FHFA issues capital rule, previews next steps on plan to release GSEs
WASHINGTON — The Federal Housing Finance Agency has finalized a rule imposing higher capital requirements for Fannie Mae and Freddie Mac to take effect once the companies exit their federal conservatorships.
The capital framework, released Wednesday, is a prelude to steps the FHFA is expected to pursue to allow the mortgage giants to retain all of their earnings, senior FHFA officials said. However, the FHFA must agree with the Treasury Department on a new retained-earnings plan soon or it could face pushback from the incoming Biden administration. President-elect Biden is set to take office on Jan. 20.
The final capital rule, which is similar to a proposal unveiled in May after the agency scrapped an earlier 2018 plan, is considered a huge step in freeing Fannie and Freddie from government control. It has been a central focus of FHFA Director Mark Calabria since he took office last year.
“The final rule is another milestone necessary for responsibly ending the conservatorships,” Calabria said in a statement.
The next step, according to senior FHFA officials, is for the FHFA and the Treasury Department to amend the preferred stock purchase agreements, which lay out the government’s ownership in Fannie and Freddie.
Those changes would allow the companies to keep the entirety of their profits. They currently have a combined $45 billion cap on their retained earnings. Advocates of privatizing the GSEs have urged the government to end the so-called net worth sweep that requires the companies to deliver profits in excess of that cap to Treasury to repay taxpayers for the 2008 bailout.
But the incoming Biden administration may favor a more cautious approach to the GSEs, and could push for maintaining the current status quo of keeping the companies in conservatorship. A pending Supreme Court case, meanwhile, is expected to give the new president greater power to fire Calabria.
If the new capital requirements had been in place as of June 30, Fannie and Freddie would have had to maintain a combined $283 billion in adjusted total capital — compared to $263 billion if the May proposal had taken effect — or would risk restrictions on dividend and bonus payments.
Part of the reason behind the increase is that the GSEs’ adjusted total assets have increased 9% since Sept. 30, as the companies have reported strong earnings thanks to low mortgage rates and a strong demand for refinancing.
The jump in projected required capital can also be attributed to the FHFA raising the floor on the adjusted risk weight assigned to mortgage exposures from 15% to 20%, which adds about $12 billion in capital to the total requirement.
That change was made after the Financial Stability Oversight Council said in September that capital requirements “materially less than those contemplated by the proposed rule” could put the GSEs and the financial system at risk. The final version of the rule better aligns the GSEs’ capital requirements with those of other market participants, the FHFA said.
Notably, the final framework provides more capital relief for credit risk transfer transactions than the May proposal. Stakeholders had expressed concern about the proposal’s treatment of CRT, which Fannie and Freddie currently take advantage of in order to offload some of their risk to third parties, and worried it would disincentivize the use of the program altogether.
The increased capital the GSEs will be required to hold for mortgage exposures could also increase the amount of capital relief a GSE could be for certain credit risk transfers to a certain extent, according to FHFA.
The final framework also cuts the credit risk capital requirement for non-performing loans that are in forbearance due to the coronavirus pandemic, which would amount to about $11 billion in capital relief.