Ratings Agency Says GSE Reform Could Take Years to Implement

Real Estate In-Depth | September 2019

Fannie Mae headquarters

WASHINGTON—A host of housing and finance organizations have expressed support for the plans submitted by the Trump Administration, specifically the Treasury Department and the U.S. Department of Housing and Urban Development, earlier this month to reform the housing finance system and the Government-Sponsored Enterprises Fannie Mae and Freddie Mac.

The Treasury Housing Reform Plan consists of a series of recommended legislative and administrative reforms that are designed to protect American taxpayers against future bailouts, preserve the 30-year fixed-rate mortgage, and help Americans fulfill their goal of buying a home. The plan includes nearly 50 recommended legislative and administrative reforms to define a limited role for the federal government in the housing finance system, enhance taxpayer protections against future bailouts, and promote competition in the housing finance system.

The HUD reform plan looks to ensure FHA and Ginnie Mae can continue to serve their important missions effectively, responsibly, and sustainably for many years to come. HUD’s reform plan seeks to accomplish four objectives: refocuses FHA to its core mission; protects American taxpayers; provides FHA and Ginnie Mae the tools to appropriately manage risk; and provides liquidity to the housing finance system.

“The Trump Administration is committed to promoting much needed reforms to the housing finance system that will protect taxpayers and help Americans who want to buy a home,” said U.S. Treasury Secretary Steven T. Mnuchin. “An effective and efficient federal housing finance system will also meaningfully contribute to the continued economic growth under this administration.”

HUD Secretary Ben Carson said, “There is still one piece of unfinished business from the financial crisis: housing finance reform. These changes to our housing finance system will help more American families achieve their dream of owning a home.”

While the National Association of Realtors, the National Association of Home Builders and the Mortgage Bankers Association released statements of support for the Treasury and HUD reform plans, Fitch Ratings stated the Treasury’s plan to reform Fannie Mae and Freddie Mac is likely to take meaningful time to come to fruition. As such, even if the administrative actions outlined in the plan are acted on, Fitch stated it does not expect any impact to the GSEs’ credit ratings in the short-to-medium term.

The Treasury plan advocates for Fannie and Freddie to build capital with the eventual goal of re-privatizing the GSEs and releasing them from conservatorship.

Treasury and the Federal Housing Finance Agency are expected to amend the Treasury’s Senior Preferred Stock Purchase Agreement, however, the number of steps to be completed prior to amending the PSPA would require a moderate level of time and resources, Fitch Ratings stated.

Currently, Fannie Mae’s and Freddie Mac’s corporate debt ratings benefit from meaningful government support under the PSPA, which requires the Treasury to inject funds into Fannie and Freddie to ensure that they maintain positive net worth. As long as Fannie and Freddie remain in conservatorship and continue to be supported by the substantial available funding under the PSPA, their ratings will continue to be linked to the U.S. sovereign rating.

The plan contains more than 30 administrative reform recommendations that are actionable, including requesting FHFA to revisit the proposed capital rules released in June 2018 and design liquidity requirements for each entity.

Fitch expects that the FHFA will likely release an updated capital adequacy proposal that would require more capital than the FHFA’s proposed (but not finalized) capital rule from June 2018.

Treasury did not take a firm view on the adequacy of the proposed capital rule although it recommended that regulatory capital requirements more closely align with those employed by banks. Fitch estimated that it would take approximately eight years to organically build the amount of risk-based capital that would be required by the initial proposed capital rules.

In terms of the GSE’s prominent role in housing finance, Fitch Ratings stated, Treasury’s plan preserves a role, albeit reduced, for Fannie and Freddie to support housing markets. A shrinkage in the agencies’ footprints would not necessarily be viewed as a reduction in the agencies’ policy roles to the extent that remaining activity is still considered a core part of the mission to provide liquidity, stability and affordability to the mortgage market. The footprint reduction would likely be achieved through changes to the entities’ underwriting criteria. More specifically, Treasury recommends the FHFA assess the agencies’ cash-out refi loans, loans for investment properties and vacation homes and larger loans, among others to determine whether they are applicable with the agencies’ statutory missions and worthy of government support.”

