that the conservatorships of Fannie Mae and Freddie Mac (the GSEs) have caused
government involvement in the mortgage market to balloon to unhealthy
proportions, the Mortgage Bankers Association (MBA) Monday released the second
in a planned series of five concept papers offering its solutions. Today's paper on risk sharing follows Key
Steps on the Road to GSE Reform, which suggests that the Federal Housing
Finance Agency (FHFA) direct the GSEs to modify the Freddie Mac PC to mirror
the exact structure of the Fannie Mae MBS so that these securities would be
considered fungible for TBA delivery.
In Up-Front Risk Sharing: Ensuring Private Capital Delivers for
MBA says a situation exists today where the
government is crowding out private capital and blocking real competition in the
market. MBA's solution to entice private
capital back is for FHFA to require the GSEs to offer risk sharing options to
lenders at the "point of sale" rather than at the back end by enhancing loans
that are already on the GSEs' balance sheets.
The GSEs should be
required to accept loans with deeper levels of credit enhancement in return for
bona fide reductions in guarantee fees and other loan level charges. MBA says that GSE (g-fees) fees have more than doubledover the last few years even as their acquisition profile shows
they are taking on very little credit risk, For example, average credit scores for
mortgage purchases prior to the crisis were about 720, today they are 760 and
weighted LTV scores outside of HARP originations are several percentage points
lower than they were pre-crisis.
With this combination
of high fees and ultra conservative underwriting it is not surprising that the
GSEs are seeing record profits. "Their
revenues are up and their costs are down, not through their execution, but
through government fiat and a privileged market position," the paper says.
Providing an option
for lenders to secure loan-level private credit enhancement could create
effective competition with guarantee fees now averaging 50 basis points. Indications are that FHFA is likely to
continue to raise these fees, perhaps to 70 basis points or higher. With an alternative private credit
enhancement channel at those higher rates consumers could be saving at least 20
basis points or $400 per year on a $200,000 loan.
Unlike what is envisioned
by the current FHFA strategic plan, this risk sharing should occur at the front
end of the transaction. FHFA is
currently calling for $30 billion in risk sharing by welcoming private capital
through additional mortgage insurance after the loans are in their hands. This benefits the GSEs, the taxpayer, and the
private insurer but not the borrower.
Moreover the GSEs maintain complete control over the transaction.
By moving the
insurance transaction to precede the sales lenders would effectively "de-risk"
the loans before selling them and the mortgage insurers would be competing for
business in the open market across hundreds of lenders rather than through negotiated
transactions with the two GSEs.
lenders today are responsible for securing credit enhancements - i.e. mortgage
insurance or lender recourse - for loans with LTV's above 80 percent, under a
front-end risk sharing arrangements the GSEs would provide a reduction in
g-fees and LLPA if lenders secured credit enhancement on lower LTV loans or
deeper enhancements on higher LTV loans that might lower them effectively to 50
or 60 percent. The result would be a much lower g-fee
designed to cover only severe or catastrophic risk.
This pricing tradeoff needs to be transparent and the opportunity to make this tradeoff needs to be open to all approved sellers and to MIs or other credit enhancers that meet rigorous financial safety standards. This risk share structure should be available across the LTV spectrum.
Deep first loss credit enhancements would significantly reduce taxpayer risk in any future distressed economic scenario. Allowing private capital to assume deeper credit risk will result in a reduction of recent guarantee fee increases intended to "crowd-in" private capital, and a net decrease in overall fees and LLPAs. As a result, the benefits of
sharing gets transferred to consumers.
potential concerns about their proposals.
First, does it over-rely on private mortgage insurers that are in some
cases still recovering from the downturn?
MBA says there are risks in any system that relies on private
capital. Private mortgage insurers have
regulated contingency reserves that largely survived the downturn and in the
event of another severe event any form of private capital enhancement that
failed would not be bailed out by taxpayers
Importantly, the existing companies have recently been able to raise significant additional equity, and there are new entrants in the market. If this proposal moves forward, many investors, not just traditional mortgage insurers, will likely see opportunity and will bring additional capital into the credit enhancement space where they need to be held to rigorous
financial strength standards.
There is also the
question of whether the GSEs would be willing participants in this up-front
risk sharing. Both are making record
profits from guarantee fees and may not be willing to give up the benefits of
what MBA calls "crowding out private credit enhancement." MBA says FHFA should require the GSEs to
offer a front-end risk sharing program as part of its stated goal of
contracting the current footprint of the GSEs in the market while maintaining
MBA's concept paper concludes by saying
that the 60 percent of new mortgage originations that are now sold to the GSEs
means that the latter's credit pricing has determined and cost of and access to
credit for a majority of all new mortgages.
By allowing other private credit enhancers to play a meaningful role at
the front end of the transaction, competition will be increased and the
benefits delivered to both taxpayers and consumers.