FHFA moves closer to ending conservatorship, issues new rule on allowing Fannie Mae, Freddie Mac to build capital

New proposal would require the GSEs to hold $234 billion in combined capital

Fannie Mae and Freddie Mac moved closer this week to ending their decade-plus-long stay in conservatorship when they announced that they are looking for financial advisors to assist in a stock offering that removes the companies from government control.

But that’s not the only step the government-sponsored enterprises are taking this week towards exiting conservatorship.

The Federal Housing Finance Agency announced Thursday that it is proposing a new rule to allow the GSEs to rebuild their capital bases in advance of leaving conservatorship.

This is actually the second time the FHFA has issued new capital rules for the GSEs in the last two years.

In 2018, the FHFA proposed a rule to implement new capital requirements for Fannie Mae and Freddie Mac.

The move made headlines at the time, but the plan was viewed as merely a thought exercise because under the rule, the capital requirements would have only gone into effect when the companies exited conservatorship.

Under the leadership of then-FHFA Director Mel Watt, the GSEs exiting conservatorship seemed like a pipe dream due to Watt’s view that it was Congress’ duty to act on housing finance reform.

But FHFA Director Mark Calabria has a different view on the matter and is moving full steam towards privatizing the GSEs.

Late last year, the FHFA announced that it was doing away with the 2018 rule and moving forward with a new rule, which was originally expected to be released earlier in 2020.

But that changed in March when the coronavirus was first taking hold in the U.S. At the time, Calabria said that the FHFA would be releasing the new capital rule in late May, which is exactly what the agency did.

According to the FHFA, the 2018 proposal “remains the foundation” of these new plans, but expands on the previous plans.

“The enhancements in the new proposal preserve the mortgage risk-sensitive framework of the 2018 proposal, while increasing the quantity and quality of the Enterprises’ regulatory capital and reducing the pro-cyclicality of the aggregate capital requirements,” the FHFA said in a statement. “Together, the enhancements in the re-proposal ensure each Enterprise’s safety and soundness and its ability to fulfill its statutory mission across the economic cycle, in particular during periods of financial stress.”

As for the rule itself, it appears that the GSEs will end up holding bank-like capital levels, roughly equal to the levels required by the world’s biggest banks, otherwise known as the “Systemically Important Financial Institutions.”

According to Instinet analyst Matthew Howlett, the new proposal would require the GSEs to hold $234 billion in combined capital, based on their asset level as of Sept. 30, 2019.

That’s far beyond the $45 billion in combined capital the GSEs are allowed to retain now and far cry from the $0 in capital they used to be allowed to hold.

“The FHFA’s proposed rule puts the GSEs on track to be the strongest capitalized financial institutions in the world, which we believe should create substantial global investor demand,” Howlett wrote in a note to clients. “We note that the release should come not only as a relief to the market (i.e., worst-case scenario avoided) but also as the strongest indication the FHFA remains committed to privatizing Fannie/Freddie and releasing them from government control.”

According to Howlett, the proposal is a clear indication that the GSEs will be publicly traded companies in the future.

“The overall proposal is clear; there is no substitute for equity capital,” Howlett wrote. “The plan is a nod by the FHFA that the GSEs need to be in a position to attract and retain substantial equity capital going forward.”

In Howlett’s view, however, the GSEs’ full exit from conservatorship likely won’t happen for several years due to how much money they’ll need to raise. According to Howlett, Instinet’s analysts now expect the GSEs to fully exit conservatorship at some point in 2024.

As for the mortgage business itself, Howlett states that these new rules could make GSE mortgages more expensive.

According to Howlett, the new plan makes it more likely that the FHFA will order the GSEs to increase the fees they charge lenders to guarantee loans (otherwise known as G-fees) by approximately 10 basis points to “improve required returns for shareholders.”

The increased G-fees would likely be passed along to the borrowers, meaning an increased interest rate or more fees on a loan.

Nevertheless, all parties involved from the government side of things are pleased with the rule.

“This national health crisis has affirmed the importance of the Enterprises’ mission to serve the American housing market during good times and bad,” Calabria said.

“When credit dries up, low- and moderate-income households are hurt most. We must chart a course for the Enterprises toward a sound capital footing so they can help all Americans in times of stress. More capital means a stronger foundation on which to weather crises. The time to act is now.”

The FHFA’s proposal is supported by Department of the Treasury Secretary Steve Mnuchin, who said that the rule is an “important” step in ending the GSE conservatorship.

“I commend Director Mark Calabria and the FHFA for their work on this issue,” Mnuchin said in a statement. “Establishing regulatory capital requirements for both GSEs represents an important step toward bringing the conservatorships to an end. Appropriate capitalization of the GSEs will be critical to protecting taxpayers, fostering market discipline, promoting stability in the housing finance system, and ensuring durable consumer access to mortgage credit.”

Both Fannie and Freddie also expressed their support for the rule.

“The reproposal of this critical rule marks another important milestone in our path out of conservatorship,” Freddie Mac CEO David Brickman said. “I thank Director Calabria for his leadership in moving this rule forward. As Freddie Mac takes unprecedented steps to assist homeowners and renters adversely affected by COVID-19, we remain focused on preparing for our responsible exit from conservatorship.”

Fannie Mae CEO Hugh Frater agreed.

“FHFA’s proposed regulatory capital rule marks the start of an important new chapter for Fannie Mae,” Frater said. “These next steps toward our recapitalization and release from conservatorship are more than 10 years in the making, and we thank Director Calabria for his leadership during this process.”

To read much more about the rule from the FHFA itself, click here and here.

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