In a Freddie Mac Perspectives blog, Kevin Palmer, SVP of Single-Family Credit Risk Transfer, explained how credit risk transfers (CRTs) and Guarantee fees (G-fees) have much more in common that one might think—one gives Freddie Mac significant insight into the other.
Guarantee fees are a retained amount of payments received on mortgages sold to Freddie Mac by banks and other sellers. In return, Freddie guarantees payment of principal and interest on the pass-through securities that they issue to their customers, or Gold PCs.
“The G-fee essentially covers the cost of providing the credit guarantee—both the non-credit costs, such as administrative costs, and credit costs, which are the expected costs plus the cost of unexpected losses,” Palmer said.
Though the G-fee normally would be for costs Freddie Mac could incur if they retained all the credit risk related to loans in their mortgage securities, the last four years they have been transferring a significant portion to the private market through their Single-Family CRT program. What CRT does for G-fees is clarify to Freddie that the G-fees are in line with what the private market would charge for the mortgage credit risk they take.
To calculate the G-fee, Freddie analyzes the cost of the past years Structured Agency Credit Risk (STACR) transactions and determines the market-implied G-fee for the lower range of what the private sector would be willing to pay to operate a credit guarantee business like Freddie Mac’s. You can see a more detailed view of that calculation below.
According to Palmer, “CRT is not only shifting risk away from taxpayers and creating new asset classes for investors, it is a key benchmark for policy discussions by providing information about what the private capital markets would charge for absorbing the credit risk generated by the credit guarantee business of a GSE.”