Fitch questioned the ability for new guarantors to effectively challenge Fannie and Freddie’s dominance in the market. Fannie and Freddie both have significant intellectual property and long-established relationships that have been built over several decades, which could prove difficult to replicate. Further, mortgage originators may be hesitant to spend the time and resources necessary build out the required infrastructure necessary to conduct operations with a new guarantor. However, if new entrants are introduced and are successful in taking market share from Fannie and Freddie, their individual policy roles could result in their ratings being notched down from the U.S. sovereign.

The plan also requests FHFA to perform broader assessments including reviews of Fannie’s and Freddie’s current business models, underwriting criteria and affordable housing initiatives, which will require significant resources and interagency coordination between Fannie Mae and Freddie Mac, FHFA, HUD, CFPB, GNMA and FSOC. Fitch believes that while these agencies will be pressed to make GSE reform a top priority, the sheer level of coordination these efforts will take could take a number of years.

The reform plan also includes a number of legislative recommendations that, if implemented, could result in a significant change in the competitive landscape of the mortgage market. While there are a number of smaller legislative recommendations that could have a relatively higher likelihood of success, like repealing the statutory definitions of the GSEs’ regulatory capital, Fitch considers the possibility of more sweeping legislative reforms to be remote in the current political environment.

These recommendations include an explicit government guarantee on the mortgage backed securities, prohibiting certain types of assets guarantors can hold, granting the FHFA increased power to regulate Fannie and Freddie, repealing the GSEs’ existing charters, and giving the FHFA the ability to charter new guarantors. If an explicit guarantee on the MBS were to replace the PSPAs supporting the enterprises, their corporate debt ratings could be de-linked from the U.S. sovereign, which would result in downgrades.

“Many of the legislative reform proposals in the plan request that Congress enact legislation to solidify administrative reforms achieved over the last several years,” Fitch Ratings stated. “The FHFA has made multiple efforts to reduce taxpayer exposure to Fannie and Freddie since the financial crisis. Most notably, retained mortgages held for investment have decreased meaningfully over the last decade while the amount of private credit risk transfer activity has increased.

“The National Association of Realtors thanks President Trump and his administration for initiating thoughtful, genuine effort toward housing finance reform. We look forward to reviewing the proposal in more detail and are optimistic that, at a minimum, the White House’s efforts will shed light on the remaining mile markers on the path to reform, along with the critical role the GSEs and Federal Housing Administration play in America’s housing market,” said NAR President John Smaby, a second-generation Realtor and broker at Edina Realty in Edina, MN.

“The Trump administration has put forward a plan for housing finance reform, with both administrative and legislative recommendations. Now, with Fannie Mae and Freddie Mac 11 years in conservatorship, it is long past time for Congress to act,” said NAHB Chairman Greg Ugalde. “For a healthy economy, all in the housing sector need to have confidence that their liquidity needs will be met. Only Congress can provide certainty to the housing finance system through durable housing finance reform, free from the whims of administration personnel changes. Failure to act by Congress surrenders reform to the federal agencies and risks postponing much needed changes for years to come.”

Robert D. Broeksmit, CMB, president and CEO of the Mortgage Bankers Association, said “MBA applauds the administration for releasing these reports, which highlight the critical need for comprehensive housing finance reform.”

He said the reports reflect many of the important priorities that MBA has long recommended, including: protecting taxpayers from future bailouts, an explicit government guarantee on qualified mortgage-backed securities for single-family and multifamily loans, increased competition and consumer choice via potential additional guarantors, and ensuring a level playing field for lenders of all sizes and business models.

“The reports recognize the need to better coordinate the roles of FHA and the GSEs. Such coordination must preserve affordable financing options for a wide range of borrowers and reflect the vital role FHA plays in the larger housing finance system,” Broeksmit added.