1,516 words. Six-minute read. See item #5 for Capital Commentary Contest.
Happy New Year! Welcome to the first issue of Arch MI’s Capital Commentary for 2022.
If you were lucky enough to spend the holidays between Thanksgiving and New Year’s Day relaxing and enjoying a respite from the day-to-day grind of your job, you must not work at the Federal Housing Finance Agency (FHFA).
Staff at the regulatory agency overseeing Fannie Mae, Freddie Mac and the Federal Home Loan Banks had no such break. Instead, they worked at breakneck speed over the past few weeks to review and issue a plethora of announcements and documents that are likely to have long-term impacts on housing affordability and the soundness of the Government-Sponsored Enterprises (GSEs).
Oh, and in between breaths, staff had to prepare Acting Director Sandra Thompson for the Senate confirmation process to become the permanent Director of FHFA after being nominated for the role by President Biden in mid-December.
In this issue of Capital Commentary, we take a deep dive into recent activities at the nation’s most powerful and important housing agency and what might come next.
1. “Capital Commentary” — 89 Times
Arch MI isn’t the only organization providing “capital commentary.”
Eighty-eight other versions were awaiting FHFA staffers when they returned from Thanksgiving break — each responding to proposed changes to the Enterprise Regulatory Capital Framework for the GSEs.
In mid-September, FHFA issued a Notice of Proposed Rulemaking amending the framework to reduce the prescribed leverage capital buffer and enhance the attractiveness of the GSEs utilizing credit risk transfer (CRT) transactions to better protect taxpayers from potential losses.
Supporters of the proposed changes:
- Arch MI. It warned the earlier capital rule “incented the GSEs to increase risk taking, risk retention and a return to the failed ‘buy-and-hold’ business model of the past.”
- Mortgage Bankers Association. President and CEO Bob Broeksmit said changes are needed because current capital standards “will encourage the Enterprises to seek higher-yielding, riskier assets in order to optimize their operations (from a capital perspective).”
- Community Home Lenders Association. The small-lender group argued that without the changes, Fannie Mae and Freddie Mac would be forced “to increase guarantee fees and loan level price adjustments (LLPAs) and/or tighten their credit standards … reduc(ing) the availability of home mortgage credit to homebuyers and homeowners.”
- Housing Policy Council. It urges more use of CRT at the GSEs because it introduces “a range of other active participants with an economic stake in monitoring mortgage market credit conditions to contain risk. These added participants mitigate potential risk-assessment and risk-management errors by the Enterprises.”
Taking a contrary view were:
- U.S. Sen. Pat Toomey, R-PA. The ranking Republican on the Senate Banking, Housing and Urban Affairs Committee worries that the proposed “two-thirds reduction in the leverage buffer could result in a material reduction in regulatory capital, increasing risks to taxpayers and financial stability.”
- CATO Institute. The libertarian think tank’s Center for Monetary & Financial Alternatives criticized the proposal as being “slanted too heavily toward promoting the use of [CRTs] rather than promoting the enterprises’ safety and soundness. … CRT use can enhance the enterprises’ safety and soundness only if CRT transactions are appropriately structured and priced, and only when the retained residual risk is appropriately capitalized.”
Expect the proposed changes to be adopted. Greater use of CRT — and after a pause in transferring credit risk on single-family loans after the pandemic began, Fannie Mae is reengaging in transactions — should reduce required capital and lower mortgage costs for affordable home loan borrowers.
Do you have FHFA staff envy? You, too, can read every comment letter on the agency’s comments webpage. Scroll to RIN 2590-AB17.
2. Goodbye PSPA Caps, Hello LLPA Hikes
A year ago, hours before the Biden administration took office, then-FHFA Director Mark Calabria and Treasury Secretary Steve Mnuchin announced amendments to the Preferred Stock Purchase Agreement (PSPA) regulating Fannie Mae and Freddie Mac. Those changes included new limits on the amount of loans GSEs could purchase from lenders, including:
- High-risk loans (determined by LTV, credit score and debt-to-income ratios).
- Investor and second-home loans.
- Loans sold through the GSEs’ cash windows.
Those caps were suspended shortly after Acting Director Thompson was appointed to her position last summer because she believed FHFA had the tools to monitor the risk of GSEs acquiring certain loans.
In early January, she rolled out one of those tools when she announced higher loan-level pricing adjustments (LLPAs) on high-balance and second-home loans.
Beginning in April, upfront fees for high-balance loans (mortgages originated in certain designated areas above the baseline conforming loan limit) will increase between 0.25% and 0.75%, tiered by LTV. There is a steeper surcharge on second-home loans. Upfront fees will increase between 1.125% and 3.875%.
