ABA s GUIDE TO ANALYSING GSE REFORM: QUESTIONS YOUR BANK SHOULD BE ASKING INTRODUCTION Both the House and Senate have begun working on legislation to address the ongoing conservatorships of Fannie Mae and Freddie Mac with the goal of reforming the role of government in the secondary mortgage market. This document is intended to provide a framework and a series of questions which can be posed within your institution to help you better analyze reform proposals. It is our hope that it will also serve as a vehicle for providing ABA your views on what your institution supports and opposes in GSE reform and to respond to questions received from lawmakers and their staffs. CORKER/WARNER AND PATH ACT In the Senate, the Corker/Warner bill (S. 1217) has been introduced and will likely serve as a framework for legislation being drafted by Senate Banking Committee Chairman Tim Johnson (D-SD) and Ranking Member Michael Crapo (R-ID). ABA s Section by Section of S. 1217 can be found here: http://www.aba.com/tools/function/mortgage/documents/abasectionbysectioncorkerwarner.pdf In the House, Financial Services Committee Chairman Jeb Hensarling (R-TX) has introduced the PATH Act which would eliminate the Federal Government s role in backing mortgage loans entirely. The Financial Services Committee has passed the PATH Act, but the full House has yet to consider the bill, and it is likely that the bill will be revised before House passage. A HFSC Section by Section of the Path Act can be found here: http://www.aba.com/tools/function/mortgage/documents/pathactsectionbysection.pdf To understand how GSE reform may impact your institution, it is important to understand the roles played by the various parties to a secondary mortgage transaction and to determine which of these roles your institution plays now and may want to play in the future. ROLES ENVISIONED UNDER CORKER/WARNER The Corker/Warner bill envisions a mortgage market where private Originators (banks, credit unions, mortgage bankers and others) originate loans, and sell them into the secondary market through a variety of channels. These channels could include other institutions acting as Aggregators, the Federal Home Loan Banks, or a newly created mutual institution that would purchase loans (likely on a cash basis) from smaller institutions. To be eligible for a secondary market transaction, loans made by Originators would be required to meet Qualified Mortgage (QM) requirements, have a minimum five percent down payment with additional credit enhancements in the form of mortgage insurance bringing the loan to value ratio on each loan to not more than 80 percent. Once aggregated, the loans would be pooled into a security issued by the Issuers. Corker/Warner envisions a number of potential Issuer
types, including private entities, a subsidiary of the Federal Home Loan Banks, and a mutual institution devoted to ensuring access to the secondary market by smaller originators. Each of these types of Issuer entities would be required to hold significant capital (and would be regulated by the Federal Mortgage Insurance Corporation established by the bill). Private Issuers and Bond Guarantors would replace the role currently played by Fannie Mae and Freddie Mac in issuing securities. Issuers would buy mortgages from originators, and create standard mortgage backed securities through a new common securitization platform (leveraging work already being done on such a platform by FHFA). Bond Guarantors would be private entities who would guarantee timely principal and interest payment on securities and hold a capital base of 10% of outstanding risk (a 10% first loss position). As in the current market, Originators could either hold or sell servicing rights. Originators and Servicers would be subject to similar representation and warranty requirements as under the current system. The new Federal Mortgage Insurance Corporation would provide a 100% full faith and credit guarantee on the mortgage securities. The FMIC would be backed by a Mortgage Insurance Fund which would (over time) have a reserve ratio of 2.5 percent of outstanding guaranteed mortgage principle. Trustees and Holders would continue to function as under the current market. ROLES ENVISIONED UNDER THE PATH ACT Under the PATH Act, the private market would, over time, supplant the roles played by Fannie Mae and Freddie Mac (and ultimately the U.S. government) in the secondary mortgage market. Originators would make loans, sell them to Purchasers, and Issuers could package them into pools and issue mortgage backed securities backed by those pools. A public utility would be created which would facilitate the pooling and securitization through a common securitization platform, but there would be no federal role in backing or guaranteeing mortgages or securities based on those mortgages. Any other roles which might develop, including that of providing credit enhancements, would be at the discretion and direction of the private market participants in the secondary market. QUESTIONS TO CONSIDER: To assist your institution in analyzing these (and potentially other) GSE reform bills, we offer a series of questions below which your bank may want to consider as you evaluate the potential impact on any legislation on your institution, your ability to participate in the secondary market, and the impact on your overall business. What role or roles does your institution play in the mortgage market? The needs of lenders in the secondary market, as well as the costs associated with participation in the market will vary significantly depending upon the role that the institution plays. At one end of the spectrum is a bank that only wants to originate loans and sell them for cash. Others may have a more complex set of needs. They may originate loans, but also purchase loans, aggregate loans, and some may choose to pool loans and issue securities. Here is a list of questions you may want to consider posing to your institution based upon the role that your institution plays or hopes to play in the mortgage market. We have also included possible departments within your institution that you may want to consider consulting based on your institution s role and your business model and structure.
