KEY mortgage finance SYSTEM REFORM CONCEPTS AND ISSUES

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General Observations:

The following concepts and topics have been compiled from various sources in an attempt to lay out and provide background for interested readers as the debate and actions take place on reforming the U.S. residential mortgage finance system.


Residential MORTGAGE FINANCE SYSTEM

The schematic here created by the FHFA depicts the life cyle of the housing and mortgage finance system. This may provide background to understand the role of today's participants and expectations on future roles as the mortgage finance system changes with legislative or regulatory actions.

One of the key areas of focus for GSE reform is the Secondary Market functions and participants, including Fannie & Freddie. A goal for mortgage finance reform is to return the mortgage finance system back to a private capital based system and reduce the role of the federal government which increased upon placement of Fannie & Freddie into conservatorship.


overview of current AND possible FUTURE roles or functions of fannie mae & freddie mac

DISCUSSION: As laid out by the FHFA in the above schematic, Fannie & Freddie have substantial roles today in many of the key functions supporting the secondary market. This duopoly today controls the secondary market for conventional mortgage loans.

DISCUSSION: Under concept laid out by a variety of organizations, including FHFA, MBA and others, Fannie & Freddie would be restructured such that their primary roles would be to aggregate loans from various originators and to arrange for the private capital credit enhancement. This would be the role of a Guarantor in the new mortgage finance system.


COMMON SECURITIZATION SOLUTION, LLC &

COMMON SECURITIZATION PLATFORM functions

DISCUSSION: A major project being undertaken by Fannie & Freddie with FHFA oversight is the development of a single MBS security and a new common securitization platform (CSP). The CSP will reside within Common Securitization Solutions LLC (CSS), which is equally owned by Fannie & Freddie.

The Single Security program will create a common mortgage-backed security to be issued by both Fannie & Freddie.

The CSP will be the IT system and operational platform. It will perform the core back office and key securitization functions such as bond issuance, settlement, disclosure, bond administration, tax reporting.

The development and implementation of the CSP is expected to be final in 2019. The cost to build is expected to be approximately $654 million and investments in preparing CSS to run and operate the CSP at approximately $465 million. Fannie and Freddie have contributed $928 million through Q4 2018 to CSS since commencement of project.

CSS is expected to be operated independently in the new mortgage finance system; possibly as a government corporation or as a private sector cooperative utility. The CSP is expected to be the focal point of all conventional mortgage securitization and open to any qualified firm meeting requirements of a Guarantor.

Sources of Information on Single Security and Common Securitization Platform:


RESOLUTION OF FANNIE & FREDDIE CONSERVATORSHIP

 

The resolution of Fannie & Freddie conservatorship is a key element of the mortgage finance system reform. Fannie & Freddie simplistically may be viewed as in two businesses: (1) single family mortgage securitization and (2) multifamily mortgage securitization and investment. Underlying each of these two businesses are critical infrastructure, technology and systems, operations and experienced staff. In addition, each GSE has other loan and investments on their balance sheet. The balance sheet risks - primarily interest rate - are managed through derivatives activities. And Fannie & Freddie recently have started making allocations to three affordable housing funds. Fannie & Freddie are also jointly involved in the development of a new common MBS security and a new common securitization platform. How do you restructure Fannie & Freddie and reposition these activities without impacting other participants in the U.S. mortgage finance system? There is renewed consensus that now is the right time to proceed to create the legislative framework for action as Fannie & Freddie's profitability is leveling off and dividends to U.S. Treasury are declining. And with the net worth floor eliminated next year, U.S. Treasury and FHFA amend agreement to establish an ongoing $3.0 billion Capital Reserve floor.

