GSE Up-Front Risk-Sharing
MBA's up-front risk-sharing proposal would provide additional execution options to lenders and have the potential to benefit borrowers through increased pricing competition and more stable product availability. Up-front risk-sharing would allow lenders to secure deeper credit enhancement in exchange for lower guarantee fees (g-fees) and loan-level price adjustments (LLPAs).
Multiple forms of credit enhancement should be eligible, including:
- "Deeper cover" private mortgage insurance (MI);
- Lender recourse; and
- Structured finance.
Private capital should cover most of the credit risk exposure, covering the risk to an effective loan-to-value (LTV) ratio of 50 or 60 percent, leaving Fannie Mae and Freddie Mac (the GSEs) to cover only catastrophic risk. Distributing the risk prior to GSE acquisition not only protects the taxpayer but encourages greater competition and a more level playing field in accessing GSE products and programs.
- Increasing the use of up-front risk-sharing would have many benefits:
- It would restore private capital to the mortgage market and reduce taxpayers' risk exposure.
- Mortgage pools would be de-risked before they get on GSE balance sheets.
- Competition would be increased for credit risk, which could lower costs and increase access to mortgage credit for homebuyers.
- It would provide improved price discovery to help ensure g-fees reflect the market price for risk.
- Market stability would be enhanced by reducing warehouse risk and increasing capital committed to the mortgage market long-term.
- Most models of the future secondary market would mandate similar risk-sharing. This initiative provides a "proof of concept" before the market is locked into a new system.
- It would preserve To-Be-Announced (TBA) execution.
- Lender utilization of up-front risk-sharing would be driven by the relative pricing of alternative executions and, importantly, by bona fide reductions in g-fees / LLPAs that reflect risk mitigation of the coverage. This requires a level of deal- and program-level transparency that the GSEs are not providing.
- To date, GSE up-front risk-sharing deals have been limited to structured recourse deals with just a few larger lenders. These structures are innovative and effective, but the GSEs should make greater use of deeper MI and lender recourse to allow lenders of all sizes to compete on a level playing field. Highly structured transactions are likely not scalable to smaller lenders nor have they been tested during adverse market conditions.
- Concerns about the financial strength of the MI industry and individual MIs have been addressed by recent capital raises and new capital requirements. With the new eligibility standards in place (PMIERs), the Federal Housing Finance Agency (FHFA) should direct the GSEs to pilot deeper MI coverage on higher LTV loans and coverage of lower LTV loans-e.g. down to an effective LTV of 50 or 60 percent-leaving the GSEs to cover only catastrophic risk. For many lenders, use of deeper cover MI would be a straightforward operational approach to up-front risk-sharing.
- Many smaller and mid-sized lenders would also benefit from greater availability of shared and full recourse executions in exchange for lower g-fees and LLPAs.
- Greater use of up-front risk-sharing would place more private capital ahead of the GSEs, protecting the taxpayer and diversifying the holders of credit risk. This is a better alternative for attracting private capital back to the market than the FHFA's prior efforts to raise g-fees in an effort to "crowd-in" private capital. It is also aligned with FHFA's goal to diversify the forms of credit risk transfer used by the GSEs.
MBA's Position/Next Steps:
- MBA strongly supports requiring the GSEs to test new approaches to up-front risk-sharing to increase private capital's role in the mortgage market, to provide additional executions for lenders of all sizes and business models, and to potentially lower costs for borrowers.
- MBA submitted a comment letter in response to FHFA's Request for Input and plans on working with FHFA and the GSEs to further the program's development.
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