Mel Watts first acts as Director of the Federal Housing Finance Agency (FHFA)
in January 2014 was to suspend implementation of increases in the fees (g-fees)
charged lenders for originating loans guaranteed by Fannie Mae and Freddie Mac
(the GSEs). The fees had been announced
the previous month by Watt's predecessor Edward Donovan. The proposed
changes included an across-the-board 10 basis point increase in up-front fees charged to borrowers in different
risk categories and elimination
of the 25 basis point Adverse Market
Charge for all but four states. Watt announced that the postponement was to
allow time to permit further review.
Thursday FHFA issued a notice requesting public input on changes to the fees,
specifically regarding their optimum level and their implications for mortgage
credit availability. The public notice
period is for 60 days or until August 4, 2014.
There are two type of g-fees, ongoing and upfront. The latter is a one-time payment made by
lenders at the time a loan is acquired by a GSE, the ongoing fees are collected
each month over the life of the loan.
Both fees serve to compensate the GSE for providing its credit guarantee. The GSE's have had a preference for upfront
fees to reflect differences in risk, based primarily on operational
considerations as upfront fees are easier to implement. Lenders frequently convert upfront fees to
ongoing fees and pass them through to the borrower in the form of an increased
FHFA, as conservator of the GSEs
since August 2008, has used its authority to direct previous guarantee fee
increases based on safety and soundness concerns related to the underpricing of
mortgage credit risk, equalizing fee charges among lenders of different sizes,
and attracting private capital back into mortgage lending. The fees were also raised by Congress in 2011
(TCCA) as a way of funding the temporary payroll tax cut it authorized in 2011
The fees are used by the GSEs to
cover three types of costs; the costs they expect to bear, on average, when
borrowers fail to make their payments; the costs of holding economic capital to
protect against potentially much larger unexpected default losses; and general administrative
expenses. Collectively these are the
estimated costs of providing the credit guarantee. Of the three the cost of capital is the most
significant and the most difficult to project and FHFA has asked the GSEs to
set their g-fee levels consistent with the amount of capital they would need to
support their business if they were financially healthy and retained capital,
something they are not allowed to do under their current conservatorship arrangement.
To determine the estimated fees
needed to cover these costs each GSE calculates "gaps." A positive gap would be the profit the GSE
expects to make on a given loan above the target rate of return on
capital. Gaps are calculated by subtracting estimated costs from charged g-fees and
are expressed on an annual basis as a percent (in basis
points) of outstanding loan balance. A negative
gap does not necessarily mean that the GSE expects
to incur a loss on a set of
loans, but rather that it expects
to earn less than its targeted
return on capital.
FHFA provided the following grid of nine LTV and credit
score buckets that shows the average g-fee currently charged by both
GSEs and the percent of total
1Q2014 loan deliveries accounted for by the
bucket in question. The grid also
combines somewhat differing assumptions
currently used by each GSE regarding the average
amount of capital required
for each of the nine risk buckets, the target return on this
capital, and the average
estimated cost of providing the guarantee, including the benefit of private mortgage insurance where applicable. The amount of capital required by the GSEs'
pricing methodology increases with higher LTVs and lower credit
scores, as the magnitude of
unexpected losses are projected to increase. Overall
estimated costs of providing
the guarantee follow the same
pattern since the cost of capital is the primary driver
of estimated costs. Estimated credit-related costs of
borrowers failing to make payments (not shown) also act
in the same direction, but with a smaller
impact than the cost of capital.
buckets where the estimated
cost exceeds the charged g-fee,
the GSEs earn a positive
return on economic capital, although less than
their target return.
Finally, it is noteworthy that increases
in g-fees on higher-risk loans may result in originators insuring/securitizing some of
these loans with Federal Housing Administration (FHA)/Ginnie Mae rather
than one of the GSEs.
While this substitution would
reduce the GSEs' footprint in the mortgage markets, it would not reduce the federal government's overall footprint. On the
other hand, increases in g-fees for lower-risk
loans may make it more
profitable for banks or other private market
participants to retain these loans rather than selling
them to the GSEs.
FHFA's Request for Input lays out 12
specific questions on which they would like public comment although it invites
comments that are not directly responsive to those questions. These questions include the following:
Are there factors other than expected losses, unexpected losses,
and general and administrative expenses that FHFA
and the GSEs should consider in setting g-fees? What goals
should FHFA further in setting g-fees?
g-fee level would private-label securities (PLS) investors find it profitable to enter the market
or would depository institutions be willing to use their
own balance sheets to hold loans? Are
these levels the same? Is it desirable to set g-fees at PLS or depository price
levels to shrink the GSEs' footprints,
even if this causes g-fees
to be set higher than required to compensate taxpayers for bearing mortgage credit risk and results in higher costs to borrowers?
GSEs continue to raise g-fees, will
overall loan originations decrease?
Should risk-based pricing be uniform across the GSEs or should each manage its own pricing?
Are there interactions with the Consumer
Financial Protection Bureau's Qualified
Mortgage definition that FHFA
should consider in determining
The remaining questions as well as a
more detailed discussion of the basis of g-fees and the implications of their
use can be found in the Request
for Input from FHFA.