The Federal Housing Finance Agency (FHFA) has released new draft requirements for private insurance companies that insure mortgages purchased by the two government sponsored enterprises (GSEs) Freddie Mac and Fannie Mae.  FHFA is inviting public comment on the draft which incorporates standards for financial capital requirements, enhanced operational performance expectations and defines remedial actions that would apply should an approved insurer fail to comply with the revised requirements.

The GSEs are required by their charters to obtain private mortgage insurance (PMI) on loans they purchase or guarantee that have loan-to-value ratios exceeding 80 percent.  Provision of this insurance is limited by the GSEs to the companies they have approved to do so.  Using private insurance from a sound counterparty, FHFA says, helps reduce the loss from default and shifts first-loss exposure from the Treasury and taxpayers to a third party.

The GSE's each maintain their own lists of approved insurers and their own criteria for approval. These criteria have not been updated since 2003 in the case of Fannie Mae and 2008 for Freddie Mac.  The existing requirements rely primarily on an acceptable rating by a major rating agency as opposed to specific counterparty risk and financial standards defined by a GSE.  They also do not adequately, in FHFA's estimation, address the liquidity of capital.

During the financial crisis and the resulting rise in defaults and foreclosures mortgage insurers and the GSEs suffered significant losses.  Several PMI companies were taken into receiverships by state insurance commissioners which regulate their operation and others stopped writing new business.

When FHFA as their conservator began the process of aligning the operations of the two GSEs it directed them to revise, expand and align their risk management requirements for the insurance and insurers.  The current draft, the agency said, is the result of a multi-year effort to produce a clear and comprehensive set of standards.  FHFA and the GSEs have consulted with state insurance commissioners and private mortgage insurers that are currently approved to do business with Fannie Mae or Freddie Mac regarding the draft requirements.

"Mortgage insurance counterparties must be able to fulfill their intended role of providing private capital, even in adverse market conditions," FHFA Director Mel Watt said. "FHFA's Strategic Plan calls on Fannie Mae and Freddie Mac to strengthen the requirements for private mortgage insurance companies that do business with them in order to reduce Fannie Mae's and Freddie Mac's overall risk exposure and protect taxpayers."

FHFA will be accepting public comment on the draft requirements for 60 days or until September 8, 2014.  The requirements, when finalized, will apply only to private insurance providers which are currently approved to write policies for GSE loans or wish to be approved to do so.

The eligibility requirements will become effective 180 after the final version is published.  In the interim any approved insurer that does not fully meet each GSE's existing eligibility requirements would continue to operate in its current status while transitioning to the new standards.  An approved insurer that does not meet all of the financial requirements would have two years to fully comply