Downsizing Fannie, Freddie could help banks, hurt nonbanks

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If housing finance reform reduces the government-sponsored enterprises' involvement in the mortgage market, banks could gain a funding advantage over nonbanks, according to a Moody's Investors Service report.

"U.S. banks are mostly funded by deposits, a comparatively low-cost and stable funding source, giving them an advantage over other financial institutions in capturing the GSEs' ceded market share," said Warren Kornfeld, a senior vice president at Moody's. Kornfeld analyzed the implications for depositories in the report.

In contrast, a material reduction of the GSEs' footprint to 35% or less of originations would have "credit negative implications" for nonbank mortgage companies because they rely on secondary market sales to repay borrowings to fund loans.

"Today almost all of the mortgages that nonbank mortgage companies originate for sale to the secondary market are guaranteed or insured by the GSEs or the U.S. government. A significant increase in the origination of far less liquid, nonagency mortgage loans would weaken the nonbank mortgage companies' funding strength, which is already below that of nonbank finance companies more broadly," said Kornfeld and Moody's analyst Gene Berman. Berman and Kornfeld analyzed the implications for nonbanks in the report.

Such potential ramifications of GSE reform could become a more timely consideration for lenders due to recent developments in Washington.

While the likelihood of legislative change remains low, a recent memorandum from the White House also calls for new administrative reform measures, Moody's noted.

Fannie Mae and Freddie Mac hold or guaranteed about half of the outstanding mortgages in the United States and have $5.5 trillion in combined total assets, according to Moody's. The two GSEs also guaranteed 45% of residential mortgages originated during the first nine months of 2018, according to data from the Urban Institute's Housing Finance Policy Center that Moody's analyzed in its report.

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GSE reform GSEs Nonbank Fannie Mae Freddie Mac Moody's