FHFA is Ready For Your Comments on Postponed G-Fee Increases

Among Mel Watts first acts as Director of the Federal Housing Finance Agency (FHFA) in January 2014 was to suspend implementation of increases in the fees (g-fees) charged lenders for originating loans guaranteed by Fannie Mae and Freddie Mac (the GSEs).  The fees had been announced the previous month by Watt's predecessor Edward Donovan.  The proposed changes included an across-the-board 10 basis point increase in up-front fees charged to borrowers in different risk categories and elimination of the 25 basis point Adverse Market Charge for all but four states.  Watt announced that the postponement was to allow time to permit further review.

On Thursday FHFA issued a notice requesting public input on changes to the fees, specifically regarding their optimum level and their implications for mortgage credit availability.  The public notice period is for 60 days or until August 4, 2014.

There are two type of g-fees, ongoing and upfront.  The latter is a one-time payment made by lenders at the time a loan is acquired by a GSE, the ongoing fees are collected each month over the life of the loan.  Both fees serve to compensate the GSE for providing its credit guarantee.  The GSE's have had a preference for upfront fees to reflect differences in risk, based primarily on operational considerations as upfront fees are easier to implement.  Lenders frequently convert upfront fees to ongoing fees and pass them through to the borrower in the form of an increased interest rate.

FHFA, as conservator of the GSEs since August 2008, has used its authority to direct previous guarantee fee increases based on safety and soundness concerns related to the underpricing of mortgage credit risk, equalizing fee charges among lenders of different sizes, and attracting private capital back into mortgage lending.  The fees were also raised by Congress in 2011 (TCCA) as a way of funding the temporary payroll tax cut it authorized in 2011 and 2012.

The fees are used by the GSEs to cover three types of costs; the costs they expect to bear, on average, when borrowers fail to make their payments; the costs of holding economic capital to protect against potentially much larger unexpected default losses; and general administrative expenses.  Collectively these are the estimated costs of providing the credit guarantee.   Of the three the cost of capital is the most significant and the most difficult to project and FHFA has asked the GSEs to set their g-fee levels consistent with the amount of capital they would need to support their business if they were financially healthy and retained capital, something they are not allowed to do under their current conservatorship arrangement.

To determine the estimated fees needed to cover these costs each GSE calculates "gaps."  A positive gap would be the profit the GSE expects to make on a given loan above the target rate of return on capital.  Gaps are calculated by subtracting estimated costs from charged g-fees and are expressed on an annual basis as a percent (in basis points) of outstanding loan balance.   A negative gap does not necessarily mean that the GSE expects to incur a loss on a set of loans, but rather that it expects to earn less than its targeted return on capital.

FHFA provided the following grid of nine LTV and credit score buckets that shows the average g-fee currently charged by both GSEs and the percent of total 1Q2014 loan deliveries accounted for by the bucket in question. The grid also combines somewhat differing assumptions currently used by each GSE regarding the average amount of capital required for each of the nine risk buckets, the target return on this capital, and the average estimated cost of providing the guarantee, including the benefit of private mortgage insurance where applicable.  The amount of capital required by the GSEs' pricing methodology increases with higher LTVs and lower credit scores, as the magnitude of unexpected losses are projected to increase.  Overall estimated costs of providing the guarantee follow the same pattern since the cost of capital is the primary driver of estimated costs. Estimated credit-related costs of borrowers failing to make payments (not shown) also act in the same direction, but with a smaller impact than the cost of capital.  Even in buckets where the estimated cost exceeds the charged g-fee, the GSEs earn a positive return on economic capital, although less than their target return.

Finally, it is noteworthy that increases in g-fees on higher-risk loans may result in originators insuring/securitizing some of these loans with Federal Housing Administration (FHA)/Ginnie Mae rather than one of the GSEs.  While this substitution would reduce the GSEs' footprint in the mortgage markets, it would not reduce the federal government's overall footprint. On the other hand, increases in g-fees for lower-risk loans may make it more profitable for banks or other private market participants to retain these loans rather than selling them to the GSEs.

FHFA's Request for Input lays out 12 specific questions on which they would like public comment although it invites comments that are not directly responsive to those questions.  These questions include the following:

• Are there factors other than expected losses, unexpected losses, and general and administrative expenses that FHFA and the GSEs should consider in setting g-fees? What goals should FHFA further in setting g-fees?
• At what g-fee level would private-label securities (PLS) investors find it profitable to enter the market or would depository institutions be willing to use their own balance sheets to hold loans? Are these levels the same? Is it desirable to set g-fees at PLS or depository price levels to shrink the GSEs' footprints, even if this causes g-fees to be set higher than required to compensate taxpayers for bearing mortgage credit risk and results in higher costs to borrowers?
• If the GSEs continue to raise g-fees, will overall loan originations decrease?
• Should risk-based pricing be uniform across the GSEs or should each manage its own pricing?
• Are there interactions with the Consumer Financial Protection Bureau's Qualified Mortgage definition that FHFA should consider in determining g-fee changes?

The remaining questions as well as a more detailed discussion of the basis of g-fees and the implications of their use can be found in the Request for Input from FHFA.