Major Updates on Mortgage Market's Future from FHFA's Watt

Melvin L. Watt, Director of the Federal Housing FinancernAgency (FHFA) told the Senate Banking Committee today that Freddie Mac andrnFannie Mae (the GSEs) will soon announce they will begin purchasing loans withrndownpayments of 3 or 5 percent, similar to those offered by FHA.  Watt made the announcement in remarks preparedrnto update to the Committee on the GSEs and the Federal Home Loan Banks forrnwhich FHFA is regulator.  The agency alsornserves as conservator of the two government sponsored enterprises.   </p

Watt summarized the financial performance of the GSEs as<bsignificantly improved since the conservatorship began in 2008.  While both entities have posted profits everyrnquarter since the beginning of 2012 he said that some of the increasedrnperformance relates to one-time or transitory items, such as the reversal of eachrnGSE’s deferred tax asset valuation allowance, legal settlements, and thernrelease of loss reserves associatedrnwith rising house prices. Other portions of the improvement are attributable to such factors as strengthened underwritingrnpractices and increased guarantee fees.</p

Watt said that while the GSEs’ financial condition and thatrnof the mortgage market has stabilized, significant challenges such as continuedrnelevated delinquency rates and counterparty exposure remain concerns. </p

Counterparty risks are in fact the focus of several supervisoryrnguidance documents prepared by FHFA for the GSEs.  One bulletin outlined the agency’srnexpectations about the increasing numbers of transfers of mortgage servicing ofrnGSE owned or guaranteed loans from federally-regulated banks to non-bankrnentities that typically have less regulation and more concentratedrnoperations.  These transfers werernidentified by the Financial Stability Oversight Council as presenting heightenedrnrisks. </p

The bulletin specifies that the GSEs should approve such transfersrnonly when they are consistent with sound business practices, aligned with each GSE’s board-approved risk appetite, andrnin compliance with regulatory and conservatorrnrequirements.  They should also bernsubject to risk-based monitoring so that all servicing transfers occurrnin a timely manner and in accordancernwith approved terms, servicing guide requirements, and applicable mortgage servicing transfer-related lawsrnand regulations.</p

Anotherrnrisk area FHFA has addressed is that of information security. In a bulletin FHFA stressed its expectationsrnthat assessment of system vulnerabilities, effective monitoring of cyber risks, and oversight of third parties that havernaccess to GSE data would be key components GSE cyber risk management. </p

FHFA’s 2014 Strategic Plan for thernConservatorships of Fannie Mae andrnFreddie outlines FHFA’s conservatorshiprnobjectives for the GSEs and the 2014 Conservatorship Scorecard detailsrnactivities and expectations for the Enterprises during 2014.   Watt said bothrnthe 2014 Conservatorship Strategic Plan and the 2014 Conservatorship Scorecard are centered around three strategic goals and outlined for the Committee somernof the accomplishments under each. </p

Strategic Goal 1: rnMaintain, in a safe andrnsound manner, foreclosure prevention activities and credit availability for new and refinanced mortgages to fosterrnliquid, efficient, competitive andrnresilient national housing finance markets.</p

FHFA is continuing the process of updating and clarifyingrnthe Representation and WarrantyrnFramework which provides the GSEs with remedies – including requiring a lenderrnto repurchase a loan – when they discover thatrna loan purchase does not meet their underwriting guidelines. This has focused on placing increased attention andrnresources on upfront quality control reviews in order to identify problems,rnpossibly even before loans are purchased and thus reduce lenders uncertaintyrnabout repurchase requirements and paving the way for reduction of currentrncredit overlays and borrower costs. </p

The first improvements in this framework went into effect inrnJanuary 2013 and there were additional refinements in May 2014.  FHFA has now announced an agreement in principlernthat will clarify and define the life-of-loan exclusions applicable to thernFramework. </p

The smaller downpayment requirements expected shortly forrnGSE loans will require that borrowers have compensating factors and riskrnmitigants such as housing counseling or lower debt-to-income rations in order forrnthe mortgage to be eligible for purchase. Additionally, like other loans withrndown payments below 20 percent, thesernloans will require credit enhancement, such as private mortgage insurance.</p

The GSEs have continued to reach out to small and rural lendersrnand Housing Finance Agencies to strengthen their understanding of how the GSEs might better serve them. Watt said theserncommunity-based institutions have a vital role serving rural and underserved markets across therncountry and FHFA knows that many of them could not be active in the housingrnmarket without access to a liquid secondary housing finance</p

The GSEs have continued to focus on loss mitigation and borrower assistance activities and asrnof August 31, 2014 had conducted more thanrn3.3 million foreclosure prevention actions since entering conservatorship.  Watt said there are still areas of the countryrnwhere the housing recovery has lagged and homeowners still need assistance sornFHFA has worked to improve foreclosure prevention with efforts such as thernNeighborhood StabilizationrnInitiative which is targeting Detroit and Chicago for a pilot program and withrnprograms to make consumers aware of the Home Affordable Refinance Programrn(HARP).  The GSEs also developedrnStreamlined Modification programs to addressrndocumentation challenges associated with traditional modifications,rnincluding for deeply delinquent loans.</p

