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CoreLogic Econ


State of Play with GSE Risk Share...

Faith Schwartz    |    Housing Policy

Despite being in conservatorship since 2008, Fannie Mae and Freddie Mac (GSEs), have remained a significant force in the residential and multifamily housing market. The collective strength of the GSEs and their continued importance to the national housing finance system has resulted in efforts to expand their risk sharing initiatives, in order to minimize exposure both internally and to taxpayers.

As shown in Exhibit 1 – Market Overview Current State: State of play RMBS, private label securitizations have been almost non-existent since 2008 and have yet to reemerge. In an effort to fill this void, a number of private placement deals versus traditionally public issued private label securitization transactions, have taken place. 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.

Absent fully private label market transactions, how do we have true price discovery of residential mortgage credit?

Today, there are two key mechanisms being utilized by investors for residential mortgage credit risk transfers. They include the Fannie Mae Connecticut Avenue Securities (CAS) and Freddie Mac Structured Agency Credit Risk Transfers (STACR). Both programs exist specifically to divert credit risk liability initially borne by the GSEs (thus taxpayers) to private market entities.

In August 2015, the Federal Housing Finance Agency (FHFA) released an overview of the GSE credit-transfer activity to date, showing that the GSEs have so far shed risk on $667 billion of unpaid principal balance (UPB). Part of the strategy for the GSEs has been to make sure their credit risk transfers activityis economical, scalable, not disruptive to the To-Be-Announced market, and to cover their unexpected losses. 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.

What does this mean for investors? The credit risk transfer market appears to be here to stay. The GSEs have efforts underway to explore additional avenues of risk sharing, though both the STACR and CAS programs have proven to be effective, attracting over 150 different investors. In a market that has been searching for how to bring back private capital, this appears to be a promising approach.

Pricing of residential credit risk continues to be dominated by the government which is guaranteeing most of the risk (up to 70 percent thus far in 2015), with bank balance sheets and private placements or offerings made to select qualified investors, taking up the balance. By establishing pricing on credit risk transfers for both unexpected and expected risks associated with mortgages over a ten year period, they are creating more transparency around the pricing for credit risk and we will be better able to establish rational pricing models that drive front-end originations for credit risk at the GSEs. Additional risk sharing strategies being explored for issuance and expansion include credit linked notes and up front risk sharing with insurers and re-insurers. Either way, the GSEs and FHFA appear to be working hard to innovate and create solutions designed to minimize taxpayer risk. Stay tuned.