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Fannie Mae, Freddie Mac look for more ways to share credit risk

GSEs provide update on risk-sharing programs; seek input on front-end deals

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The federal government is looking for additional methods and mechanisms that it can use to transfer credit risk currently borne by Fannie Mae and Freddie Mac, and therefore the American taxpayers, to private investors.

On Wednesday, the Federal Housing Finance Agency published details of the credit risk-sharing histories of Fannie and Freddie, and issued a request for input on ways that the government-sponsored enterprises can shift more risk to the private market.

According to the FHFA report on the risk-sharing deals, the GSEs executed a total of 43 risk-sharing deals in 2015, moving a portion of the risk on $417.1 billion in unpaid principal balance to private investors.

The FHFA report states that in total, the GSEs have transferred a portion of the risk on $837.9 billion in UPB since 2013.

According to the FHFA report, the corresponding amount of credit risk transferred on these loans is $30.6 billion, which represents, on average, about 3.6% of the UPB of credit loss protection for those loans.

The risk-sharing deals are significant because they provide further protection against credit loss for the GSEs beyond primary mortgage insurance, which is currently the “dominant method” for sharing risk on higher loan-to-value mortgage acquisitions.

But, as the FHFA cautions, mortgage insurance isn’t necessarily enough to cover for loan losses, especially in a “stress event” like the housing crisis.

“During stress events such as the recent financial crisis, for example, loan-level losses can exceed mortgage insurance coverage, leaving the Enterprises with the remaining credit risk,” the FHFA said in its report.

“For example, Enterprise loans with LTV ratios above 80% that were originated in 2006 and 2007 experienced average loss severities ranging from 29.4% to 33.2% after giving credit to any mortgage insurance benefit or lender indemnification,” the FHFA continued. “For many of these loans, loss severities exceeded the applicable mortgage insurance coverage level, which caused the Enterprises to absorb additional losses.”

And with the GSEs capital buffer on its way to zero, increasing the need for more robust risk-sharing programs from the GSEs moving forward.

Per the Preferred Stock Purchase Agreements, which went into effect when the government took Fannie and Freddie and require the government-sponsored enterprises send dividends to the Department of the Treasury each quarter that they are profitable.

Currently, under the PSPAs, the GSEs are prohibited from rebuilding capital and each of the GSEs’ capital base is required to be reduced, with their capital reserves scheduled to be drawn down to $0 in 2018.

To that end, the FHFA also put out a request for input for improving its current risk-sharing offerings and developing new risk-sharing structures.

Part of that request for input centers on possible, additional “front-end” credit risk transfer structures.

According to the FHFA, it distinguishes between “front-end” and “back-end” credit risk transfer transactions based on when the arrangement of the credit risk transfer occurs.

“Front-end” or “up-front” credit risk transfer transactions are those in which the arrangement of the risk transfer occurs prior to, or simultaneous with, the acquisition of residential mortgage loans by one of the GSEs, such as a collateralized recourse transaction.

“Back-end” credit risk transfer applies to transactions in which the arrangement of the risk transfer occurs after the acquisition of residential mortgage loans by the GSEs.

Much of the GSEs current risk-sharing is conducted via “back-end” transactions, including Freddie Mac’s Structured Agency Credit Risk or Fannie Mae’s Connecticut Avenue Securities debt transactions.

According to the FHFA, it is exploring more front-end risk-sharing moving forward.

One of those potential methods is developing a deeper mortgage insurance structure, which the FHFA said that it is currently evaluating with the GSEs.

Click here for the FHFA’s full risk-sharing report, and click here for the FHFA request for input on future risk-sharing.

“The Credit Risk Transfer Progress Report demonstrates transparency and documents that there has been a great deal of progress in the credit risk transfer market in a short period of time, even though the market is still relatively young,” said FHFA Director Mel Watt.

“The Request for Input demonstrates our commitment to build upon the progress and expand the array of credit risk transfer products,” Watt said. “Feedback from stakeholders is critical as we explore additional ways to enhance these programs and expand the investor base.”

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