For individuals and families who rent rather than buy,rncontinuing to support affordable rentalrnhousing is also an ongoing priority for FHFA and the GSEs and the StrategicrnPlan and Scorecard maintain the GSE’s multifamily production levels. FHFA has alsorncontinued to emphasize the GSEs’ role in thernaffordable rental housing market, and has provided them with additionalrncapacity to provide financing for suchrnhousing. </p

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Strategic Goal 2:  Reduce taxpayerrnrisk through increasing the role of private capital in the mortgage market</h2

 FHFA has reformulated this goal so that it no longer involves specific steps torncontract the GSEs’ market presence but rather focuses on ways to scale back their overall risk exposure.  One initiative has been to strengthen thernGSEs’ counterparty requirements for private mortgage insurers and the agency isrnreviewing comments in response to draft PrivaternMortgage Insurer Eligibility Requirements. rnIts assessments and policy decisions will take into account both safetyrnand soundness considerations andrnpossible impacts on access to credit and housing finance market liquidity.rn</p

FHFA also increased the 2014rnScorecard target to achieve a meaningful creditrnrisk transfer of $90 billion in unpaid principal balance, up from $30 billionrnin 2013 and has encouraged the GSEs to test multiple types of credit riskrntransfer structures, which includernsecurities-based transactions and insurancerntransactions.</p

As of November 1, 2014, Fannie Mae has transferred therncredit risk associated with $183 billionrnin unpaid principal balance of single-family mortgages, and Freddie Mac hasrntransferred credit risk associatedrnwith $169 billion in unpaid principal balance of single-family mortgages. In each transaction, the GSEs retained arnsmall first-loss position in the underlying loans, sold a significant portion of the risk beyond the initial loss andrnthen retained the catastrophic risk in thernevent losses exceeded the private capital support.  The GSEs also continue to reduce the size ofrntheir retained mortgage portfoliosrnconsistent with the terms of their agreement with the Treasury Department. </p

Strategic Goal 3: Build a new single-familyrnsecuritization infrastructure for use by thernGSEs and adaptable for use by other participants in the secondary marketrnin the future</p

FHFA’s final strategic goal is to BUILD a new infrastructurernfor the GSEs’ securitizationrnfunctions which includes development of the Common Securitization Platform (CSP) infrastructure and to improve thernliquidity of Enterprise securities.  Progress in 2014 includes the identificationrnof a Chief Executive Officer for Common SecuritizationrnSolutions (CSS), the corporate entity which is owned jointly by Fannie Mae andrnFreddie Mac and will ultimately house and operate the CSP.   Therngovernance structure and operating agreements concerning the CSS have been finalized and considerablernprogress made on the design-and-rnbuild phase of the CSP. </p

In pursuing a Single Security for the two GSEs FHFA’s toprnpriority is to deepen and strengthen liquidity in the housing finance markets.  Today the mortgage-backed securities issued by Fannie Mae and Freddie Mac trade inrnseparate “to-be-announced” (TBA) markets where there is a price disparityrnbetween them largely due to greaterrntrading volumes of Fannie Mae securities.rnThis imposes an additional cost on Freddie Mac to remain competitive.  </p

Watt said one of his first decisions as FHFA directorrnwas to suspend scheduled increases in guarantee fees believing that the subjectrnrequired more feedback from stakeholders. The agency requested comment both onrnthose increases and on proposed GSE housing goals for 2015 through 2017 and isrncurrently reviewing both sets of comments with an eye to both safety andrnsoundness of the GSEs and the possible impact on access to credit and housingrnfinance market liquidity. .  </p

Turning to the Federal Home Loan Banks (FHLBanks), Watt saidrnthe system remains strong.  Theirrnaggregate balance sheet has increased over thernpast two years, but remains considerably smaller than in peak years.rnAdvances totaled $545 billion as thernend of the third quarter of 2014, up from $499 billion at year-end 2013, butrndown 50 percent from a peak of $1.01rntrillion in the third quarter of 2008. </p

Watt says his agency’s supervision of the FHLBanks’ expandingrnmortgage programs involves oversight of operationalrnissues required by two new products – Membership Partner Finance (MPF) Direct and MPF Government MBS.  The FHLBank of Chicago is likely to begin offering both of these late thisrnyear or early next.  Under MPF Direct,rnparticipating members would sell non-conformingrnand conforming, single-family, fixed-rate mortgage loans to the Chicago Bank, which would concurrently sell thernloans to a third-party private investor for securitization.  The Chicago Bank expects, at least initially,rnthat loans sold will be “jumbornconforming” loans – capped at $729,750 for single unit loans in the contiguous United States.</p

Under the second program, the bank would purchase government guaranteed or insured loans,rnaccumulate the loans on its balance sheet eventually pooling them in securitiesrnguaranteed by the Government National MortgagernAssociation (Ginnie Mae).

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