Twelve years ago, at the height of one of our country’s worst financial disasters, the U.S. federal government took steps to preserve the soundness of government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. When Congress gave the Federal Finance Housing Agency (FHFA) increased oversight of the enterprises, the agency placed them into a conservatorship to sustain them through the crisis. Because these extraordinary actions were never intended to be permanent, the FHFA has in recent years taken steps to wean the GSEs off the conservatorship and help them stand on their own again – including implementing new liquidity requirements that took effect September 1.
Meanwhile, Fannie and Freddie recently announced they will assess a 50-basis point Loan-Level Price Adjustment (LLPA) on certain refinance transactions. Called the Adverse Market Refinance Fee (AMRF), this 0.5-percent addition to consumers’ refi transactions was originally scheduled to also take effect on September 1.
Was this a coincidence? What part does the AMRF play in the GSEs’ ongoing conservatorship story? While the COVID-19 pandemic continues to prevent us from gathering around the office water cooler, the timing of the two events has sparked much discussion in the mortgage industry in recent weeks.
In 2007, mortgage default rates and foreclosures hit the country hard. Mounting losses, collapsing home prices, and a weakening economy raised concerns about the GSEs’ viability. By June 2008, Fannie and Freddie reported a combined net loss of $8.7 billion. A month later, the Housing and Economic Recovery Act (HERA) of 2008 was signed into law, granting the GSEs more than $200 billion in U.S. Treasury Department support and giving the federal government enhanced oversight of their activities.
In September of that year, finding that the GSEs’ losses would likely prevent them from paying their obligations and threaten the global financial markets, the FHFA placed Fannie and Freddie into a conservatorship – a statutory process intended to preserve and conserve the GSEs’ assets and put the companies in a sound and solvent condition.
HERA tasked the FHFA with achieving one of three possible outcomes:
The FHFA obviously chose the second outcome, but it never intended to exercise control over Fannie and Freddie indefinitely. In fact, HERA legally bound the FHFA to remove the GSEs from government control once they were found to be operating in a “safe and sound manner,” including maintenance of capital and internal controls.
The FHFA also suspended the GSEs’ statutory capital classifications and regulatory capital requirements. The GSE’s financial support agreement through a Senior Preferred Stock Purchase Agreement also limited their ability to hold capital. Throughout the conservatorship, the FHFA has monitored whether Fannie and Freddie make prudent business decisions when pricing transactions and managing their books of business.
“Long-term, continued operation in government-run conservatorships is not sustainable for Fannie Mae or Freddie Mac,” the FHFA says on its website. “Each company has a small capital reserve, is operating on a remaining, finite financial commitment from taxpayers, and cannot rebuild capital under the terms of support from Treasury. Until Congress determines the future of Fannie Mae and Freddie Mac and the housing finance market, FHFA will continue to carry out its responsibilities as conservator.”
While no one will forget the dark days of the 2008 housing market crash and resulting recession, there is no question that 12 years later, conditions have significantly improved. Housing markets have recovered, delinquencies and foreclosures have declined, and the GSEs no longer acquire loans with high-risk features. The creation of the Uniform Mortgage-Backed Security (UMBS) and the development of the Common Securitization Platform (CSP) improved liquidity and uniformity in the mortgage-backed security market and continue to support the 30-year fixed rate mortgage. The transfer of enterprise interest rate and credit risk to private sources of capital plays an increasing role in the system.
But that’s not enough, said the FHFA in a strategic plan published last fall following years of discussion about and proposed rulemakings to wind down the conservatorship. The plan, released in October 2019, sought to prepare Fannie and Freddie for their eventual exits from conservatorship, a precondition of which was that the GSEs “build their capital to levels commensurate with safety and soundness.”
In May, the FHFA inched closer to that plan when it published in the Federal Register a proposed new regulatory capital framework for the GSEs. The 424-page proposal had two components: A risk-based capital requirement plan that targets a risk-invariant minimum capital level after surviving a stress event; and a revised minimum leverage capital requirement specified as a percentage of total assets and off-balance sheet guarantees. Public comments on the proposal were due August 31.
