The Single Security: Good for Investors, Lenders & Borrowers
By Mike Sorohan
May 19, 2019
In less than two weeks, a project more than seven years in the making will come to fruition: the Uniform Mortgage-Backed Security (UMBS) a new MBS to be issued and guaranteed by either Fannie Mae or Freddie Mac and backed by fixed-rate 30-, 20-, 15- or 10-year single-family mortgage loans.
By most accounts, the June 3 event should be anticlimactic. The grunt work took place over the past several years, as the Federal Housing Finance Agency (which has overseen the safety and soundness of Fannie Mae and Freddie Mac for the past 10-plus years) oversaw efforts by the government-sponsored enterprises and their joint venture, Common Securities Solutions (CSS), to develop the Common Securitization Platform.
After development and extensive testing, investors of Fannie Mae and Freddie Mac mortgage-backed securities can purchase the single security, which proponents (including the Mortgage Bankers Association) say will benefit both the secondary mortgage market and conventional mortgage borrowers.
"We're ready," says Fannie Mae Senior Vice President of Capital Markets Renee Schultz, a sentiment echoed by Mark Hanson, Freddie Mac Senior Vice President of Securitization. "It's been a long haul, many years in the making. There was close collaboration across the entire industry."
For MBA, which has been deeply involved in pushing FHFA and the GSEs toward the single security, June 3 will mark a satisfying milestone. "We want the secondary mortgage market to be as liquid as possible," said Dan Fichtler, MBA Director of Housing Finance Policy. "It effectively means there should be strong demand from investors for these securities, which at the end of the day means lower interest rates for borrowers on their mortgages."
The idea of a Single Security has been discussed for years, but gestated in 2012, four years after the GSEs went into conservatorship.
In February 2012, FHFA issued A Strategic Plan for Enterprise Conservatorships (https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/20120221_StrategicPlanConservatorships_508.pdf), which announced the goal of building a new securitization platform. That October, FHFA issued Building a New Infrastructure for the Secondary Market (https://www.fhfa.gov/PolicyProgramsResearch/Research/PaperDocuments/FHFA_Securitization_White_Paper_N508L.pdf), proposing two complementary goals: 1) replacing the "outmoded" proprietary infrastructures of the Enterprises with a common, more efficient model; and 2) establish a framework consistent with multiple states of housing finance reform, including greater participation of private capital in assuming credit risk.
In October 2013, Fannie Mae and Freddie Mac formed CSS, a joint venture to build and operate the CSP; in August 2014, FHFA issued its first Request for Input on the proposed Single Security structure. Feedback from that RFI (including from MBA) resulted in updates to the platform in 2015, development of the single security through 2017 and testing and implementation in 2018 and 2019.
The result is a hybrid, of sorts. Components of the Single Security initiative include aligning key features, which mainly follow Fannie Mae's mortgage-backed securities structure; investor disclosures, which generally follow Freddie Mac's Participation Certificates; and certain policies and practices related to removal of loans from securities. In addition, the Single Security allows investors to exchange their legacy TBA-eligible 45-day Freddie Mac Participation Certificates for new 55-day Single Securities issued by Freddie Mac.
CSS acts as each Enterprise's agent to facilitate issuance of single-family mortgage securities, release related at-issuance and ongoing disclosures and administer the securities post-issuance. In addition, CSS created operational capabilities necessary to run the CSP.
"Issuance of UMBS should improve the overall liquidity of the Enterprises' securities and help ensure liquidity of the nation's housing finance markets," said CSS CEO Dave Applegate.
On March 7, the Securities Industry and Financial Markets Association announced its To-Be-Announced (TBA) Guidelines Advisory Council approved revisions to good delivery guidelines for the UMBS. Fannie Mae began accepting forward UMBS trades with a trade date on or after March 12 and settlement dates on or after June 3. On May 7, Freddie Mac commenced its offer to investors to exchange certain eligible Freddie Mac securities for TBA-eligible UMBS Mirror Certificates, the final project milestone before June 3.
"Freddie Mac Gold PC investors who want the benefit of the new single security, or UMBS, should find the exchange frictionless," Hanson said. "Ultimately, our goal is a larger, more fungible secondary mortgage market, with greater liquidity for investors, better returns to U.S. taxpayers, and lower costs for homebuyers."
From the start, MBA was involved. MBA Senior Vice President for Research & Economics (and Chief Economist) Mike Fratantoni noted MBA worked closely with FHFA, serving on an advisory group that provided input not only on the Single Security, but the future of the entire secondary market.