Link to Senior Preferred Stock Agreements (FHFA website)                   Link to FAQs on Senior Preferred Stock

Link to Fact Sheet on Senior Preferred Stock Agreements                      Link to 2017/12/21 FHFA Announcement Capital Reserve

Link to Fannie Mae letter amending SPSA                                              Link to Freddie Mac letter amending SPSA    

 

Fannie Mae & Freddie Mac - Treasury Payments and Profitability Trends: Using a pro forma pre-tax adjusted income approach (not perfect and others may have their own approach), let's eliminate the impact of taxes, credit costs (provision or benefit for credit losses and other real estate expenses), litigation settlements, various gains, losses or net impairment of investment securities and gains or losses on derivative activities. The resulting "adjusted income" shows a declining trend toward a new sustainable level reflecting the change in business models (CRT costs, reduction in investment securities, etc.). Annually Fannie & Freddie are earning between $25 and 30 billion. Assuming pre-tax P/E equivalent of 10, could Fannie & Freddie's combined value be $250 to $300 billion? On 2017/12/21, U.S. Treasury and FHFA agree to amend preferred stock agreement to create a Capital Reserve requirement of $3 billion with quarterly earnings above that level to be declared and paid as dividends: Fannie Mae letter, Freddie Mac letter and FHFA announcement. Through Q4 2018 and including and expected Q1 2019 payment, U.S. Treasury has received a net $106 billion and earned an annualized +11% on their senior preferred stock holdings.


GUARANTEE FEES

Guarantee fees will be an important element as mortgage finance system reform occurs. Today, Fannie & Freddie charge an average annual g-fee of 55 basis points that includes 10 bps for Temporary Payroll Tax Cut Continuation Act of 2011 and has leveled off over the past few years. Fannie & Freddie earn a net guarantee fee of 45 basis points after remitting the 10 bps “payroll tax” charge back to the U.S. Treasury. This is Fannie & Freddie's core revenue source to cover their MBS guarantee risk, including the cost of the credit risk transfer programs (Freddie Mac indicates in S.E.C. filing that CRT costs utilize approximately 31%, on average, of their g-fee revenues for those specific portfolios).

Here is link to FHFA website page on Guarantee Fees.


GUARANTORS AND CREDIT RISK TRANSFER

 

DISCUSSION:  Fannie & Freddie have implement credit risk transfer (CRT) programs over the past several years. These CRT programs have CRT bonds and insurance. The above table summarizes the CRT bond activity and risk transferred. Fannie & Freddie also use insurance to transfer some of the retained risk from these CRT bond programs. While there are a variety of means to estimated the cost of these programs to transfer risk to private investors, we show an estimate of the portfolio lifetime costs over the typical 10 - 12 year life of these bonds. Depending upon your estimates of duration, these lifetime costs may translate into 15 to 18 bps annually. Freddie reports that the CRT program utilizes approximately one-third of the average guarantee fee that it charges for those portfolios underlying CRT transactions.

DISCUSSION: Fannie & Freddie have implement credit risk transfer (CRT) programs over the past several years. These CRT programs have CRT bonds and insurance. The above table summarizes the CRT bond activity and risk transferred. Fannie & Freddie also use insurance to transfer some of the retained risk from these CRT bond programs. While there are a variety of means to estimated the cost of these programs to transfer risk to private investors, we show an estimate of the portfolio lifetime costs over the typical 10 - 12 year life of these bonds. Depending upon your estimates of duration, these lifetime costs may translate into 15 to 18 bps annually. Freddie reports that the CRT program utilizes approximately one-third of the average guarantee fee that it charges for those portfolios underlying CRT transactions.

DISCUSSION:  While there are differences in transaction structures for loss sharing as Fannie & Freddie continue the R&D, there is generally a L-shaped loss sharing or risk transfer arrangement structured. The GSEs have generally retained approximately 70 percent of the First Loss Position while transferring that level of risk in the more senior tranches.  As Fannie & Freddie continue to develop a market for CRT transfers, is this the expected standard going forward - with or without GSE reform?

DISCUSSION: While there are differences in transaction structures for loss sharing as Fannie & Freddie continue the R&D, there is generally a L-shaped loss sharing or risk transfer arrangement structured. The GSEs have generally retained approximately 70 percent of the First Loss Position while transferring that level of risk in the more senior tranches.

As Fannie & Freddie continue to develop a market for CRT transfers, is this the expected standard going forward - with or without GSE reform?

