BI Regulation Watch: GSE Capital Requirements
Team: Government
BI Government Analyst
Fannie-Freddie Capital Rule Should Do Job, But Virus a Wild Card
Even with FHFA delaying its capital rule proposal until at least May, we are now more confident the regulator will meet investor expectations and be supportive of Fannie Mae and Freddie Mac’s relisting. The constraint now shifts to whether the coronavirus can be contained before doing irreversible damage to the process of returning the GSEs to shareholders. (03/20/20)
1. What’s Next?
Next Key Event:
· Re-proposal set for second half of May.
· FHFA’s timeline could slip if the coronavirus isn’t contained.
Last Key Event:
· Re-proposal timeline updated to May by Calabria.
· March 18, 2020.
Rule re-proposed in May, perhaps.
We’re confident the Federal Housing Finance Agency can meet its May deadline if the pandemic allows, but caveat that unsuccessful containment could derail the plan. The proposal would be open for comment for 30-60 days, most likely, and could be completed by year-end. A final rule isn’t as necessary as a well thought out proposal upon which the Treasury Department, the government-sponsored enterprises’ shareholders, potential investors and other stakeholders can base plans and expectations. (03/20/20)
2. What’s the Outlook?
Credit Risk Transfers Likely Remain Favored
Proposal may exceed expectations.
FHFA’s thinking seems to have shifted on GSE capital, greatly limiting downside risk of a suboptimal rule subvertng demand for a relisting of the GSEs. FHFA Director Mark Calabria’s pledge to achieve economic attractiveness and an indication he’s focusing on detailed risk-based rules instead of a draconian leverage requirement suggest to us the proposal will be a net positive for the GSEs, which may even retain some edge over banks if they have more detailed mortgage risk matrixes to work with. (03/20/20)
3. What’s at Stake for Fannie and Freddie?
2018 Proposal: Fannie 3.4%, Freddie 3%
MBS dominance for Fannie and Freddie.
FHFA may have to de-prioritize its goal of achieving a multi-guarantor future — never easily achievable, in our view — if Fannie and Freddie perform well through the coronavirus crisis. We see less risk that FHFA pursues a leverage constraint that would apply more frequently to limit Fannie and Freddie’s size, given scale may be key to propping up the housing market during a downturn. The proposal’s emphasis on risk-based capital and CRT likely ensure adequate ROE to support a relisting. (03/20/20)
4. What’s at Stake for Mortgage Originators?
Fannie, Freddie PLS Treatment May Change
Less dependence on Fannie, Freddie.
Despite the virus’s destabilizing impact, we expect a new capital rule may make concessions with future portfolio lending or private label securities in mind, though Fannie and Freddie may retain their implicit and explicit guarantee advantage. The proposal’s procyclicality, which would have turbocharged qualified mortgage demand as prices rose, likely remains curtailed, improving bank competitiveness. The rule may reflect a new appreciation for the fragility of some nonbank originators. (03/20/20)
5. What’s the Issue?
Rule Documents:
· 2018 Enterprise Capital Requirements Proposed Rule (will be superseded by 2020 proposal)
Industries Impacted:
· Mortgage gurantors Fannie Mae and Freddie Mac
· Mortgage originators including JPMorgan, Bank of America, Wells Fargo, Quicken Loans, U.S. Bancorp
· Mortgage insurers including Arch Capital, Essent, Genworth, MGIC, Radian, United Guaranty
Government Entity:
· Federal Housing Finance Agency (FHFA)
Fannie and Freddie’s capital requirements.
FHFA is increasingly likely to adhere to its 2018 capital rule proposal when issuing a new version under Director Calabria. The rule likely requires enough capital to be a significant barrier to entry for competitors and takes on a more counter-cyclical character. Under a 2018 proposal, Fannie would have needed $115 billion and Freddie $66 billion as of September 2017 — enough capital to cover the government-sponsored enterprises’ “peak cumulative losses,” according to FHFA. (03/20/20)
6. What Else?
Treasury becomes the bottleneck.
If an accommodative proposal comes in May, which we see as reasonably likely, the bottleneck will be Treasury’s willingness and ability to proceed, which will depend on virus containment, fallout and the 2020 election. While the proposal will be recognizable, we still expect mark-to-market LTVs to be ditched. Deferred-tax-asset fixes likely remain to avoid large paper losses. The GSEs’ new business model is likely made permanent with exemptions for trust assets and credit risk transfers (CRTs). (03/20/20)
Final Rule Likely Informed By 2018 Proposal