By the Numbers

The impact of FHFA announcements on mortgage credit

| September 17, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The suspension of caps on Fannie Mae and Freddie Mac purchases of investor and other loans and revisions to their capital requirements promise to reshape mortgage credit markets. The suspension of caps should modestly lower the flow of these agency-eligible loans into private securitizations. And the revised capital standards should increase the appeal of credit risk transfers, opening that market to a surge in issuance.

The Federal Housing Finance Agency along with the US Treasury on September 14 suspended portions of January amendments to the Preferred Stock Purchase Agreements struck between former FHFA Director Calabria and former Treasury Secretary Mnuchin. The announcement lifted limits on the amount of multifamily loans, single-family non-owner-occupied loans and higher risk loans the enterprises could purchase, along with lifting limits on originator use of the cash window. The FHFA on September 15 announced efforts to amend the GSE capital rules put in place by former Director Calabria last December.

The announcements reverse policies enacted in the late stages of Calabria’s tenure shaped by the looming probability that he could be removed as a result of a June Supreme Court decision that would allow a sitting president to fire an FHFA director. The court eventually handed down that decision.

Gauging the impact of lifting the caps on PLS supply

The caps on non-owner-occupied loan purchases had pushed a healthy share of these loans into private securitizations, and lifting the caps should reverse some of these flows. Lifting the caps likely alleviates some pressure on originators who might otherwise have to warehouse and hedge the loans before securitization or sale to another investor. Ease and certainty of execution should bring many of these loans back to the GSEs.

The removal of the caps may have a limited impact for originators currently tapping private execution, assuming agency-eligible investor loans continue to fetch a higher price in the private market. Looking at the population of loans delivered to the enterprises in June shows—assuming a ‘AAA’ execution of $1-16 back of UMBS 2.5%–that roughly two-thirds of those loans would get at least a quarter point higher price in private label execution. By September, however, the share getting an estimated quarter point premium dipped to just 11% of total deliveries. The explanation for this is likely two-fold:

  • Overall deliveries of investor loans to the enterprises in recent months have steadily declined as the private label share has risen; the population of loans still delivered to the enterprises presumably had progressively better agency execution (Exhibit 1).
  • Agency execution also likely improved due to the removal in August of the 50 bp adverse market delivery charge on all refinances coupled with an improvement in specified pool pay-ups.

Exhibit 1: Sizing up deliveries of investor loans across GSE and private label

Source: Fannie Mae, Freddie Mac, Intex, Amherst Pierpont

The flow of loans in private securitization could also depend on changes in loan level pricing adjustments, a topic getting some play in Washington. Higher LLPAs on investor loans would provide the enterprises with valuable revenue for subsidizing mission-related affordable housing initiatives, which seem more important to current FHFA leadership. Raising LLPAs on investor loans may also coincide with FHFA leadership’s goals to level the playing field between less affluent first-time home buyers and investors on lower-priced properties that require renovation and refurbishment. Admittedly raising LLPAs may be somewhat of a delicate balancing act as increasing them materially could push the overwhelming majority of investor loans to private channels, driving an overall reduction in the revenue stream that the enterprises garner from those loans.

The flow of loans will also likely depend on the value of base servicing in private securitization. Variable servicing compensation structures have become increasingly prevalent in the private-label market, and they allow originators to assign nominal valuations to the servicing associated with performing loans. This feature is valuable to both banks and non-banks. Given the current low level of interest rates, current coupon IO multiples, especially those on what are viewed to be more positively convex investor loans, are substantial and will only expand given a back-up in rates. The amount of up-front capital that an originator would have to post against a 25 bp strip is substantial, likely close to six times the coupon currently and will only increase as rates sell off potentially creating additional incentives for originators to choose private-label execution.

Gauging the impact of capital changes on CRT issuance

Proposed changes to the Enterprises’ Regulatory Capital Framework could be a game changer, paving the way for meaningful increases in CRT issuance. FHFA, under previous leadership, substantially diluted the capital benefits associated with issuing CRT and called into question the economic feasibility of issuance, arguing that premiums paid on loss coverage associated with CRT were well in excess of actual losses, a claim that many market participants found as a dubious knock against what has been widely viewed as one of the most important structural evolutions in de-risking the enterprises in the wake of the Global Financial Crisis.

This statement from FHFA likely signals a meaningful departure from how previous leadership viewed CRT:

“CRTs are insurance against a severe stress to the housing sector and protect the Enterprises against high-cost, low-probability events, even when those events do not occur. Therefore, the lack of significant defaults does not imply that CRTs are ineffective or economically unreasonable. CRT premiums should be weighed against the relief from capital requirements, imputed capital constraints, imputed or actual costs of capital and other factors.”

FHFA has proposed two changes to the treatment of CRT. First, the prudential floor of 10% on the risk-weight assigned to any retained CRT exposure would be replaced with a prudential floor of 5%. The proposal would also remove the requirement that an enterprise apply an overall effectiveness adjustment to its retained CRT exposures. The existing capital framework reduced the benefits associated with issuing CRT by roughly 50%, but the proposed changes would likely reverse the majority of that dilution. An example in the FHFA announcement concludes that the regulatory capital benefit associated with issuing CRT would rise by 42% under the proposed framework primarily as a function of the 50% reduction in the risk-weight floor on retained senior exposures. Given that the largest driver of the increased benefit is lower amounts of capital held against non-issued senior exposures, this change, if adopted, should be broadly applicable to both outstanding and potential future CRT issuance, putting the capital benefits roughly in-line with benefits garnered under the 2018 proposed framework.

This likely sets the stage for growing amounts of issuance, potentially in the near term. The FHFA proposal is open for a 60-day comment period. But given what appears to be a fairly material change in the value associated with issuing CRT from the enterprises’ regulator, decisions to increase issuance may come ahead of that. The largest source of contingent supply could come from Fannie Mae, which has recently acquired nearly $1.2 trillion of loans where the agency has yet to transfer any of the credit risk. According to its most recent 10-Q filing, roughly one-third of Fannie Mae’s single-family guaranty book, totaling $1.178 trillion in principal balance, has been acquired in the past two years and does not carry any credit enhancement. It appears that this balance represents CAS-eligible reference collateral. Fannie Mae makes additional disclosures for loans that fall out of the scope of the program due to maturity, LTV or coupon type. Assuming Fannie Mae were to adopt Freddie Mac’s most recent structure, transferring 175 bp of credit risk in the form of a four-tranche 0.25% to 2.0% corridor of risk would translate to just over $20 billion in notional risk transfer, which nominally does not seem insurmountable, but does represent nearly half the existing float of CRT. Given this, supply will likely be meted out over time to mitigate elevated costs of risk transfer associated with a large supply technical.

Chris Helwig

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