Melvin L. Watt, Director of the Federal Housing Finance Agency (FHFA) told the Senate Banking Committee today that Freddie Mac and Fannie Mae (the GSEs) will soon announce they will begin purchasing loans with downpayments of 3 or 5 percent, similar to those offered by FHA. Watt made the announcement in remarks prepared to update to the Committee on the GSEs and the Federal Home Loan Banks for which FHFA is regulator. The agency also serves as conservator of the two government sponsored enterprises.
Watt summarized the financial performance of the GSEs as significantly improved since the conservatorship began in 2008. While both entities have posted profits every quarter since the beginning of 2012 he said that some of the increased performance relates to one-time or transitory items, such as the reversal of each GSE's deferred tax asset valuation allowance, legal settlements, and the release of loss reserves associated with rising house prices. Other portions of the improvement are attributable to such factors as strengthened underwriting practices and increased guarantee fees.
Watt said that while the GSEs' financial condition and that of the mortgage market has stabilized, significant challenges such as continued elevated delinquency rates and counterparty exposure remain concerns.
Counterparty risks are in fact the focus of several supervisory guidance documents prepared by FHFA for the GSEs. One bulletin outlined the agency's expectations about the increasing numbers of transfers of mortgage servicing of GSE owned or guaranteed loans from federally-regulated banks to non-bank entities that typically have less regulation and more concentrated operations. These transfers were identified by the Financial Stability Oversight Council as presenting heightened risks.
The bulletin specifies that the GSEs should approve such transfers only when they are consistent with sound business practices, aligned with each GSE's board-approved risk appetite, and in compliance with regulatory and conservator requirements. They should also be subject to risk-based monitoring so that all servicing transfers occur in a timely manner and in accordance with approved terms, servicing guide requirements, and applicable mortgage servicing transfer-related laws and regulations.
Another risk area FHFA has addressed is that of information security. In a bulletin FHFA stressed its expectations that assessment of system vulnerabilities, effective monitoring of cyber risks, and oversight of third parties that have access to GSE data would be key components GSE cyber risk management.
FHFA's 2014 Strategic Plan for the Conservatorships of Fannie Mae and Freddie outlines FHFA's conservatorship objectives for the GSEs and the 2014 Conservatorship Scorecard details activities and expectations for the Enterprises during 2014. Watt said both the 2014 Conservatorship Strategic Plan and the 2014 Conservatorship Scorecard are centered around three strategic goals and outlined for the Committee some of the accomplishments under each.
Strategic Goal 1: Maintain, in a safe and sound manner, foreclosure prevention activities and credit availability for new and refinanced mortgages to foster liquid, efficient, competitive and resilient national housing finance markets.
FHFA is continuing the process of updating and clarifying the Representation and Warranty Framework which provides the GSEs with remedies - including requiring a lender to repurchase a loan - when they discover that a loan purchase does not meet their underwriting guidelines. This has focused on placing increased attention and resources on upfront quality control reviews in order to identify problems, possibly even before loans are purchased and thus reduce lenders uncertainty about repurchase requirements and paving the way for reduction of current credit overlays and borrower costs.
The first improvements in this framework went into effect in January 2013 and there were additional refinements in May 2014. FHFA has now announced an agreement in principle that will clarify and define the life-of-loan exclusions applicable to the Framework.
The smaller downpayment requirements expected shortly for GSE loans will require that borrowers have compensating factors and risk mitigants such as housing counseling or lower debt-to-income rations in order for the mortgage to be eligible for purchase. Additionally, like other loans with down payments below 20 percent, these loans will require credit enhancement, such as private mortgage insurance.
The GSEs have continued to reach out to small and rural lenders and Housing Finance Agencies to strengthen their understanding of how the GSEs might better serve them. Watt said these community-based institutions have a vital role serving rural and underserved markets across the country and FHFA knows that many of them could not be active in the housing market without access to a liquid secondary housing finance
The GSEs have continued to focus on loss mitigation and borrower assistance activities and as of August 31, 2014 had conducted more than 3.3 million foreclosure prevention actions since entering conservatorship. Watt said there are still areas of the country where the housing recovery has lagged and homeowners still need assistance so FHFA has worked to improve foreclosure prevention with efforts such as the Neighborhood Stabilization Initiative which is targeting Detroit and Chicago for a pilot program and with programs to make consumers aware of the Home Affordable Refinance Program (HARP). The GSEs also developed Streamlined Modification programs to address documentation challenges associated with traditional modifications, including for deeply delinquent loans.