The price hikes follow Thompson’s declaration that FHFA wants the GSEs to focus on their core-mission borrowers while accumulating capital. The price hikes are also likely to be a windfall for the private-label securities market, says HousingWire. Redwood Trust President Dashiell Robinson told the industry publication, “In today’s current market, we see private-label securitization execution for these [high-balance and second-home loan] products as more favorable than selling to the GSEs, which should only become more apparent.”
So, what’s next? Most experts expect FHFA will soon lower LLPAs for more traditional GSEs loans to reduce mortgage costs for lower-income borrowers with lower FICO® scores.
3. GSEs under the Gun on Affordable Lending
If there ever was a doubt about a new emphasis at FHFA under the Biden administration to promote affordable lending, it was dispelled when the agency not only mandated Equitable Housing Finance plans last fall but also recently rejected the latest Duty to Serve (DTS) proposals from both Fannie Mae and Freddie Mac.
DTS requirements compel the GSEs to issue three-year plans that outline how they will serve three underserved markets: manufactured housing, affordable housing preservation and rural housing.
Both Fannie and Freddie submitted DTS plans in mid-2021 for 2022–24. (Listen as Freddie Mac’s Mike Dawson describes the challenges facing those markets in an Arch MI PolicyCast podcast.) HousingWire reports (“FHFA to GSEs: Back to the Drawing Boards on Duty to Serve”) that both GSEs were informed their plans were inadequate.
That’s good news to the Underserved Mortgage Markets Coalition, a group of 20 affordable housing organizations that urged FHFA to “request substantially improved” proposals from the GSEs.
Equitable Housing Finance plans were filed with FHFA at the end of 2021 but have yet to be made public by the regulatory agency. FHFA instructed the GSEs to develop plans that will “identify and address barriers to sustainable housing opportunities … including advancing equity in housing finance over the next three years.”
4. Advise & Consent
Thompson took center stage, along with Federal Reserve Gov. Lael Brainard (nominated to serve as Fed Vice Chair), on Jan. 13 before the Senate Banking, Housing and Urban Affairs Committee when the panel considered her nomination to be permanent FHFA Director.
- Notably, there were no fireworks.
Asked by committee Chairman Sherrod Brown, D-Ohio, what she has done to ensure the GSEs have adequate capital, Thompson cited the proposed changes to encourage CRT.
- “One of the steps that we’ve taken is to encourage the use of the credit risk transfer program, which, as you well know, Fannie Mae and Freddie Mac are the largest holders of mortgage credit risk in the United States, I dare say the world. One of the things that we’d like to do is facilitate moving that credit risk off the backs of the taxpayers and into the hands of the private sector.”
Thompson doubled down on CRT’s benefits when asked by Sen. Mike Rounds, R-South Dakota, how she might further utilize it:
- “[The GSEs] don’t have enough capital to withstand a severe event. If something really, really bad happens, the event will have to be paid for once again by the taxpayers. … We just believe that it is critical for the enterprises, especially while they’re under-capitalized, to continue to transfer credit risk away from the taxpayers and into the hands of private investors.”
Ending the GSE conservatorships was on the minds of three Republican Senators (Thom Tillis of North Carolina, Bill Haggerty of Tennessee and Toomey).
- Thompson said the agency “would defer to Congress on the exit from conservatorship for the GSEs.” She noted, “there are a number of issues that Congress will have to address specifically. If the enterprises exit conservatorship, will the companies be private? Will they be public? What form will they be? Congress must weigh in on [these issues] so the FHFA can get the enterprises ready.”
5. Contest #21: Moving on Up
The days of record-low interest rates for mortgages appear behind us as inflation soars to its highest rate in 40 years. Experts expect the Federal Reserve to start raising interest rates soon, with mortgage rates perhaps reaching 4% by year-end, according to the Mortgage Bankers Association. All things being equal, 4% isn’t too bad, although it is likely to slow homebuying. When I bought my first home, my prime mortgage rate was 13.25%.
Take the quiz: What was the highest U.S. prime mortgage rate and when was it recorded?
To be entered into the contest to win a Capital Commentary mug and saucer, email your answer to [email protected] by midnight, February 1.
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About Arch MI’s Capital Commentary
Capital Commentary newsletter reports on the public policy issues shaping the housing industry’s future. Each issue presents insights from a team led by Kirk Willison.
About Arch MI’s PolicyCast
PolicyCast — a video podcast series hosted by Kirk Willison — enables mortgage professionals to keep on top of the issues shaping the future of housing and the new policy initiatives under consideration in Washington, D.C., the state capitals and the financial markets.
About Kirk Willison
As VP of Government and Industry Relations for Arch MI and a mortgage finance expert with more than 25 years in government relations, Kirk speaks candidly with an array of the most influential industry and policy thought leaders in the nation.
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