May capital hinder house possession for Fannie and Freddie?

WASHINGTON – A proposal to increase Fannie Mae and Freddie Mac's capital levels more than five-fold after companies return to the private sector has worried both the mortgage industry and consumer groups over concerns that the plan will skyrocket housing costs could drift.

The proposed regulation, tabled by the Federal Housing Finance Agency in May, would align capital requirements for government-sponsored companies with those of big banks and incorporate the spirit of several post-2008 crisis regulations. The plan would not go into effect until after Fannie and Freddie were released from the Conservatory whenever that happens.

However, in comments to the FHFA, many industry groups and even the two companies themselves pushed for the idea that the GSEs should be treated like banks.

"While US banking capital provides a useful precedent, corporate business models and risk profiles differ significantly from banks," said Ricardo Anzaldua, executive vice president and general counsel, Freddie. "Unlike banks, the companies are pass-through monoline companies that focus on a traditional, well-understood and secured asset class."

The plan would lead to a tremendous effort to strengthen the GSE's balance sheets. For example, if the framework had come into effect in September 2019, companies estimate that the FHFA should have held total capital of $ 234 billion, which is 3.85% of its total assets and 13.9% of its risk-weighted assets. Currently, Fannie and Freddie's retained earnings are capped at a total of $ 45 billion.

Ed DeMarco, president of the Housing Policy Council and former acting director of FHFA, agreed that GSEs are vastly different from banks. He suggested that in addition to banks, the capital framework also use insurance companies as a point of comparison for Fannie and Freddie.

"Banks are not primarily engaged in the mortgage guarantee business, which is the core business of corporations," he said in the group's comment letter. "In addition, unlike banks, companies are not dependent on deposits for financing, so they are not exposed to the same liquidity and interest rate risk as banks."

Community Mortgage Lenders of America also urged the FHFA to treat Fannie and Freddie more like insurance companies and less like banks.

“We are very skeptical of arguments that the GSEs have to reflect bank-like capital standards, as they have consolidated their business models as insurance companies and a … supervisory authority can keep them in this area better than the old regulatory model. Said the group, referring to the FHFA.

However, the proposal was not made general. Some noted that the new capital regime is not as strict as the regulatory standards imposed on the largest and most complex banks.

Sheila Bair, a former chairwoman of the Federal Deposit Insurance Corp. and member of the Fannie board of directors, described the FHFA's proposal as a "highly credible framework" that would protect taxpayers from losses while ensuring a return on investment for shareholders. Though the plan would go further than a 2018 proposal formulated by the previous leadership of the FHFA, Bair is still striking a middle ground.

"The rule proposed by the FHFA seems to strike a good balance," she wrote in a comment. "While much stronger than the 2018 proposal, it would still only require about half the capital required under the rules governing global systemic banks that protect the FDIC from loss."

However, Fannie and Freddie both warned that a higher capital benchmark would require their profits to grow in order to meet the requirements. That could require them to increase the fees they charge lenders to secure mortgages, they said.

"In order to meet the requirements of the proposed rule while generating a return sufficient to attract loss-making private sector capital, increases in guarantee fees may be required," said Celeste Brown, Fannie's CFO. "The final capital framework should take into account the potential impact of such guarantee increases on the borrowers Fannie Mae serves and the affordability of housing in general."

Anzaldua estimated that the proposed capital framework could force Freddie to increase his guarantee fees by up to 35 basis points. If those fees increase, lenders would likely pass the additional costs on to consumers, he said.

"Certain negative effects on our business and markets could result from this increase," he said.

A joint comment from 14 consumer groups said the end result was reduced availability of mortgage credit, "with an acute impact on low- to middle-income and skin-colored families."

“This would be done directly, by pricing many borrowers with lower credit scores and higher credit-worth ratios out of the GSE channel, and indirectly, by having higher credit scores and lower LTV borrowers generating a large part of the current system cross , subsidies are being priced to make lending more affordable, ”said groups, including the Center for Responsible Lending and the National Community Reinvestment Coalition.

On the flip side, however, Bair also noted that strong capital requirements would reduce the likelihood of another taxpayer bailout for GSE.

"What we learned from the great financial crisis is that weak capital requirements lead to financial instability and crisis, and that the brunt of the damage caused by this instability lies disproportionately on LMI families, and particularly African-American families," she said.

The Mortgage Bankers Association suggested that the proposed capital requirements were too high and also questioned the framework's use of a fixed leverage ratio.

"The capital required by the framework is too high and may too often be determined by leverage rather than risk-based standards," wrote Robert Broeksmit, President and Chief Executive of the MBA.

Broeksmit also argued that the capital framework was too complex.

"Taken together, these multiple, complex, and overlapping constraints are likely to thwart the FHFA's goals of giving companies – and the wider marketplace – a clear signal of how much capital companies need to run their businesses safely and soundly as they work could to reduce this requirement or to allocate the capital more efficiently, ”said Broeksmit.

The proposal provides that in addition to the leverage requirement, Fannie and Freddie maintain a leverage capital buffer and a “mandatory capital conservation buffer amount” consisting of a stress capital buffer, a countercyclical capital buffer and a stability capital buffer.

Fannie and Freddie would have to hold excess regulatory capital equal to the required capital conservation buffer or face restrictions on capital distributions and bonus payments, similar to what is expected for banks regulated by the Federal Reserve, the FDIC, and the state controller of the currency.

In particular, the stability capital buffer would violate the GSEs' mission to provide liquidity to underserved communities in times of stress, argued Vince Malta, president of the National Association of Realtors.

"In particular, the stability buffer, which grows proportionally to the role of companies in the market, would increase in a crisis, precisely when the GSEs should take on a more supportive role, which implies a larger market share," he wrote.

Many commentators also expressed concern about the handling of credit risk transfers by the proposal that Fannie and Freddie are currently using to outsource some of their risk to a third party. However, the new proposal would increase capital requirements on the amount of exposure a GSE retains through a credit risk transfer, which some believe would affect the overall use of the program.

"Treating credit risk transfer by the proposed rule would prevent the use of credit risk transfer and treat it as another risk to manage rather than as a critical means of absorbing credit losses," DeMarco said. "The result will be … an increase in systemic risk."

Freddie Mac also pleaded with the FHFA to reconsider policy.

"The capital framework should take into account the mitigating nature of CRT and the historical political support from FHFA and Treasury in developing the CRT program," said Anzaldua.

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