FHFA capital adjustments may spur credit score threat switch issuance

The Federal Housing Finance Agency's reassessment of the capital requirements of government-sponsored companies is likely to increase the use of credit risk transfers, observers said.

Fannie Mae hasn't closed any new CRT deals since March 2020, while Freddie Mac's issuing pace has been slower than in previous years. Both agencies responded in part to the revision of the GSE framework by former FHFA director Mark Calabria, which asked them to allocate more funds to these deals.

By late last year, Fannie Mae and Freddie Mac had transferred a portion of the $ 4.1 trillion credit risk to mortgages with unpaid principal. These have a combined risk of approximately $ 137 billion, according to an FHFA report released in August. These include security issues, insurance / reinsurance transactions, senior subordinated securitisations, and a variety of lender risk-sharing transactions.

Last year, Freddie Mac's CRT deals totaled $ 484 billion UPB, the highest since the asset class was launched in 2013. The first half of that year was $ 419 billion.

But for 2020, Fannie Mae made just $ 164 billion, the second lowest ever; only in 2013 were there fewer transactions, at 32 billion US dollars.

"Some reversal (Calabria's capital rule) could certainly be a source of new supply of CRT, bring Fannie Mae back to market and make it economically more beneficial to operate CRT for both companies," said BTIG analyst Eric Hagen.

Fannie Mae stopped issuing just before the pandemic began, but the securitization market has changed dramatically since then.

"Part of the reduction in risk transfer is due to the significant widening of credit spreads for CRT and non-guaranteed tranches since the beginning of the COVID-19 pandemic last year," said a report by Barclays analysts Anuj Jain and Pratham Saxen. "However, the spreads have normalized now, but the rate of risk transfer from the GSEs remains slow, driven in part by the capital requirements that came into effect earlier this year."

Additionally, for mortgage-backed securities investors, CRT deals are a means by which investors can compare and evaluate the cost of capitalizing on mortgage credit risk, Hagen said.

Therefore, "an increase in issuance would be a welcome development for yield-hungry credit investors, while creating perhaps the strongest backdrop for lenders who (before last March) shared the risk with the GSEs on their own loans like PennyMac," he notes, one opinion which Barclays analysts agree with.

"We believe that these proposed changes, if implemented, should lead to increased risk transfer from the GSEs, especially in a low-yield environment where the demand for spreads is very high," the Barclays report said .

The changes would increase capital incentives for the GSEs that conduct CRT transactions, Keefe, Bruyette & Woods analyst Bose George said in a report.

"While the impact on risk-based capital can vary, we believe that we believe the minimum risk-based capital will also decrease by about 25%, suggesting that the risk-based capital could also be around 3%," he wrote.

Freddie Mac did not comment on the proposed changes. However, in its formal comments on the Calabria proposal, which was finalized last November, the company said, "Our recommendations would encourage the purchase of additional protection rather than reducing the use of CRT. The lower limit of 10% should be increased by 25% to be replaced. " in the replacement level that is required to achieve complete loss protection for the stress scenario. "

Freddie Mac had also called for the 10% discount for third-party tranches to be replaced with a modified process to apply an overall effectiveness adjustment, but only for certain CRT transactions that may have higher idiosyncratic or complexity risks than existing structures or transaction sizes using Freddie Mac.

They appear to be in line with the FHFA's revised proposal that would replace the regulatory floor of 10% of the risk weight assigned to each withheld CRT exposure with a floor of 5% and remove the requirement that Freddie Mac and Fannie Mae have one Apply overall effectiveness to match the retained CRT exposures.

Fannie Mae's comment on the Calabria proposal suggested something similar; "In order to better tailor the treatment of CRT to the identified specific risks, Fannie Mae recommends removing the minimum risk weight of 10% for retained CRT tranches and increasing the overall effectiveness adjustment for single-family CRT," the agency stated that its own recommendation "the Addressed concern that covered loans could be funded from a pool if new CRT cover is not available ”.

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