The strength of Fannie Mae and Freddie Mac in the housing market, despite being under conservatorship of the FHFA since 2008, has prompted the GSEs to expand risk sharing initiatives in order to transfer more risk to the private market and minimize risk to taxpayers as well as internally, according to CoreLogic SVP of Government Solutions Faith Schwartz.
On CoreLogic's blog this week, Schwartz noted that many private placement deals have taken place vs. traditional private label securitization transactions, which have been almost nonexistent since the conservatorship began.
"In addition, bank balance sheets remain opportunistic and purchase the whole loans that fall outside of the government agency business where those loans fit the individual bank model, risk appetite, funding sources and capital structure," Schwartz said.
Without private label securitizations, investors are using two key mechanisms for residential mortgage credit risk transfers: the Connecticut Avenue Series (CAS) for Fannie Mae and the Structured Agency Credit Risk Transfers (STACR) for Freddie Mac, which were created for the specific purpose of diverting credit risk liability from the GSEs (hence the taxpayers) to the private market.
Through a combined total of 22 CAS and STACR transactions since 2013, Fannie Mae and Freddie Mac have transferred risk on $667 billion in unpaid principal balance (UPB), according to a report released in August 2015 by the GSEs' conservator, the FHFA.
"Either way, the GSEs and FHFA appear to be working hard to innovate and create solutions designed to minimize taxpayer risk."
"Part of the strategy for the GSEs has been to make sure their credit risk transfers activity is economical, scalable, not disruptive to the To-Be-Announced market, and to cover their unexpected losses," Schwartz said. "Currently, the credit-transfer programs cover losses except for catastrophic losses. And they are not insuring their standard credit enhancements such as mortgage insurance policies or structured credit enhancements."
This indicates that risk sharing is here to stay, Schwartz wrote. The CAS and STACR transactions have attracted more than 150 investors, and FHFA said the transfer of risk on $667 billion in UPB exceeds the FHFA's goals in less than three years. The effectiveness of CAS and STACR transactions "appears to be a promising approach" in a market that has been searching for a way to bring back private capital, Schwartz said.
"Credit risk transfer is now a regular part of the Enterprises’ business," FHFA wrote in the August report. "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. These loans constitute about half of all Enterprise loan acquisitions."
Schwartz wrote that the government is creating more transparency around the pricing of credit risk by establishing pricing on credit risk transfers for both expected and unexpected risks attached to mortgages over a 10-year period. Thus, rational pricing models driving front-end originations for credit risk at the GSEs can be established.
"Additional risk sharing strategies being explored for issuance and expansion include credit linked notes and up front risk sharing with insurers and re-insurers," Schwartz wrote. "Either way, the GSEs and FHFA appear to be working hard to innovate and create solutions designed to minimize taxpayer risk."