The Federal Housing Finance Agency (FHFA) has completed the first phase of a process mandated in 2019 by publishing a report on the performance of Fannie Mae’s and Freddie Mac’s single-family credit risk transfers (CRT).
That year, the FHFA called for a comprehensive review of the GSEs’ CRT programs for the first time since their inception in 2013. As an initial step toward that objective, the report estimates the historic and projected net costs of the GSEs’ CRTs, discusses the performance of CRT vehicles during the COVID-19 pandemic, and identifies areas for research and analysis to clarify CRT-related costs and benefits and assess potential risks to the GSEs and the housing finance markets.
The report focuses on securities issuance and insurance/reinsurance credit risk-sharing vehicles, which account for about 90 percent of all CRT issuance to date.
“Given the size and complexity of the CRT market, this report is an important step to fulfill FHFA’s statutory duties as a prudential regulator,” says FHFA Director Mark Calabria. “The report is especially timely as it incorporates initial lessons from the COVID-19 stress and raises issues related to potential changes in the design of CRT structures while the enterprises continue building capital. The findings of this report, and the research that it calls for, will inform FHFA’s and the enterprises’ decisions about how best to utilize CRT in the future.”
Key findings from the report include:
Risk in force: Between July 2013 and February 2021, about $126 billion of risk in force (RIF), or the GSEs’ maximum credit risk coverage, had been placed through securities issuance and insurance/reinsurance CRTs. As of February 2021, $72 billion combined RIF at issuance remained in force on a reference pool of $1.7 trillion in unpaid principal balance (UPB).
The GSEs’ net cost (defined as CRT benefits (investor write downs and counterparty reimbursements) minus CRT costs (interest and premiums)) through February 2021: $15.billion (The GSEs received approximately $0.05 billion via investor write downs and counterparty reimbursements and paid approximately $15 billion in interest and premiums).
The GSEs’ net cost, projected lifetime (i.e., the sum of $15.0 billion in net cost through February 2021 and projected net cost over the remaining lifetime of active CRTs):
- Baseline scenario: $32.6 billion
- Severely-stressed scenario: $20.6 billion under severely stressed housing market conditions similar to those of the 2008 financial crisis
Fast prepayments accelerate the reduction of credit risk protection: The amount of credit risk protection that CRTs provide the GSEs decreases as the principal balances of the reference pool mortgages are paid down. As a result of fast prepayments starting in mid 2019, by September 2020, soon after COVID-related delinquencies began to increase, almost all of the most senior investor tranches in securities issuance CRTs issued before 2020 had been fully paid off.
CRTs remain untested by a serious loss event: With the prospect of potential future losses at the onset of COVID-19, some investors suggested that their willingness to continue to invest in CRTs was contingent on the GSEs’ amending or suspending certain contractual provisions of early fixed-severity securities issuances. The GSEs affirmed that COVID-related forbearance mortgages would be treated as specified in the contracts and disclosures.
The report identifies also several areas beyond its scope that are in need of research and analysis to inform the future direction of the CRT programs:
(1) more accurate measurement of the amount of credit risk transferred via CRTs over time, as well as CRT-related costs and benefits;
(2) the GSEs’ exposure to counterparty risk through insurance/reinsurance CRTs and the costs, benefits and potential risks of the GSEs’ approaches to mitigate counterparty risk;
(3) the efficacy of, and potential costs and benefits of innovations to, certain features of CRT structures; and
(4) the value of the information about credit risk that has been and can be derived from CRT pricing.
To read the full report, click here.