The following links to sources of information on various Fannie & Freddie CRT programs may be informative:

Freddie Mac Credit Risk Offerings                 Fannie Mae Credit Risk Offerings

STACR Investor Profiles                                   CAS Investor Profiles

STACR Issuance Calendar                              CAS Issuance Calendar                    


SMALL LENDER ACCESS

"Small Lender" access has been a key topic over the past few years in discussions of mortgage finance system reform and GSE reform. Only in recent years has the guarantee fees charged to small lenders become equal to that charged large lenders - no more volume discounting. Small Lender access may also be relevant as consideration of regulation continues as there is concern that the costs of compliance is disproportionate to small lenders. In Senate Banking Committee hearings in 2017 and in 2013, there were sessions on "Maintaining Access for Small Lenders", "Protecting Small Lender Access to the Secondary Market" and "Creating a Housing Finance System Built to Last: Ensuring Access for Community Institutions". Small lenders - banks, thrifts, credit unions, mortgage banks, mortgage brokers and others - play an important role in our mortgage finance system and need a level playing field and equal access to the secondary market.

DISCUSSION:  Small lenders remain an important source of mortgage originations and mortgage sales into the secondary market. This is especially true for those community financial institutions serving rural markets. For discussion purposes, let's define "small lender" using the bank & thrift data above as having less than $10 billion in total assets. During Q3 2018, "small lender" community banks & thrifts sold nearly $56 billion of mortgage loans originated for resale into the secondary market. This level represents ~15 percent of agency MBS issued during that quarter. So while not dominant, "small lenders" play a critical role in the U.S. mortgage finance system and require equal access as any changes to the functioning of the secondary market occur.

DISCUSSION: Small lenders remain an important source of mortgage originations and mortgage sales into the secondary market. This is especially true for those community financial institutions serving rural markets. For discussion purposes, let's define "small lender" using the bank & thrift data above as having less than $10 billion in total assets. During Q3 2018, "small lender" community banks & thrifts sold nearly $56 billion of mortgage loans originated for resale into the secondary market. This level represents ~15 percent of agency MBS issued during that quarter. So while not dominant, "small lenders" play a critical role in the U.S. mortgage finance system and require equal access as any changes to the functioning of the secondary market occur.

DISCUSSION:  It is also important to understand that the credit quality and underwriting of mortgage loans by "small lenders" has been superior to that of the top 100 banks as reported by the Federal Reserve. While loan delinquency did rise during the mortgage crisis, it was still only one-third of the level of loan delinquencies reported for the large banks. And, even today,as mortgage loan quality continues to improve for all banks, "small lenders" loan delinquency remains less than one-half that of the larger banks.

DISCUSSION: It is also important to understand that the credit quality and underwriting of mortgage loans by "small lenders" has been superior to that of the top 100 banks as reported by the Federal Reserve. While loan delinquency did rise during the mortgage crisis, it was still only one-third of the level of loan delinquencies reported for the large banks. And, even today,as mortgage loan quality continues to improve for all banks, "small lenders" loan delinquency remains less than one-half that of the larger banks.


AFFORDABLE HOUSING SUPPORT

DISCUSSION: With home prices continuing to rise, homeownership rate falling, rental vacancy rates declining and rents rising, there remain concerns over the affordability of housing: owner-occupied and rental. This is a topic of much discussion, including at a recent Senate Banking Committee hearing: Center for Responsible Lending testimony.

There several key affordable housing programs in place today. The Federal Home Loan Banks have an affordable housing assessment annually that is used by the eleven FHLBanks to support affordable housing and first-time home buyers (link to program summary).

Starting in 2017, Fannie & Freddie started making allocations to support two housing trust funds, including HUD's Housing Trust Fund (65% allocation) and Treasury's Capital Magnet Fund (35% allocation). Link to FHFA report on Fannie & Freddie programs to support affordable housing and underserved markets.

Together, these important programs invest approximately $0.8 billion annually in support of affordable housing.

As GSE and mortgage finance system reform discussions continue, affordable housing will be a key element of those discussions.