Housing Finance Reform: To Be Announced
As Congress contemplates GSE reform, changes that could affect the liquidity in our housing finance markets must be handled with care.
Government-sponsored entities (GSE) Fannie Mae and Freddie Mac have been under U.S. government conservatorship since the recession in 2008. Also, Ginnie Mae is wholly owned by the government. Collectively, the government guarantees more than 60 percent of home loans in America through mortgage-backed securities (MBS) issued by these agencies.
The GSEs were never intended to remain under government protection. In March 2019, the Trump administration directed the Treasury Department (Treasury) to develop a plan for ending the GSE conservatorship and facilitate competition in the housing finance markets.
Changes in the mortgage guarantee and funding structure will affect liquidity in the housing markets as much as or more than interest rates. Bankers understand these risks and are working with their trade associations to communicate their views.
Blueprint for GSE Reform
In September 2019, the Treasury released its blueprint for ending the GSE conservatorship. The American Bankers Association (ABA) provided testimony to Congress, mostly supporting the Treasury’s plan. Key provisions highlighted by the ABA include:
- Continued accessibility to the mortgage market for borrowers of all income levels
- Explicit guarantees, fully priced and transparent, for all MBS issuers
- Appropriate capitalization and liquidity standards for Fannie Mae and Freddie Mac
- Consistent regulation, including underwriting standards, for MBS participants
- Preservation of the Federal Home Loan Bank advance programs
- Preservation of the to-be-announced (TBA) market and “cash window”
The Independent Community Bankers of America (ICBA) and Mortgage Bankers Association (MBA) also released their statements on the Treasury’s plan, examined below. This article addresses only the last bullet, which is vital in preserving liquidity in the housing finance markets.
Lenders with moderate to high mortgage volume use the TBA market to facilitate their agency MBS trades and/or hedge their interest rate risk. Many smaller lenders don’t hedge or use TBAs but instead use the GSE cash window, whereby lenders may sell individual loans directly to the GSEs. These must be preserved to maintain liquidity in the housing markets.
The housing markets have long benefited from a trading convention unique to the agency MBS, called TBAs or TBA forward trades. TBAs, also known as lender swaps, are the most common type of mortgage securitization transaction. TBAs account for more than 90 percent of agency MBS trades.
They’re called TBAs because the particular securities being traded aren’t known at the time of the trade—the particular securities are to be announced just before delivery. In fact, the loans underlying the securities in many cases haven’t yet been originated. Only agency MBS, including those issued by the GSEs, are TBA eligible.
Agency MBS consist of conforming loans that meet certain qualified mortgage, ability-to-repay and other underwriting guidelines. The Dodd-Frank Act made those guidelines stricter following the 2008 recession.
The GSE Advantage
Agency MBS (those issued by the GSEs or Ginnie Mae) and TBAs are exempt from SEC registration requirements. In a TBA trade of an agency MBS, only six general parameters—price, par, coupon, issuer, maturity and settlement date—must be known at the trading date. A mortgage lender originating high volumes of GSE conforming loans can lock interest rates, hedge their interest rate risk and sell loans into agency MBS pools using TBAs.
Contrast that with private-label securitizations (PLS), which require compliance with the SEC’s Regulation AB rules and disclosure of more than 200 data elements on the underlying loans. Partly because of the hangover from the 2008 recession, but also because of the competitive disadvantage as compared to agency MBS, PLS account for only a small share of the housing finance market today. One objective of GSE reform is to create competition in the housing finance markets; therefore, the GSE advantage must be addressed.
Level the Playing Field?
The Treasury didn’t specifically mention TBAs but suggested the GSEs be put on a more level playing field with PLS issuers and new entrants, including possible additional disclosures of loan-level detail. The Treasury acknowledged that disclosure requirements may have adversely affected the PLS market but suggested disclosures could ultimately improve access to mortgage credit.
The GSE exemption has certainly spurred liquidity, making TBA trades possible and the most common vehicle for agency MBS trading. Disclosure requirements for new entrants are necessary, as noted by the ABA. However, if there are additional disclosure requirements for GSEs, this could be disruptive, at least in the short term. The long-term benefits may outweigh the short-term disruption, but leveling the playing field should be measured against other alternatives.
The Securities Industry and Financial Markets Association (SIFMA) has long-standing MBS clearing and settlement standards. SIFMA’s “good delivery” requirements are industry standard for MBS and TBA traders. To the extent these are working, there doesn’t seem to be any need to reform the trading process for agency MBS and TBAs. However, the GSE advantage must be addressed.
The MBA favors a single security initiative. In June 2019, the GSEs finalized their uniform mortgage-backed security (UMBS), which replaced the former separate Fannie Mae and Freddie Mac TBA-eligible securities with this single security. MBA believes a single security for the GSEs and new entrants, presumably retaining many of the same efficiencies as UMBS, is necessary to avoid an adverse effect on liquidity.
The ICBA favors immediately recapitalizing the GSEs, perfecting the UMBS single security model and keeping what works for the GSEs. It stated the TBA market for agency MBS should be preserved and recommended avoiding new structures that would be make the resulting MBS non-TBA eligible or market disruptive. The ICBA doesn’t support additional guarantors or entrants who could access the GSE guaranty.
Whatever the answer, preserving the “good delivery” requirements for agency or agency-like MBS, including TBAs, is essential. Given the uncertainty, a deeper dive into the TBA market seems warranted.
Keeping the Cash Window Open
Smaller lenders sell individual loans or pools of loans through the GSEs’ cash window, usually for a better price than would be obtained for a small TBA transaction. The Treasury, ABA, ICBA and MBA have all recognized the cash window must remain open for GSE reform to work for community banks and small lenders.
The Treasury has recommended that any new guarantor of single-family mortgages be mandated to establish a cash window that offers smaller lenders the ability to sell mortgages, with or without servicing rights retained. The Treasury recommends the guarantors be prohibited from offering volume-based discounts or other incentives that would disadvantage smaller lenders. These are positives for small lenders and community banks.
GSE reform is a game changer. The Treasury and industry have recognized the importance of preserving the cash window for facilitating MBS transactions, but there are some details to be worked out to preserve the TBA market. Bankers should become familiar with how GSE reform will affect their communities and should consult with their trade associations and Congress representatives to express their views. For more information, reach out to your BKD trusted advisor or use the Contact Us form below.