Fannie Mae: Even Big Lenders Have Questions about Front-End Risk Sharing

Common Securitization Platform Fannie Mae Mortgage Insurance
Photo by NCinDC

The more private sector players think about front-end risk sharing, the more consensus there is on proceeding with caution.

Since 2012, the Federal Housing Finance Agency has required Fannie and Freddie to transfer a portion of the credit risk on the loans they acquire to the private sector. The official rationale for this policy is to reduce the chance that taxpayers would again be forced to shore up the GSEs. In fact, credit risk sharing appears to be part of a strategy to force Fannie and Freddie to surrender their business in order to make it easier to achieve the Treasury Department’s goal of winding down the GSEs. Since 2013, Fannie and Freddie have transferred nearly 90 percent of the credit risk on eligible loans to private market investors such as banks and mortgage insurers. Until now, most of these transactions have been “back-end” transfers – where Fannie and Freddie transfer credit risk on loans they have already acquired and securitized. Over the summer, FHFA sought input on transferring the credit risk when loans are originated, or at the “front end.”

Last week, the American Bankers Association sent a letter to FHFA that seemed to endorse the dramatic changes in the multi-trillion-dollar mortgage market by regulatory fiat. “Absent legislative reform, the development and standardization of credit risk transfer programs is likely to be one of the most substantial transformations of the secondary mortgage market to occur since the conservatorship of the GSEs was announced in September of 2008,” the letter said.

However, when it comes to front-end risk sharing, the ABA is more cautious. The letter expressed concerns these transfers could add costs for borrowers and create new complexities in originating home loans mortgages. The ABA’s bottom line was to not jeopardize the back-end risk sharing.

“One of the clear benefits of back-end credit-risk transfers is that it has no impact on loan origination, as the credit-risk transfer happens after the sale of the loan to the GSEs,” ABA Senior Vice President Joseph Pigg wrote. “Front-end credit-risk transfers may not necessarily include such benefits.”

The Mortgage Bankers Association, whose members are also eager to get a larger piece of Fannie and Freddie’s business, has also urged FHFA to continue to look before it leaps.

“MBA has for decades advocated for a bright line between primary and secondary markets,” MBA’s President David Stevens wrote in the letter to the Federal Housing Finance Agency (FHFA). “One aspect of this bright line is that primary market lenders select front-end credit enhancements, while the GSEs structure back-end credit enhancements.”

The MBA stressed the importance of transparency and recommended ways to make sure small lenders aren’t put at a competitive disadvantage in pricing their loans as a consequence of front-end risk-sharing. Like the ABA, the MBA is on board with back-end transfers but acknowledged some downsides to these transactions as well, such as the fact that Fannie and Freddie have to “warehouse the risk for several months before they can complete the risk-transfer offerings.”

The concern expressed by the big lenders about the impact on small lenders and borrowers notwithstanding, the Community Home Lenders Association (CHLA) and the Community Mortgage Lenders of America continue to warn that risk sharing will inevitably lead to domination by big lenders.  They remain suspicious of front-end transactions. For its part, the Independent Community Bankers Association weighed in to acknowledge Fannie and Freddie should consider new and better ways of managing risk but its letter to FHFA started with a more fundamental issue of risk: the depletion of Fannie and Freddie’s  capital reserves since implementation of the 2012 with the Net Worth Sweep. “ICBA urges the FHFA to direct the Enterprises to develop and implement a capital restoration plan,” the letter stated.

The recent spate of letters raises good questions. Another question, to which there is no answer, is whether Fannie and Freddie would be engaging in these types of risk sharing transactions in the first place without the mandate from their conservator. As former Fannie Mae executive Timothy Howard has noted, it is not clear these transactions make good business sense.

Eventually, the election season will end and lawmakers can direct their attention to the wholesale changes in mortgage finance that are already underway.  We can only hope the next President and Congress can weigh in on risk-sharing and other so-called reforms before Fannie and Freddie are out of capital.