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The adverse market refinance fee on mortgages is unwarranted

The fee has nothing to do with risk — it's about building up the capital of Fannie and Freddie

Fannie Mae and Freddie Mac released their Q3 earnings last week, reflecting a combined $6.7 billion in net income, up significantly from the previous quarter. This strong performance was not unexpected, but makes the upcoming 50 basis point adverse market refinance fee more puzzling.

In their earnings Q3 2020 10-Q release, Fannie Mae states the following, “We are implementing a new adverse market refinance fee in light of the increased costs and risk we expect to incur due to the COVID-19 pandemic.”

Seriously? Fannie produced $7.2 billion in consolidated net income YTD with an impressive fourth quarter likely yet to come. And while they certainly are key to providing enormous liquidity to the nation’s housing system, the results would never be what they were if it were not for two things.

First, Federal Reserve actions loaded taxpayers with debt that now exceeds total GDP, pushing mortgage rates to historic lows. Second, agency MBS is one of two Triple-A rated instruments in housing on this earth, along with GNMA MBS, and draws investors globally. That rating has nothing to do with the GSEs’ skill sets, it comes from the government guaranty backing these companies.

In other words, for the GSEs, this success was unavoidable. The government’s response to the COVID pandemic drove rates low, spurring consumer demand and the GSEs now benefit by being able to execute through any private capital option because of their exclusivity of the guaranty.

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So one has to ask, why are they piling on to their earnings with a new 50bps adverse market refinance fee? Keep in mind, over half of their guaranty book this quarter was rate and term refinances. Add in cash-out loans and the total refinance book is running approximately two thirds of total new production. 

The implications for the adverse market fee starting Dec. 1 are clear, as stated in Fannie’s own 10-Q, “If refinances continue to be a large proportion of our acquisitions in 2021, we expect our average charged guaranty fee on new single-family conventional acquisitions to increase in 2021 as a result of the new adverse market refinance fee we plan to implement on December 1, 2020.” And they add, “For every $1 billion in eligible refinance loans we acquire, we will collect $5 million in adverse market refinance fees, which will be amortized into net interest income over the contractual life of the loans as a cost basis adjustment.”

So, is this warranted? After all, they state that this was implemented in light of increased costs and risks given COVID implications. This is where I dispute the point. In fact, I would argue that this was done simply because FHFA director Mark Calabria saw an opportunity to build capital more quickly to achieve his stated goal of releasing the two companies from conservatorship. They are, in essence, arbitraging the work of other federal agencies to stem the impact of COVID on the economy and using this as an opportunity to skim profits as opposed to supporting the housing sector.

So is there more risk in refis? The answer is no. The Federal Reserve of New York looked at refinanced GSE loans on default risk and released a detailed analysis of post-HARP refinance borrower performance to determine the net impacts to risk resulting from refinancing millions of Americans into lower rates after the Great Recession. Their conclusion, after a lengthy fact-based analysis was simple, “we find that lowering monthly mortgage payments by refinancing decreases the likelihood of default — on mortgages as well as other debts — substantially.”

What adds to reducing the risk for the GSEs this time? Refinancing a borrower during COVID resets the qualification test. In other words, the GSEs get to see refreshed income, FICO, and asset data, thus insuring that this pool of borrowers are survivors of the COVID degradation to the economy. In short, they are getting the best credit quality borrowers in the mortgage market with confirmed fresh credit data.

In addition, whether through an AVM and subsequent PIW (property inspection waiver) or a full appraisal, they are getting the benefit of resetting the new LTV which lowers the expected severity rate in the event of default, let alone lower expected default altogether.

The New York Fed study showed that it didn’t take much of a payment reduction to improve default risk. The GSEs are driving billions of volume into new MBS that are the best of credit quality borrowers amid a pandemic. They have re-benchmarked their book, and continue to do so.

For Fannie and Freddie, this free ride on the back of a Fed-driven rate rally is an integrity question. I now understand why so many call for a utility-like governance structure for these two companies. This needless profit-taking on the backs of homeowners at a time when legislators and other regulators are doing everything possible to put as many dollars in consumers’ hands in order to stave off an even worse outcome is something that should alarm Americans.

And for the reader, don’t just take the New York Fed’s study as fact. Look at these statements from Fannie Mae’s own Q3 10-Q:

  1. “Credit-related income (expense). Increases in mortgage interest rates tend to lengthen the expected lives of our loans, which generally increases the expected impairment and provision for credit losses on such loans. Decreases in mortgage interest rates tend to shorten the expected lives of our loans, which reduces the impairment and provision for credit losses on such loans.”
  2. “Home price growth in the third quarter of 2020 was unseasonably strong despite the COVID-19 pandemic, benefiting from continued low interest rates, low levels of supply and high levels of demand, particularly from first-time homebuyers. We currently expect home prices on a national basis to increase 7.0% in 2020, compared with 4.8% home price growth in 2019.”
  3. “Benefit from lower actual and projected interest rates. For much of 2020, we continued to be in a historically low interest rate environment. As mortgage interest rates decline, we expect an increase in future prepayments on single- family loans…which decreases the expected impairment relating to term and interest-rate concessions provided on these loans and results in a benefit for credit losses.

In the end, they credit the performance of their book on three things: lower rates, high home price appreciation, and recategorizing some loans from HFI to HFS.

The bottom line? The FHFA, in its hell-bent effort to release the GSEs, is using a global pandemic and subsequent federal response to thumb its nose again at its role here. Instead of helping facilitate every dollar possible to be put in the hands of the consumer, they are skimming massive incremental revenue starting Dec. 1 into their coffers off the refinance business, the portion of their book that is the least risky. That’s not me saying it’s less risky — it’s simply taking them at their own words.

The GSEs are critical tools for the U.S. housing system. But these actions should make everyone ask the big question: Will the housing finance system really be better off by turning these companies back into privately held mega-firms whose goals for returns exceed the responsibility of their own charters? After all, if this is how they behave in a national crisis, what’s next?

I’ll end with this. My intent is not to antagonize the FHFA or the GSEs. I am simply using their data, their words, and pointing out the obvious. This 50bps adverse market refinance fee has nothing to do with risk. It’s all about their own ulterior motives to build capital and be released. As taxpayers who will ultimately be held responsible for supporting the Fed’s MBS purchases, the national debt obligations, and the guaranty behind these two firms, we should demand better. 

This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.

To contact the author of this story:
Dave Stevens at

To contact the editor responsible for this story:
Sarah Wheeler at

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