Fannie Mae's latest risk-sharing transaction taps a new source of private capital: reinsurers.
The transaction, Credit Insurance Risk Transfer 2014-1, shifts the risk of default on a $6.42 billion pool of 30-year, fixed-rate loans that Fannie Mae acquired between January and March of 2014.
Fannie purchased insurance from an insurance entity that then transferred 100% of its risk to three domestic reinsurers, not identified by the government-sponsored enterprise. This reinsurance is collateralized; each reinsurer was required to deposit collateral equal to one-third of the coverage in a trust account.
Fannie Mae is required by its regulator, the Federal Housing Finance Agency, to shift some of the risk of the mortgages that it ensures to the private sector in order to limit the exposure of U.S. taxpayers. Previous transactions have tapped institutional investors and monoline mortgage insurers.
Unlike two of the most recent deals, Fannie Mae is retaining the first 50 basis points of losses on the loans reinsured by CIRT 2014-1. Only when this layer is exhausted does the company receive funds to compensate it for the next 300 basis points of loss, up to a maximum coverage of approximately $193 million.
The coverage term is 10 years.
Depending upon amount that these loans pay down and the amount that becomes seriously delinquent, the aggregate coverage amount may be reduced at the three-, five- and seven-year anniversaries from the effective date.
In late October, Fannie and JPMorgan Chase entered into a transaction that offloads the risk of a $989 million reference pool of agency mortgages originated by JPMorgan Chase Bank. In this case, investors are taking the first losses; Fannie will only absorb losses once the 4.75% credit enhancement provided by deal has been drawn down.
In a separate transaction, Redwood Trust has made a private, bilateral deal with Fannie to sell the agency $1.1 billion of conforming loans, on which Redwood will absorb the first 1% of credit loss.
While CIRT does not offload the first loss, it does have something in common with JPMorgan Chase and Redwood Trust transactions: CIRT uses actual losses to calculate benefits. By comparison, in Fannie Mae’s flagship risk-sharing program, Connecticut Avenue Securities, benefits are triggered when loans are delinquent for 180 days.
In a press release, Andrew Bon Salle, executive vice president, single-family underwriting, pricing and capital markets, said that investors have expressed a preference for this type of exposure.
"The reinsurance market is an attractive potential source of private capital because it currently bears a small amount of U.S. residential mortgage risk," he said.
While investors prefer exposure to actual losses, there is a potential drawback for Fannie Mae: it may have to wait longer to file a claim. Loans can stay delinquent for an extended period of time, and it can take time to repossess a property and sell it. Rob Schaefer, vice president, credit enhancement strategy and management, said that this analogous to insurance that Fannie Mae has purchased from monoline insurers on pools of mortgages.
Unlike these pool transactions, however, Fannie Mae is covered for 100% of the loss on any loan, at least until the collateral is exhausted. Past pool transactions have had coverage limits at the individual loan level or the aggregate pool level.
The loans in the CIRT’s reference pool have loan-to-value ratios between 60% and 95%.
By comparison, the loans referenced in the JPMorgan Chase transaction had a weighted average LTV of 76%; the reference pool for the most recent CAS transaction was split into two groups, one with a weighted average LTV of 76.4% and one with a weighted average LTV of 92.2%.
Fannie Mae did not provide information on the cost of the insurance provided by CIRT 2014-1. However, Schaefer said that it was "competitive" with other kinds of risk-sharing transactions. "We feel it was good execution, comparable to the execution we are getting in CAS," he said in a telephone interview.
Schaefer said there appears to be more appetite from insurers with multiple lines of business for mortgage default risk. "The biggest achievement was developing the structure, so that it's repeatable. Next year our goal is to expand the universe of counterparties that we can do this with."