"It was important to have a place at the table," Fratantoni said. "Our members rely on Fannie Mae/Freddie Mac liquidity as the lifeblood of their business. We wanted to maximize our members' chances of success and keep our members apprised of what's going on."
Another important element was MBA's 2017 white paper, GSE Reform: Creating a Sustainable, More Vibrant Secondary Mortgage Market, which offered MBA's recommended approach to GSE reform (https://www.mba.org/advocacy-and-policy/gse-reform).
The CSP provides many potential benefits, MBA said. First, it significantly upgrades the core infrastructure at the heart of the agency MBS market. Second, by updating it jointly for Fannie Mae and Freddie Mac, it has fostered the alignment necessary to support the Single Security.
Fichtler noted the single security should reduce investor concerns and level the playing field. "In many ways they are nearly identical securities, so it doesn't make sense for them to be separate markets," he said. "The core of the UMBS is to take these two markets, which are already very liquid, and combine them and make them even more liquid."
Fratantoni agreed. "Fannie Mae had more mortgage-backed securities outstanding than Freddie Mac, and as a result they traded more favorably and at a higher price, and it put Freddie MBS at a disadvantage," he said. "We think the UMBS would at least level the playing field. Instead of a Fannie Mae MBS market at $3 trillion and a Freddie Mac market at $2 trillion, we will now have a single $5 trillion market."
In preparing for the June transition, Fannie Mae's Schultz said the company realized "this was going to be a huge endeavor." Together with Freddie Mac, it organized internal teams to meet with investors, conduct information sessions and appear at numerous industry conferences (including the MBA Annual Conventions and MBA Secondary Market Conferences) to provide progress reports--and to urge companies to get on board.
"In the past year we saw that industry participants realized this was happening and that changes were coming," Schultz said.
Unlike Freddie Mac, the UMBS did not require an overhaul of Fannie Mae's MBS, which largely serves as the model for the single security. Nonetheless, Schultz said, the CSS replaced and updated several internal systems used to issue securities. "Our customers shouldn't see any real changes in their day-to day operations," she said. "There's already been widespread trading. We continue to do testing. We have a third party ensuring compliance. There is a lot happening behind the scenes to make sure things go as planned."
On the other hand, Freddie Mac had substantially more work to do. "It was critical for us to level the playing field with minimum disruption to the market," Hanson said. "Twenty-nine years ago Freddie Mac unveiled the Gold PC program, and it was designed to have the best set of guarantees and offerings to transition the Freddie Mac TBA program. Now, we wanted to improve what was already there."
In addition to conforming its Gold PC program to the UMBS, Freddie Mac also created an exchange program for its current securities. Freddie Mac is offering to exchange its 45-day payment delay TBA-eligible and non-TBA-eligible Gold Mortgage Participation Certificates (Gold PCs) securities for Freddie Mac 55-day payment delay, TBA-eligible UMBS Mirror Certificates (UMBS) and non-TBA-eligible Mortgage-Backed Securities Mirror Certificates (MBS), respectively. Freddie Mac is also offering to exchange its 45-day payment delay TBA-eligible and non-TBA-eligible Giant PCs for Freddie Mac 55-day payment delay, TBA-eligible Supers Mirror Certificates and non-TBA-eligible Giant Mortgage-Backed Securities Mirror Certificates, respectively.
"The exchange program is the mechanism for getting us to a larger, more fungible market," Hanson said. "We wanted to give investors the option--not the requirement--of exchanging the old securities for the new. You're still getting a security back on those loans, the difference being the payments comes in on the 25th of the month, not the 15th." He added that Freddie Mac expects to cease issuing Gold PCs after May 31.
With June 3 looming, neither Freddie Mac nor Fannie Mae anticipate a "Y2K" scenario in which systems fail. Hanson and Schultz say they are confident that extensive development and testing have anticipated any potential problems. "Of course we have to be mindful of any implementation hurdles and challenges, but we're confident that if anything pops up, we'll be able to work it through," Hanson said.
And as far as the broader secondary market goes, MBA's Fratantoni says he hopes the success of the UMBS attracts other secondary market players.
"We do see other competitors getting into the market," Fratantoni said. "Before the UMBS, competitors had to start from scratch to compete in a $5 trillion market. Now with the UMBS, it dramatically lowers the cost of entry."