For Originators (mortgage department wholesale and retail): 1. How many loans do we sell into the secondary market annually? Volume is important, as with virtually all markets, higher volume has usually resulted in better pricing. 2. Do we sell loans in bulk or do we sell loans on an individual basis for cash? Again, this question relates to volume and price. Many small lenders or larger lenders with small numbers of mortgage originations do not generate sufficient loan volume to sell in bulk and have a need to be able to sell loans individually for cash. 3. Am I willing to sell loans to a potential competitor? Do I risk my customer relationship by selling to a possible competitor? 4. Would my bank benefit from a specific channel for smaller bank (or smaller loan volume) access to the secondary market and would I be willing to commit capital to fund such an entity? 5. Do I want to retain servicing, or do I prefer to sell that asset? 6. What s my banks customer base? What impact would the proposal have on jumbo loan business? 7. Does my bank intend to make mortgage loans that are not QM loans? What will be our strategy for funding such loans if they are not eligible for sale into a new government backed secondary market? For Purchasers/Funders/Aggregators (Treasurer or CFO and mortgage department wholesale): 1. What is my business model and what are the capital requirements I face? This category includes any number of possible business lines, including correspondent lending, provision of warehouse lines, and others. Each will have specific capital requirements and under GSE reform could have specific loss positions ahead of any federal guarantee. Additionally, capital will be needed to provide for pipeline hedging activities. 2. Should this function be combined with that of the Issuer(s) or is the market better served by having these functions separate? 3. Should the Federal Home Loan Banks be allowed to serve as aggregators? 4. What impact would a separate mutual entity have if your institution has a correspondent or wholesale mortgage business? 5. What impact would the lack of a federal guarantee (as contemplated under the PATH Act) have on the ability to fund purchases of loans? For Issuers (Treasurer, CFO, mortgage department, securitization group): 1. What level of capital will be required to meet first loss positions required under GSE reform? For example, under the Corker/Warner model there is a 10% first loss position required for issuers. This will require issuers to maintain significant capital. In addition, depending upon how the market is structured, additional capital may be needed to offset counterparty risk. 2. Should there be a mutual institution specifically devoted to ensuring access for small lenders? What impact would this entity have on your institution s correspondent or wholesale mortgage business?
3. Should there be multiple Issuers or only one, which could function as a public utility and issue securities eligible to be guaranteed for the entire industry? What benefits or issues would this pose for your bank? 4. Should the Federal Home Loan Banks be allowed to issue securities? For Credit Enhancers (mortgage insurance subsidiaries, reinsurance companies): It is unlikely that banks will operate as credit enhancers directly under any iteration of GSE reform, but quite possible that subsidiaries or affiliates of banks may do so. Such affiliated or subsidiary entities could include Mortgage Insurance companies providing credit enhancement at the loan level, or bond guarantors providing insurance on bonds (for example, Corker/Warner contemplates private bond guarantors who would ensure timely payment of principal and interest on covered securities. Note that Corker/Warner does not allow entities to function as BOTH mortgage insurers and bond guarantors). 1. Is this an opportunity to enter a business line your institution is currently not in? 2. What impact will this have if your institution has a mortgage reinsurance affiliate? For Servicers (mortgage servicing subsidiaries, loan operations): 1. Will I want to retain servicing on my own loans? 2. Will I want to purchase servicing on loans originated by others? 3. What capital requirements and counter party risks will I face? 4. How will new Basel capital treatment of mortgage servicing rights work within the context of the first loss positions required under the Corker/Warner model? For Trustees (corporate trustee department): Can your institution meet and charge for the obligations placed on securitization trustees established by Corker Warner? For Holders (Treasury, Investment Department): 1. What is the potential impact on your institution s investment strategy and portfolio? 2. Would investment policies need to be changed? 3. What impact would the lack of any federal guarantee on mortgage backed securities (as contemplated by the PATH Act) have on our willingness to invest in mortgage backed securities? 4. Will there be a potential capital or liquidity impact? CONCLUSION Despite the recent developments on GSE reform in both the House and Senate, there remains much work to be done before a legislative solution is enacted. It will be essential that the banking industry makes its voice heard, both collectively and through individual institutions. Reform proposals can have a major impact on banks current and planned business models. As stated above, it is our intent that
this guide will assist you in analyzing reform proposals, in answering questions posed by lawmakers and their staffs, including those recently posed by the Senate Banking Committee, and in providing us with feedback which can better help us represent the views of your bank and the industry overall.