The credit risk transfer (CRT) process has come a long way since the GSEs began their de-risking effort more than three years ago, according to a recent brief produced by the Urban Institute. They state that in the early CRT deals, the GSEs transferred only synthetic mezzanine risk to a relatively small group of investors in capital market transactions, but now the GSEs are transferring first loss and mezzanine risk to a broader range of investors. Urban Institutes states that the GSEs and the Federal Housing Finance Agency, have accomplished a lot in a short period of time.
The authors of the brief note, though, that in order to fulfill its significant potential, CRT still has a way to go. They share that their primary criticism of the framework is that it focuses almost exclusively on how various risk sharing structures might effectively reduce the current risk to the GSEs. Additionally, they state that they feel the FHFA focuses too little on how such structures might contribute to a housing finance system that is more stable and robust over time, and not at all on how these structures might impact consumers or the broader financial system. They then offer their thoughts on what they feel is the best path forward within a broader framework.
The brief says that to date, credit risk transfers have been dominated by back-end transactions to transfer mezzanine risk to capital markets. The authors report that as of the end of 2015, the GSEs have transferred at least some of the risk on $693.2 billion of unpaid principal balance through Fannie Mae’s Connecticut Avenue Securities as well as Freddie Mac’s Structured Agency Credit Risk transactions. They compare this with only $131.1 billion through their back-end insurance and re-insurance transactions, and $12.7 billion through front-end risk sharing.
Urban Institute goes on to recommend expanding the CRT effort to include greater focus on a wider range of structures and sources of private capital to provide the broader experience and price discovery needed to understand what mix of structures and sources of capital will best serve the housing finance system, not just today but through the business cycle and over the long term. The authors state that these include lender recourse transactions across lenders of all sizes, deep cover mortgage insurance, back-end capital market transactions by loan-to-value ratios and credit score ranges, and catastrophic risk transfers.
Urban Institute states that this expanded vision for CRT will extend the experimental phase of the exercise, but they note that now is the time to help answer the critical questions about who should take risk ahead of the taxpayer and how, so that when legislators return to the question of long-term reform they are informed with what Urban Institute feels is needed to lead them down the right path.
They also state that although they believe their recommendations are consistent with the FHFA’s existing authority, if the FHFA believes that any are not, then they suggest that FHFA work with Congress. The brief states that given the broad bipartisan support for its objectives, Urban Institute feels it is likely to find a receptive audience.