By the Numbers

A big bump in the road to Freddie Mac second liens

Brian Landy, CFA | May 31, 2024

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.

Freddie Mac’s recent proposal to buy second liens has triggered the heaviest response in 10 years to a pending change in housing regulation, drawing hundreds of comments from a wide range of interest groups, politicians and individuals. An estimated 60% of responses from major interest groups opposed the change. The volume and tone of responses likely surprised Freddie Mac’s regulator, the Federal Housing Finance Agency, throwing into doubt a smooth path to approval. If the FHFA does allow the proposal to move ahead, it would likely require Freddie Mac to address concerns raised in the comments and possibly require a joint launch with Fannie Mae to ease concern about prepayment speeds in existing MBS.

The outpouring came during a 30-day comment period, ending May 22, required under FHFA rules for pending changes in Fannie Mae, Freddie Mac or Federal Home Loan Bank regulation. Freddie Mac’s second lien proposal drew the largest response to a proposed FHFA rule since 2014 and the seventh largest response ever (Exhibit 1). The FHFA received heavy responses to proposed reforms in membership requirements in the Federal Home Loan Bank system (2014), to the GSEs duty to serve underserved markets (2016) and to affordable housing goals at the FHLBanks (2018).

Exhibit 1. Number of comments on FHFA rules and notices by quarter.

Note: Total number of comments received for open RFCs in each quarter.
Source: FHFA, Santander US Capital Markets.

Of the comments posted by named interest groups, slightly more than 60% opposed the Freddie Mac proposal. That included a group of Republican senators and congressmen. They raised concerns about Freddie’s unfair advantage over private lenders, the potential to increase systemic risk and misalignment with Freddie’s mission to improve housing affordability. A Democratic congressman separately opposed the rule change, concerned that it only benefits current homeowners and widens the wealth gap. Support and opposition to the proposal are not following strict party lines.

Comments from individuals also showed a variety of opinions. Some in support of the proposal were loan officers. People opposed to it included a housing counselor concerned the proposal diverts resources away from improving housing affordability. And several respondents coordinated and submitted an identical letter in opposition to the proposal, concerned about the potential to increase inflation and hurt the economy.

Below are short summaries of the comments submitted by six industry and policy groups. Three of the groups are against the proposal, one felt there was not enough information to render an opinion, and two groups support the proposal. Each presented a thoughtful response to the proposal, with a lot of detail that cannot be captured in a summary paragraph. Interested readers can find the original comments here. Search on “Rule or Notice No” equal to “2024-N-5” to load all the comments to the closed-end second lien notice. Unfortunately, it is not possible to link directly to the individual comment letters.

Structured Finance Association

The SFA recommended that the FHFA not approve Freddie Mac’s proposal. The response notes that there is already a large and healthy market for subordinate lending using private capital. Freddie Mac’s competitive advantage would crowd out private capital and expand Freddie’s footprint. The SFA does not feel that Freddie Mac should enter this market to improve liquidity, since liquidity is already good. And it does not feel that this proposal helps Freddie Mac assist underserved markets or meet its housing goals. It also feels the proposal could support further home price appreciation, exacerbating affordability challenges. The proposal would also increase consumer spending and inflation. It would also put more risk onto Freddie Mac’s balance sheet, a risk ultimately borne by the taxpayer.

Securities Industry and Financial Markets Association

SIFMA also recommended that the FHFA not approve Freddie Mac’s proposal. It raises similar issues as the SFA’s response—private capital is adequately supporting existing subordinate lending and the market does not need Freddie Mac’s support, this lending does not appear to support Freddie Mac’s core mission, and it raises the risk on Freddie’s balance sheet that is ultimately covered by taxpayers. The response also raises concern about the effect on the TBA market, since this proposal should slow prepayment speeds of discount first-lien mortgages, lowering convexity and value. This would raise mortgage rates to first lien borrowers, which is contrary to Freddie’s mission. Pricing could suffer for credit-risk transfer transactions as well since higher combined loan-to-value ratios should increase the credit risk of first liens in CRT transactions.

American Bankers Association

The American Bankers association also recommends that the FHFA deny Freddie’s proposal to purchase second liens. It feels private markets are adequately addressing the need for second liens, and Freddie has not demonstrated it would make second liens cheaper. It points out that current second liens are typically used by higher income borrowers and Freddie’s product would likely attract similar borrowers, so does not support lending to low-to-moderate income borrowers. The proposal would raise the risk to the GSEs and taxpayers. The response also feels that the questions the FHFA posed in the RFC should have been answered by Freddie Mac before asking for public comment.

Mortgage Bankers Association

The MBA feels that Freddie Mac’s proposal lacks sufficient detail to render an opinion and recommended that the FHFA address these shortcomings. The MBA lists some of the potential benefits of the program, namely better liquidity for closed-end seconds that could lower the cost of these loans for borrowers. However, it notes the uncertainty regarding whether the program would expand access to second liens or merely cannibalize existing lenders. The comment lists questions about expected pricing, volume caps, the effect on UMBS, and numerous other issues.

Urban Institute

The Urban Institute submitted comments in favor of the proposal. It focused on consumer needs—many borrowers have spent down their savings but need cash for things like home improvements or debt consolidation. Borrowers have long been able to do this with a cash-out refinance, but that is very expensive when mortgage rates are high. The second lien parameters mirror the limits Freddie Mac sets on first lien cash-out refinances, so the second liens should not be any riskier to Freddie than the cash-out refinances it would have guaranteed if rates were lower. Second liens had poor credit performance during the 2008 financial crisis, but that risk should be mitigated by the 80% cap on combined LTV and the ability-to-repay rules.

National Fair Housing Alliance

The National Fair Housing Alliance also supports the proposal, although would like some changes. It feels the product supports Freddie’s mission by allowing borrowers access to home equity without prepaying low-rate first lien mortgages, and this supports secondary market activity and access to mortgages. It would like Freddie to be able to purchase second liens from any minority depository institution, even if Freddie Mac does not own the first lien. And it would like to see data disclosures about race and ethnicity.

Credit Unions

Finally, there was strong support for the proposal from credit unions. Three credit union groups all responded to the proposal. For example, the Cooperative Credit Union Association feels it would improve mortgage-lending liquidity for credit unions, one of Freddie Mac’s mandates. Credit unions could free up balance sheets by selling second liens to Freddie. It also notes that the additional volume would help smaller credit unions meet the minimum annual mortgage volumes needed to remain an approved Seller/Servicer with Freddie Mac.

A more complicated decision for the FHFA

The opposition from key interest groups, the comments from members of the Senate and House and the broad interest from individuals raises political risks for the FHFA. Since the 2021 Supreme Court decision that the FHFA director serves at the will of the President, it has lost some of the insulation from political pressure that it has had in the past. At this point, it seems unlikely the FHFA will approve the Freddie Mac proposal without regard to the comments received. The Freddie Mac proposal looks like it will at least be delayed if not denied.

Brian Landy, CFA
brian.landy@santander.us
1 (646) 776-7795

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