It looks like the credit risk-sharing bonds from Fannie Mae and Freddie Mac aren’t going away anytime soon.
In fact, according to a new report from the Federal Housing Finance Agency, the three-year-old risk-sharing program, which is designed to help alleviate some of the financial risk for taxpayers and attract private capital back into the market, is going to expand and improve on its current structure.
The report from the FHFA, called “Overview of Fannie Mae and Freddie Mac Credit Risk Transfer Transactions,” states that the FHFA will “continue to encourage the Enterprises to engage in large volumes of meaningful credit risk transfer.”
According to the FHFA, Fannie and Freddie have made “significant progress” in developing a market for the risk-sharing bonds, demonstrated by the fact that the GSEs have already transferred significant credit risk on loans with over $667 billion of unpaid principal balance.
“Credit risk transfer is now a regular part of the Enterprises’ business,” the FHFA said in its report. “The Enterprises are currently transferring a significant amount of the credit risk on almost 90% of the loans that account for the vast majority of their underlying credit risk. These loans constitute about half of all Enterprise loan acquisitions.”
Freddie Mac and Fannie Mae began offering credit-risk mortgage bond deals in an effort to attract private capital back into the mortgage finance system in 2013.
Freddie Mac was the first out of the gate with a $500 million offering. In the subsequent months, Fannie Mae launched its own $675 million offering.
Since then, both of the GSEs have issued deals frequently – Freddie under its Structured Agency Credit Risk program and Fannie Mae under its Connecticut Avenue Securities program.
According to the FHFA, the deals have attracted a number of different investor types, including asset managers, hedge funds, insurance and reinsurance companies, banks, sovereign funds, real estate investment trusts, and lenders.
More than 150 investors have participated in the STACR and CAS programs to date, with 50-70 investors typically participating by purchase in any given transaction, the FHFA said.
The FHFA also laid out its near-term goals for risk-sharing deals, including expanding the credit risk-sharing deals into other types of loans, such as adjustable-rate mortgages, 15-year mortgages, and others, where the economics make sense, the FHFA said.
The FHFA also established the following goals:
- Developing better measures of credit risk and the amount of risk transferred
- Broadening the investor base for these transactions to attract a diverse and durable source of private capital
- Refining transaction structure designs to improve execution
- Developing a more diverse mix of structures to better withstand market fluctuations
- Exploring methods to facilitate greater use of credit risk transfer, such as obtaining real estate mortgage investment conduit treatment for credit-linked notes
- Implementing the credit-linked notes structure, which has many advantages as compared to the Enterprise-issued STACR/CAS debt structure
The FHFA also cautions that because the risk-sharing bonds are still relatively new, the performance of the bonds throughout the various stages of an entire housing price cycle is unknown.
“Specifically, we cannot know the extent to which investors will continue to participate through a housing downturn,” the FHFA said. “Additionally, the investor base and pricing for these transactions could be affected by a higher interest rate environment in which other fixed-income securities may be more attractive alternatives.”
Ideally, the FHFA said, the market for the risk-sharing deals would be able to withstand the entire housing price cycle.
To accomplish this, the FHFA said that Fannie and Freddie need to do the following:
- Develop innovative methods of credit risk transfer that encourage investment throughout the housing market cycle, particularly during adverse market conditions as experienced in 2008
- Use multiple types of transactions designed to attract a wide variety of investors
- Continue to expand the investor base for securitized products as well as look for additional sources of private capital to participate in credit risk transfer activities
- Issue a large enough volume of transactions to ensure a liquid primary market for securitized investment products such as STACR and CAS
- Encourage a liquid secondary market for securitized products that gives investors a viable exit strategy
- Avoid flooding the market for any particular type of risk transfer product in a way that leads to poor transaction economics or causes investors to abandon the market because the value of their existing holdings is reduced
- Encourage standardization of credit risk transfer in the long term, so that the market for credit risk transfer becomes as deep and liquid as possible
- Encourage a diverse group of financial, advisory, and housing-oriented companies, including minority- and women-owned businesses, to participate in credit risk transfer transactions in order to build a stable pool of third-party service providers and provide necessary competition to ensure an efficient market for their services
- To the maximum extent feasible, continue to provide transparency and facilitate an open exchange of information by being open to new ideas and input and encouraging greater information sharing among industry participants and policy makers
Click here to read the entire FHFA report.