For individuals and families who rent rather than buy, continuing to support affordable rental housing is also an ongoing priority for FHFA and the GSEs and the Strategic Plan and Scorecard maintain the GSE's multifamily production levels. FHFA has also continued to emphasize the GSEs' role in the affordable rental housing market, and has provided them with additional capacity to provide financing for such housing.
Strategic Goal 2: Reduce taxpayer risk through increasing the role of private capital in the mortgage market
FHFA has reformulated this goal so that it no longer involves specific steps to contract the GSEs' market presence but rather focuses on ways to scale back their overall risk exposure. One initiative has been to strengthen the GSEs' counterparty requirements for private mortgage insurers and the agency is reviewing comments in response to draft Private Mortgage Insurer Eligibility Requirements. Its assessments and policy decisions will take into account both safety and soundness considerations and possible impacts on access to credit and housing finance market liquidity.
FHFA also increased the 2014 Scorecard target to achieve a meaningful credit risk transfer of $90 billion in unpaid principal balance, up from $30 billion in 2013 and has encouraged the GSEs to test multiple types of credit risk transfer structures, which include securities-based transactions and insurance transactions.
As of November 1, 2014, Fannie Mae has transferred the credit risk associated with $183 billion in unpaid principal balance of single-family mortgages, and Freddie Mac has transferred credit risk associated with $169 billion in unpaid principal balance of single-family mortgages. In each transaction, the GSEs retained a small first-loss position in the underlying loans, sold a significant portion of the risk beyond the initial loss and then retained the catastrophic risk in the event losses exceeded the private capital support. The GSEs also continue to reduce the size of their retained mortgage portfolios consistent with the terms of their agreement with the Treasury Department.
Strategic Goal 3: Build a new single-family securitization infrastructure for use by the GSEs and adaptable for use by other participants in the secondary market in the future
FHFA's final strategic goal is to BUILD a new infrastructure for the GSEs' securitization functions which includes development of the Common Securitization Platform (CSP) infrastructure and to improve the liquidity of Enterprise securities. Progress in 2014 includes the identification of a Chief Executive Officer for Common Securitization Solutions (CSS), the corporate entity which is owned jointly by Fannie Mae and Freddie Mac and will ultimately house and operate the CSP. The governance structure and operating agreements concerning the CSS have been finalized and considerable progress made on the design-and- build phase of the CSP.
In pursuing a Single Security for the two GSEs FHFA's top priority is to deepen and strengthen liquidity in the housing finance markets. Today the mortgage-backed securities issued by Fannie Mae and Freddie Mac trade in separate "to-be-announced" (TBA) markets where there is a price disparity between them largely due to greater trading volumes of Fannie Mae securities. This imposes an additional cost on Freddie Mac to remain competitive.
Watt said one of his first decisions as FHFA director was to suspend scheduled increases in guarantee fees believing that the subject required more feedback from stakeholders. The agency requested comment both on those increases and on proposed GSE housing goals for 2015 through 2017 and is currently reviewing both sets of comments with an eye to both safety and soundness of the GSEs and the possible impact on access to credit and housing finance market liquidity. .
Turning to the Federal Home Loan Banks (FHLBanks), Watt said the system remains strong. Their aggregate balance sheet has increased over the past two years, but remains considerably smaller than in peak years. Advances totaled $545 billion as the end of the third quarter of 2014, up from $499 billion at year-end 2013, but down 50 percent from a peak of $1.01 trillion in the third quarter of 2008.
Watt says his agency's supervision of the FHLBanks' expanding mortgage programs involves oversight of operational issues required by two new products - Membership Partner Finance (MPF) Direct and MPF Government MBS. The FHLBank of Chicago is likely to begin offering both of these late this year or early next. Under MPF Direct, participating members would sell non-conforming and conforming, single-family, fixed-rate mortgage loans to the Chicago Bank, which would concurrently sell the loans to a third-party private investor for securitization. The Chicago Bank expects, at least initially, that loans sold will be "jumbo conforming" loans - capped at $729,750 for single unit loans in the contiguous United States.
Under the second program, the bank would purchase government guaranteed or insured loans, accumulate the loans on its balance sheet eventually pooling them in securities guaranteed by the Government National Mortgage Association (Ginnie Mae).