Credit Risk Transfer in a New World – The Waterfall of Risk Falls Squarely on Private Capital

This article was originally published on the GoRion blog. Last month I highlighted the role of the front-end insurance risk share process around Credit Risk Transfer (CRT).  I reviewed what the front-end risk share model is in the current state and noted the expanded efforts underway to broaden the pool of MI’s and reinsurers as counterparties to expand the front-end offerings.  This is in addition to the already successful back-end CRT which has found great success thus far.  So, the key question for 2017 is what does CRT look like in a post housing reform environment where much of the capital at risk is not the government credit guarantee but is comprised of private capital? First, it is important to remind readers of some of the reasons CRT is successful and oversubscribed by the credit investors.  The path to expand investment of private capital has been built by the GSE’s in the current CRT efforts by their continuous improvement in the quality of credit, process, and workflow.  The private sector can leverage these standards as they expand their own offerings.  The post crisis credit and servicing guidelines have added certainty to credit investors and interest from private capital has subsequently surged. While we are all appreciative of the clarity of government standards and the credit guarantee in housing finance, the thinking is that progress and innovation will be more prominent if there are opportunities to expand offerings for mortgages by leveraging the private sector.  Most agree it is attractive to find more participation of capital in housing through private markets though it has been slow to advance post crisis. CRT has stimulated that advancement and creativity and will continue to be a positive force in the next stages of housing finance. One concept around this innovation is to leverage CRT in the private sector. This forward thinking was recently documented in the paper, Toward a New Secondary Mortgage Market, by Michael Bright and Ed DeMarco. Women in Housing Finance (WHF) hosted a lunch session on November 10, 2016 with Michael Bright, Director of the Milken Institute, and Ed DeMarco, Senior Fellow, Milken Institute during which Michael and Ed discussed their paper. My interest in this subject, other than the overall discussions that have taken place over the past eight years, was how they thought “CRT” was a central component of the new Secondary Mortgage Market. This next section explores some of those ideas. This is NOT a commentary on which way housing reform should go. In fact, if there is one common concept across most thought processes on housing reform, it is the government role of explicit guarantee for the catastrophic tail risk. The most interesting part of this proposal is that it seems to be less disruptive than other proposals. Further, it places significant private capital ahead of government at risk capital in the new housing world order. This contemplation was evident in the overview as discussed by the Milken scholars. The next section speaks to some of the details in this review. Many of the concepts are shared in other papers that attempt to place private capital well in front of the “at risk” government guarantee.  

The Capital At Risk in the Fully Functioning Market, Funded by the Private Sector, Rolls Up to 8%

Summary of private capital ahead of government guarantees:
  • 4% through CRT shed in first loss position.
  • An additional 2% of capital needed by way of purchasing a share ownership, of a mutual concept.
  • Additional capital as funded by industry and loans, deal by deal, up to 2% which is contributed to the insurance fund managed by the regulator, in this case the Federal Housing Finance Agency (FHFA). This is funded by the industry, much like the FDIC funding in case of a stress event.
The concept brought forth in the paper contemplates that the GSE’s would go through receivership and become reconstituted as entities mutually owned by their seller servicers. Industry has “skin in the game” and quality matters. The securitization vehicle would be to leverage Ginnie Mae as a standalone agency outside of the US Department of Housing and Urban Development (HUD), creating a full faith and credit wrap on the mortgage backed securities, much like they do with VA, FHA and USDA rural today. Enhanced oversight, funding and independence would be necessary for Ginnie Mae to fulfill this role and be effective. FHFA would become the supersized regulator of the US housing finance system to include monitoring capital in the system in front of the government guarantee, as well as monitoring standards for private credit enhancements and managing the mortgage insurance fund which is developed and contributed to by industry. The mutual (those entities who invest in the GSE’s) would need to shed 4% capital in overall transactions so the full market would have disseminated risk share on the transactions (versus the concentrated risk of today). While this is an assumption in the paper, it is notable that it may not be economic to shed risk in all cycles. Alternately, another form of risk share will be necessary to ensure the syndicated credit risk sharing is priced fairly and accurately. The securitization platform recently updated by Ginnie Mae is the suggested platform with some comparisons and studies via the Common Securitization Platform (CSP) currently under a build jointly from both GSE’s in a joint venture.  

Why Does This Approach Become an Attractive Example to Leverage the CRT Model?

Simplicity: This model seems simpler than deconstructing entities and creating new entities. This is a simplistic overview leveraging current tools available to the market subject to certain charter changes and adjustments. Less Disruptive: This appears to be less disruptive to the markets. The attraction of this option is that appears to be less disruptive to the market, places significant private capital ahead of taxpayers, and leverages the models already built by the GSE’s and the regulator to thoughtfully advance the need for private capital to get in front of government guarantees. Ginnie Mae securities are already very liquid, trading north of GSE securities in price, and they would have the advantage of a known MBS. Of course, it will take an act of congress to make progress along these lines but one can hold out hope that housing reform is a priority going forward. Retrofit current organizations: This model works within an existing framework with some “tweaks.” Another highlight is that this does not contemplate building yet another agency to make this happen. The idea is to retrofit the activities of the players to accommodate a new construct. Housing reform has proven to be a challenging endeavor. But this is one way to continue to leverage the CRT model in an expanded marketplace. CRT is taking on a life of its own: We have recently seen a new proposed bill, Reps. Ed Royce, R-CA, and Gwen Moore, D-WI, offer a new Taxpayer Protection and Market Access for Mortgage Finance Act of 2016, which requires the GSE’s to engage in more credit risk transfer transactions. This includes more ways to help small lenders, and expand risk share with the MI’s, and adjust some securities and tax laws to allow REITs to invest in GSE credit risk bonds. Private capital is adequate to protect the taxpayer for up to 8% capital at risk. Originators have “skin in the game” to originate and service quality residential loans.  


Housing reform and use of CRT is a complex issue. Clearly, rebuilding the housing finance system is no easy task. And even with all of the talk on housing reform in recent years we have seen little real movement advancing the ball for GSE’s to be removed from conservatorship. We all heard a snippet from the incoming Treasury Secretary, Mnuchin, who was quoted saying that the GSE’s will be taken out of “government ownership” restructured and privatized. So buckle up and get ready. Whatever comes next, we can be assured that new proposals in housing finance reform from industry, think tanks, administration officials, and hungry credit investors, will likely continue to put CRT front and center in their plans. This successful burgeoning marketplace offers us new avenues to explore given the demand and necessary risk sharing that will be in place, largely funded by private capital. The call for a liquid safe and sound secondary mortgage market system should “Trump” any variations that do not ensure this is the case. And the GSE’s and FHFA have created the path forward on how to integrate CRT into the many variations of reform we may see in the upcoming administration. Sources contain information from the WHF seminar and the paper “Toward a New Secondary Mortgage Market” and may be found at This is the final installment in a monthly Credit Risk Transfer (CRT) series on the GoRion blog. CRT is a significant accomplishment in bringing back private capital to the housing sector. This young effort, three years strong, has already shown promising investor appetite while discussions are underway to expand offerings to front-end risk share executions. My goal in this series is to share insights around CRT as it evolves with the private sector.