In June, the GSEs quietly revealed in their Securities and Exchange Commission (SEC) filings new liquidity requirements established by the FHFA. Based on a stressed scenario that assumes Fannie and Freddie may not have access to debt funding from the market for an extended period of time, the guidelines require them to fund any cash needs with certain liquid assets in their portfolios.
In reaction to this change, the GSEs warned that the new requirements are more stringent than their existing liquidity requirements and those of banks and other depository institutions, which could result in higher funding costs in the future and negatively impact their net interest income.
The FHFA’s compliance date for the new liquidity requirements was September 1.
On August 12, the GSEs announced to mortgage lenders that they will add an “adverse market refinance fee” to certain refinance transactions – also starting on September 1. After that date, loans purchased or delivered into mortgage-backed security pools would be subject to a 50-basis point fee, or 0.5 percent.
It wasn’t the first time the GSEs implemented such a fee. In 2007, seeking to stave off significant losses from the looming financial crisis, Fannie imposed a 0.25-percent LLPA on all mortgages it bought from lenders. Freddie Mac followed by adding a 0.5-percent LLPA. Given the magnitude of the crisis and the financial hit the GSEs sustained from it, these actions didn’t raise eyebrows.
But the 2020 AMRF did produce strong reactions, for two reasons. First, the GSEs gave the mortgage industry only two weeks’ notice to implement the fee.
“Borrowers moving toward closing with locked rates prior to September 1 would have faced unanticipated cost increases, just a matter of days from closing,” said Christopher Morton, Senior Vice President of Public Affairs for the American Land Title Association (ALTA).
Second, the GSEs’ reasons for implementing the AMRF seemed to conflict with a booming refi market and a much healthier economy than what we experienced in 2008.
“This fee is twice as much as the 25-basis point adverse market fee from 2008, which was way worse of a recession than this is,” said Kevin Peranio, Partner and Chief Lending Officer at Paramount Residential Mortgage Group (PRMG) Inc., on his LinkedIn video channel.
Much to everyone’s relief, the FHFA on August 25 directed the GSEs to delay implementation to December 1 – but questions about the timing of the AMRF’s original implementation date and the GSEs’ changing liquidity standards remain.
In their defense, the GSEs said the AMRF is necessary to cover an estimated $6 billion in expected COVID-19 pandemic losses – namely in forbearance and foreclosure expenses and losses. Providing a rationale for changing the GSEs’ liquidity requirements as part of its efforts to end the conservatorship, the FHFA has commented, “The current strong economic conditions, coupled with the certainty that an unfavorable turn in the business cycle and housing market will someday come, argue for moving quickly to restore enterprise capital and address the remaining vulnerabilities in our housing finance system. The current lack of capital at the enterprises poses significant risk to taxpayers and the homeowners, borrowers, and renters who rely on a strong and stable housing finance system.”
These statements have only seemed to fuel skepticism in the mortgage industry.
“The original effective date was pathetic,” said Michael Faraci, Senior Manager of Specialty Products at American Financial Network Inc., and host of a mortgage industry podcast, “Mikey Town.”
“It was a sorry excuse for a policy change, and it was incredibly out of character for the FHFA, and for Fannie and Freddie,” Michael added. “Usually, they give you so much lead time on changes that you almost forget about them by the time they happen, because you got the announcement so long ago. Many people are wondering if this was a way they could grab a bunch of extra capital really quickly.”
Christopher said ALTA and other industry trade groups will continue to have “honest dialogue” with the FHFA about these ongoing issues.
“The GSEs have made it clear that with some of the requirements placed on them with regard to policy judgments by Congress and others, coupled with delaying foreclosures and evictions, there will be an impact financially,” he said. “They have been clear about the fact that they have to be responsible and measured, and make judgments along the way. The good news is, because we have had open lines of communication with FHFA, we will be able to reexamine what all of this means.”