DeMarco Outlines Plan to Merge Fannie, Freddie into New Securitization Firm

Edward J. DeMarco announced that the Federal Housing Finance Agency plans to establish a new entity, independent of Fannie Mae and Freddie Mac (GSEs), to design and implement a new securitization platform for the secondary market.  The entity, initially owned and funded by the GSEs, it would have an independent CEO and Board of Directors and would be housed in a separate location from the two companies.

His announcement was made in a speech to member of the National Association of Business Economics in which the acting director of FHFA laid out the goals his agency has set for the two government sponsored enterprises (GSEs) in 2013.

DeMarco told the economists that "there seems to be broad consensus that Fannie Mae and Freddie Mac will not return to their previous corporate forms."   The Obama Administration has made clear that their preferred course of action is to wind down these government sponsored enterprises (GSEs) and none of the proposed Congressional legislation envisions them exiting conservatorship in their current corporate form.  Recent changes in the GSEs' agreement (PSPA) with Treasury that replaced the previous 10 percent dividend with a sweep of net income into Treasury means the GSEs will not be building the capital required to regain their former corporate status.

In the face of this uncertain future, FHFA, developed a 2012 Strategic Plan for its conservatorship which set forth three broad goals for the GSEs:

1.   Build a new infrastructure for the secondary mortgage market.

2.   Gradually contract the GSEs' dominant presence in the marketplace while simplifying and shrinking their operations.

3.   Maintain foreclosure prevention activities and credit availability for new and refinanced mortgages.

DeMarco said FHFA made considerable progress toward these goals on the Conservators' Scorecard it developed to focus the activities of the GSEs and said he was laying out its priorities for executing the Strategic Plan in 2013.   

DeMarco started with the need, because of the GSEs' uncertain future and a general desire for private capital to re-enter the market, to gradually contract the GSEs market presence over time.

Guarantee fees for the GSEs were increased twice in 2012 to around 50 basis points which nearly doubled the pre-conservatorship fee.  This was not primarily to raise revenue but to bring credit risk pricing closer to what would be required by private sector providers and at some point to encourage private capital back into the market.  "We are not there yet," DeMarco said, "but in conversations with market participants, I think we are getting closer."  FHFA also laid the groundwork in 2012 to meet goals of executing on risk sharing transactions.

The FHFA 2013 Scorecard has three priorities:

• A target for its single family credit guarantee business of $30 billion of unpaid principal balance in credit risk sharing transactions in 2013 for both GSEs and a requirement of using multiple types of risk sharing transactions to meet the target. These transactions will allow FHFA to evaluate the pricing and the potential for further execution in scale. FHFA also expects to further increase guarantee fees in 2013 and risk sharing transactions should provide valuable information as to how close current guarantee fee pricing is to where private capital would be willing to absorb credit risk.
  
• The GSEs have a smaller market share of the multifamily market and there are other providers of credit in that market. While the GSE share of new originations did increase during the financial downturn, it returned to a more normal position in 2012. Each GSE's multifamily business has weathered the housing crisis and generated positive cash flow and each GSE takes a different approach to these businesses which embed some type of risk sharing. Given that the multifamily market's reliance on the GSEs has returned to a more normal range, FHFA is setting a target of a 10 percent reduction in multifamily business volume from 2012 level which is expected to be achieved through some combination of increased pricing, more limited product offerings, and tighter overall underwriting standards.

• The GSEs' retained portfolios have declined steadily since 2009 as required by the PSPAs. The composition of these portfolios has also changed significantly from being dominated by the GSEs' own mortgage-backed securities (MBS) and performing whole loans. As those securities have been paid down, and as the need to work through delinquent loans increased, the retained portfolios have become less liquid, thus FHFA is setting a target of selling 5 percent of the less liquid portion. In other words their retained portfolios excluding agency securities. This added requirement to sell from the less liquid portions of their retained portfolios should lead to an even faster reduction than is required under the PSPAs.

The basic premise of the Build goal is that the GSEs' outmoded proprietary infrastructures need to be updated and maintained in such a way as to provide enhanced value to the mortgage market.  These infrastructures are not the most effective when it comes to adapting to market changes, issuing securities that attract private capital, aggregating data, or lowering barriers to market entry.  An updated infrastructure should also have benefits beyond the GSE business model; operable across many platforms, so that it can be used by any issuer, servicer, agent, or other party that decides to participate.

In a white paper issued last October FHFA raised the issue of the scope of the securitization platform.  One approach is to focus the platform on functions that are routinely repeated across the secondary mortgage market, i.e. issuing securities, providing disclosures, paying investors, and disseminating data, where standardization could have clear benefits to market participants.

The new entity announced by DeMarco to develop and implement the securitization platform will be designed to function like a market utility, as opposed to rebuilding the proprietary infrastructures of the GSEs and its functions are designed to operate as a replacement for some of this legacy infrastructure, however, the overarching goal is to create something of value that could either be sold or used by policy makers as a foundational element of the mortgage market of the future.

The October white paper also set out broad ideas for a model contractual framework which would identify areas where greater standardization would be valuable to the mortgage market of the future.  DeMarco said this is an optimal time to further consider how best to address contractual shortcomings identified during the past few years.

Another aspect of the Build goal is the Uniform Mortgage Data Program or UMDP.  The GSEs have worked through an industry process set up through MISMO - the Mortgage Industry Standards Maintenance Organization -- to move this process forward and have developed a Uniform Loan Delivery Dataset and a Uniform Appraisal Dataset and begun work on the Uniform Mortgage Servicing Dataset.  Developing standard terms, definitions, and industry standard data reporting protocols will decrease costs for originators, servicers and appraisers and reduce repurchase risk.

Finally, FHFA seeks to make further progress on the third strategic goal, maintaining foreclosure prevention activities, and promoting market stability and liquidity to build on progress made in 2012 with improvements to the Home Affordable Refinance Program and the representation and warranty framework which will eventually move the process to more upfront monitoring.  

In 2013 FHFA place to enhance the post-delivery quality control practices and transparency associated with the new rep and warranty framework and work to complete rep and warranty demands for pre-conservatorship loan activity.

DeMarco said FHFA has a couple other priorities for 2012.  One is to update master policies for private mortgage insurance and formulate eligibility standards. While this effort can be looked at as maintaining credit availability, it also seeks to strengthen and clarify standards to increase the reliability of this form of credit enhancement and help mortgage insurance remain a viable risk transfer mechanism in the future.

There is also an effort to develop aligned standards for forced placed insurance. FHFA could have initiated any of a variety of GSE-centric approaches such as self-insurance or developing other structures to obtain insurance but these would not have addressed how a future mortgage market without GSE's would address force placed insurance.  Therefore FHFA plans to bring together a range of stakeholders to analyze a way to set standards more broadly applicable to the mortgage market and enable greater regulatory coordination in an effort to consider the various issues associated with force placed insurance.