CRT: A Means to an End Despite Lack of Housing Reform

This article was originally published on the GoRion blog. As we look forward to 2017 and the critical issues facing the nation’s housing finance system, one of the paramount matters will be the ongoing development of the Credit Risk Transfer (CRT) initiative. The Federal Housing Finance Agency (FHFA) and the two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, have enjoyed many CRT successes in their goal to de-risk the government. Earlier in 2016, FHFA released a request for information (RFI) to determine the next steps for the CRT activity. The principles listed on Credit Risk Transfer are:
  1. Reduce Taxpayer Risk
  2. Make Economic Sense
  3. Ensure Continuity of Core Business
  4. Create Repeatable Transactions
  5. Be Scalable
  6. Ensure Counterparty Strength
  7. Appeal to a Broad Investor Base
  8. Promote Stability through economic and housing cycles
  9. Ensure Transparency
  10. Provide a Level Playing Field
The recent progress report issued by FHFA informs us that as of December 31, 2015, the GSEs transferred credit risk on an unpaid principal balance (UPB) of $838 billion with a notional coverage up to 3.6 percent. In October during the first CRT conference – co-hosted by Andy Davidson, AD-Co and IMN in New York City – Fannie Mae representatives noted they had transferred risk since inception of the program on three quarters of $1 trillion dollars of UPB. This is significant and it is remarkable to see such progress in a short period of time. Despite lack of action in Congress, the GSEs and FHFA continue to move forward on changing the market, creating the largest private capital asset class for mortgage credit risk investors, while continuing to maintain broad credit availability and a highly functioning mortgage market.  

The 30-Year FRM Challenge

Part of the challenge to housing reform is how to satisfy the requirement to maintain the 30-year fixed rate mortgage market. This has created much debate on the value to consumers around the 30-year fixed rate mortgage and the importance of a healthy forward trading market. The government guarantee remains a key driver of success in the global capital markets. A 30-year mortgage and healthy “to be announced” (TBA) market has been the backbone to liquidity, standardization and scale in years past. Yet, a 30-year fixed rate mortgage is not an attractive instrument to put on the balance sheet of a bank. Therefore, finding a path to preserve this in the face of housing reform remains a high priority. There are a number of questions being asked across the industry and within the United States Congress.
  • Is it necessary to have a government guarantee on mortgages for investors?
If the answer is yes, how can we be sure to have private capital step in front of the government guarantee in order to absorb necessary default losses and avoid a taxpayer bailout? Other questions include:
  • Will the government adequately price credit risk?
  • Is there enough private capital available to place in front of the government guarantee?
  • Is private capital alone enough for a functioning market?
  • Will private capital stay in the market in volatile times?

Government Guarantee Consensus Grows

With the government left holding losses from the worst days of the crisis, those debates continue today. There is a growing consensus from most parties that some kind of government guarantee will provide stability and be a necessary component for any housing reform model. Indeed, while varying models are introduced through thought leadership white papers and briefings, the call for a government catastrophic risk guarantee is now part of most proposals. Today, CRT is the largest new asset class attracting private capital for residential mortgages. This is playing a very significant role in establishing the market for credit investors while lowering credit risk to the enterprises and taxpayer. The GSEs and “The Street” boast of a deepening credit investor market which bodes well for the health of housing. The deals are generally oversubscribed at 2-to-1. The capital market teams at the GSEs have remained focused on achieving these goals pursuant to the annual FHFA scorecards. Fannie Mae, Freddie Mac and their regulator have done a remarkable job in creating this market while the GSE status remains in limbo through conservatorship. Notably, the GSEs have been averaging $16 to 17 billion per year in CRT and have room to grow that amount, further reducing taxpayer liability. Professionals involved with reform efforts in Washington are not hopeful we will have housing reform any time soon though progress in housing continues to be made through efforts like new and enhanced CRT executions.  

Investors Hungry for CRT?

Despite lack of reform, FHFA and the GSEs have now paved the way for private CRT transactions to continue in the marketplace due to strong and growing investor appetites. The improved mortgage manufacturing process, improved representation and warranty clarity, and increase in purchase certainty prior to sale of the loan, has improved overall agency loan performance. Per both GSEs, the credit performance on CRT is outperforming the 2001/2002 “normal” book year pre-crisis. While the investors are non-government entities, it is important to note that the government remains in control of the investor expansion in mortgage credit risk. The strong standards being set by the GSEs add value to the investor who wants certainty and clarity around the rules, the product and the risk in which they are investing. The lessons we are learning through CRT innovation will certainly play into the discussions around the role of government and private capital as we continue to reshape the housing finance of the future. This is the first 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.