Mortgage Bankers Propose Swapping Risk Exposure for Lower Fees

  • Trade Group says Fannie, Freddie insurance tabs have doubled
  • Originators would back loans before they're bundled into bonds

Mortgage bankers are offering to take on increased default risk under a plan that would reduce the insurance fees they pay when their loans are bundled into Fannie Mae and Freddie Mac securities.

The Mortgage Bankers Association is seeking explicit 2016 targets for this kind of “up-front” risk-sharing, the trade association said in a Monday letter addressed to Mel Watt, director of the Federal Housing Finance Agency, which oversees Fannie and Freddie.

The originators would purchase private mortgage insurance to limit their exposure to losses on the loans. Borrowers might also benefit from lower guarantee fees promised to participating mortgage providers, according to the letter.

The push comes after the government-sponsored enterprises have more than doubled the fees in recent years, according to the mortgage bankers group. Previously, the risk was pushed into the pools of loans that underlie Fannie and Freddie mortgage-backed securities, putting taxpayers on the hook when borrowers defaulted.

‘Little Capital’

“From our view, the upfront approach is preferred because Fannie and Freddie have so little capital and that amount of capital is declining over time,” Mike Fratantoni, chief economist of the mortgage-bankers group, said in an interview. “The system may be better off if the risk is dispersed before it gets to the GSEs, particularly if they are aggregating risk and then distributing it later.”

Fannie and Freddie were taken over by the government in 2008 after a surge in mortgage defaults. Taxpayers paid $187.5 billion for the bailout, though the companies returned more than that to them in subsequent years, leaving them with little capital and with reserves that will wind down by 2018.

New Approaches

The U.S. has been seeking new approaches to risk sharing since 2012 to reduce the chances of further federal aid. FHFA has previously said it’s exploring approaches such as the one being offered by the mortgage bankers. During that period, the government housing companies issued 96 percent to 99 percent of all new mortgage-backed securities, according to Freddie Mac

So far, the primary method of risk sharing has involved selling bond investors the credit risk of home loans that were already sold to the mortgage giants and pooled into securities. Around two dozen such transactions totaling $12 billion have been completed this year, according to Nomura Holdings Inc. data.

Mortgage bankers contend that transferring risk to private insurers would mitigate chances that the GSEs would need a bailout from the Treasury Department under dire circumstances. It also would avoid exposure to volatility in yield spreads, such as the market swings in the third quarter that contributed to losses on derivatives positions that Freddie Mac used to hedge its risk, the letter said.

Under the mortgage bankers’ model, Fannie and Freddie would essentially serve as “catastrophic” insurers, said Guggenheim Securities analyst Jaret Seiberg. That could be a model for the market in the future, he said.

‘Least Expensive’

“Deep mortgage insurance is the least expensive form of private-sector risk sharing, which is why it will eventually win out,” Seiberg said. “The political pressure is to keep down costs for home buyers.”

Some experimentation with the approach has already taken place this year. Only very large mortgage originators have tested it out, raising concern that Fannie and Freddie might offer preferential terms to their best customers.

Participants so far have included JPMorgan Chase & Co., PennyMac and Redwood Trust. Their deals don’t disclose agreed-upon fees that advocates say would entice lenders to participate. That is a major weakness, the Urban Institute’s housing policy chief Laurie Goodman said in an interview. “There should be more transparency.” She suggested a competitive bidding process.

The mortgage bankers also called for transparency into the fee structures, and for such partnerships to be available to more lenders, the group’s Fratantoni said.

Risk of the insurers failing, reminiscent of the collapse of the so-called monolines during the financial crisis, is also a factor the market needs to consider, said Goodman, joined by Urban Institute’s Jim Parrott and Moody’s Analytics chief economist Mark Zandi in a report published Tuesday.

“The bond market would also be a big fan of movement towards up-front risk sharing,” said Steven Abrahams, a Deutsche Bank AG mortgage analyst. But “there is lots of room to improve in these programs.”

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