R-TX), the Chair of the House Banking Committee, are going to go along with the mortgage finance industry on this or whether they will push for a system with far less government involvement than is contemplated by the MBA.