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GSEs ramp up risk sharing to mixed reviews

The government-sponsored enterprises Fannie Mae and Freddie Mac ramped up efforts in 2016 to offload the default risk on their riskiest single-family mortgages.

The GSEs’ federal regulator continues to hold up the risk transfer programs as one of the success stories of the postrecession conservatorship, but their methods continue to draw mixed reviews from the industry.

creditriskThe enterprises met the goal of transferring risk on 90 percent of the target loans in 2016, the GSE regulator the Federal Housing Finance Agency (FHFA) reported last month. Fannie and Freddie transferred a portion of the risk on $548 billion in single-family loans in 2016, which is up from $420 billion in 2015, $378 billion in 2014 and just $90 billion in 2013.

Last year, the actual amount of risk transferred to private sources totaled $18.1 billion in exposure, just over 3 percent of the loan balances, FHFA said. The targeted loans were typically 30-year fixed mortgages with loan-to-value (LTV) ratios from 60 percent up to 97 percent.

Fannie and Freddie began to do deals with a select few private investors in 2013 as a way to reduce the risk on American taxpayers who ultimately back the federally-controlled GSEs. In total through 2016, the GSEs have transferred risk on loans with an unpaid balance of $1.4 trillion. The risk assumed by the investors has totaled $49 billion, or 3.4 percent of the loan balances, the FHFA said. 

The GSEs are still doing the lion’s share of risk sharing by issuing synthetic securities, which are purchased by a few investors, such as money managers and hedge funds. Investors cover a portion of the risk for a fixed period in exchange for payments. This is known as a so-called “back-end deal” because the risk is transferred after Fannie and Freddie purchase the loans.

In 2016, 72 percent of the risk sharing was done through this debt issuance mechanism via Fannie’s Connecticut Avenue Securities (CAS) and Freddie’s Structured Agency Credit Risk (STACR) issuances, according to the FHFA. The GSEs transferred another 25 percent of the risk by purchasing credit protection from reinsurance companies, which insure a portion of the risk on a pool of hundreds of thousands of loans. 

Most industry trade groups support the risk transfers, but they disagree on what mechanisms to use. The nonbank trade group, the Community Home Lenders Association, for example, supports the current back-end structures and opposes front-end deals where a portion of the risk is retained by a large bank or lender. 

“The success of the significant number of back-end risk sharing transactions shows this is a viable and effective way to do this, so CHLA continues to discourage the GSEs from doing up-front risk sharing, particularly with vertically integrated Wall Street banks,” CHLA Executive Director Scott Olson told Scotsman Guide News. 

The U.S. Mortgage Insurers (USMI), which represent private insurers, have been aggressively lobbying for deeper coverage on individual loans on the front end. Private insurance on Fannie and Freddie loans ends when the LTV reaches 80 percent. The insurance industry would like to cover a greater percentage of the loan risk on 80 LTV and above loans, as well as cover loans at lower loan-to-value ratios. Critics, though, are skeptical that private insurers could cover the losses in a catastrophic downturn, and taxpayers would be on the hook for the losses. 

The USMI disputes that, however, citing figures that private mortgage insurers paid out more than $50 billion in claims during the last downturn.

“It can be done on a level playing field for lenders of all sizes, and can offer greater transparency with respect to pricing, which could benefit borrowers,” USMI President Lindsey Johnson told Scotsman Guide News. “Perhaps best of all, and unlike other pilots, MI transfers risk on the front-end before it ever reaches the GSE balance sheets.”

A bad deal? 

Others, including the GSE private shareholders, have spoken out against the risk transfers. One of the critics has been Fannie’s former Chief Financial Officer Tim Howard, who said in November during a forum hosted by the shareholder group Investors Unite that federally mandated risk sharing was costing Fannie and Freddie significant amounts of money, and the private companies were assuming little or no risk in these deals. 

Glen Corso, executive director of the Community Mortgage Lenders of America, participated in the forum and left convinced that the current risk transfers were a bad deal for the GSEs. He said that CMLA would support front-end risk transfers, such as deeper private insurance, if it “genuinely shifted risk from the GSEs” and produced a cost savings for consumers. 

“We could only support front-end risk sharing that accomplished both criteria,” Corso said.


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