Written By: Joel Palmer, Op-Ed Writer
One of the most significant operational changes of the government-sponsored enterprises of Fannie Mae and Freddie Mac since the federal government assumed ownership is the strategic transfer of credit risk.
A program that started five years ago has quickly evolved into a significant market for credit risk transfer securities.
When the 2008 financial crisis hit, the combination of plummeting home prices and rising mortgage defaults put at risk mortgage-backed securities backed by Fannie and Freddie. This required a $188 billion bailout from the federal government, which took over ownership.
In 2012, the Federal Housing Finance Agency (FHFA) developed a program to transfer credit risk. Within three years, according to an August 2015 FHFA report, the GSEs were transferring credit risk on nearly 90 percent of the loans that accounted for their overall credit risk, and that made up half of their overall acquisitions.
Since 2013, Fannie Mae alone has transferred credit risk on over $896 billion in single-family mortgages.
Credit risk transfer isn’t a new concept for GSEs and has been part of their operations long before government conservatorship. What has evolved are the methods used and the markets created for credit risk transfers.
Take, for example, last month’s announcement by Fannie Mae of a second transaction of what it termed front-end Credit Insurance Risk Transfer (CIRT).
The CIRT program was developed to transfer credit risk to reinsurers. According to Fannie Mae, “The reinsurance market is a significant and attractive source of private capital because it currently bears a small amount of U.S. residential mortgage risk and its other forms of risk are not correlated to Fannie Mae to any meaningful degree.”
Fannie has conducted about a dozen CIRTs to the insurance market. What has made the last two (the February transfer and another conducted in October 2016) is that they were executed on a “flow” basis. This meant the transfers were committed to before Fannie Mae had even acquired the covered loans.
The February CIRT is a loan pool with an unpaid balance of about $15 billion, consisting of 30-year, fixed-rate loans with LTVs between 60 percent and 80 percent. Fannie Mae will retain risk for the first 50 basis points of loss on a pool of loans of approximately $15 billion. If this approximately $75 million retention layer is exhausted, the participating mortgage insurance companies will cover the next 250 basis points of loss on the pool, up to a maximum coverage of approximately $375 million, said the company’s press release.
The October 2016 CIRT consisted of 30-year, single-family mortgages with an unpaid balance of about $3.7 billion, and with LTVs between 80 and 97 percent.
In a statement at the time of the October transaction, Rob Schaefer, Fannie Mae’s vice president for Credit Enhancement Strategy and Management, said the “front-end CIRT expands the options that Fannie Mae can use for transferring mortgage credit risk away from taxpayers, while tapping a diverse source of capital and risk-sharing partners.”
In addition, the new structure “leverages the enhancements that were pioneered in our existing CIRT program, including a streamlined operational process, improved certainty of coverage, and enhanced counterparty protections.”
Also last year, Fannie included 15-year and 20-year fixed rate mortgage in the covered loan pool for the first time. This provided reinsurers “a more diversified investment opportunity,” said the company in a statement.
Not only is the CIRT strategy good for the GSEs and taxpayers, it is also a potential opportunity for insurers.
Jonathan Glowacki and Mike Jacobsen of Milliman, a global actuarial firm, wrote in a paper last year titled “The Trillion-Dollar Marketplace,” that, “The risk-and-reward profile of these credit risk sharing transactions can be an attractive avenue for insurance companies to deploy capital, either from the asset side of the balance sheet or through participation in the insurance structures.”
About the Author
As an NAMP® Opinion Editorial Contributor, Joel Palmer is a freelance writer who spent 10 years as a business and financial reporter and another 10 years in marketing for the insurance and financial services industries. He regularly writes about the mortgage industry, as well as residential and commercial real estate, investments, and retirement income planning. He has also ghostwritten books on starting a business, marketing, and retirement income planning.