Fannie Mae and Freddie Mac are Exceeding Credit Risk Transfer Goals

In just three years, Fannie Mae and Freddie Mac have transferred significant credit risk on loans totaling more than $667 billion in unpaid principal balance (UPB), exceeding the goals set by their conservator, according to the FHFA's Overview of Fannie Mae and Freddie Mac Credit Risk Transfer Transactions for August 2015 released Friday.

With the transfer of credit risk on loans totaling more than $667 billion in UPB, the GSEs have made substantial progress toward achieving the FHFA's goal of transferring more credit risk to the private sector.

"Credit risk transfer is now a regular part of the Enterprises’ business. The Enterprises are currently transferring a significant amount of the credit risk on almost 90 percent of the loans that account for the vast majority of their underlying credit risk," FHFA said in the report. "These loans constitute about half of all Enterprise loan acquisitions."

"Credit risk transfer is now a regular part of the Enterprises’ business." — FHFA

FHFA said that going forward it will set specific goals in the annual conservatorship scorecard and work closely with staff members at Fannie Mae and Freddie Mac to help the GSEs develop and evaluate their credit risk transfer structures. FHFA is encouraging the GSEs to continue engaging in large volumes of meaningful credit risk transfer.

According to FHFA, there are three measures used to jointly consider in the amount of credit risk being transferred: 1) the proportion of loans on which at least some risk is transferred; 2) UPB of loans covered by the credit risk transfer; and 3) amount of risk transferred as a percent of the total estimated amount of credit risk for a group of loans.

On the first measure, FHFA said it the GSEs are transferring about 90 percent of UPB for the largest category of loan acquisitions, which contain most of the new acquisition credit risk – that is, non-Home Affordable Refinance Program (HARP) refis that are fixed-rate 30-year loans with LTV ratios higher than 60 percent. On the second measure, Fannie Mae has transferred credit risk on $370.8 billion in UPB through eight Connecticut Avenue Series (CAS) transactions, while Freddie Mac has transferred credit risk on $235.5 billion in UPB through 14 Structured Agency Credit Risk (STACR) transactions. FHFA said both Enterprises have met their scorecard goals each year since 2013 as far as credit risk transfer amounts in terms of UPB. Also, while STACR/CAS issuances have been the accounted for the vast majority of credit risk transfer to date, the amount of credit risk transferred through insurance/reinsurance and other programs is growing.

FHFA said the third measure of credit risk transfer, the amount of credit risk inherent in a loan pool, cannot be directly observable at the time the credit risk is transferred. In fact, this measure can only be assessed for a given pool of loans by using a credit model, according to FHFA.

"The credit model should account for the fact that the amount of credit risk in the pool will vary according to the credit risk characteristics of the loans in the pool (e.g. credit score and LTV), the quality of underwriting at the time, and, importantly, the state of the housing market (whether or not there is a price bubble in play) at the time the loans are acquired," FHFA said in the report. "This third measure is often translated into a measure of capital that should be sufficient to cover unexpected losses. The credit risk transfers are a means to reduce that amount of required capital."

More than 150 investors have participated in the STACR and CAS programs; any given transaction will typically feature anywhere from 50 to 70 investors, according to FHFA. Asset managers make up the largest share of participating investors with 53 percent; hedge funds have the next largest share with 31 percent.

Even with the success of the Enterprises' credit risk transfer programs in their first three years, much is yet to be determined.

"Because the programs have not been implemented through an entire housing price cycle, it is too soon to say whether the credit risk transfer transactions currently ongoing will make economic sense in all stages of the cycle," FHFA said. "Specifically, we cannot know the extent to which investors will continue to participate through a housing downturn. Additionally, the investor base and pricing for these transactions could be affected by a higher interest rate environment in which other fixed-income securities may be more attractive alternatives."

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