Proposed FHFA changes would harm smaller lenders

After a two-year pause due to COVID, the Federal Housing Finance Agency is back with a proposal to significantly increase capital requirements and liquidity ratios for all Fannie Mae and Freddie Mac independent mortgage bank seller/servicers.

The Community Home Lenders Association appreciates that the FHFA moved substantively in the direction suggested by our 2020 comment letter, to create different financial requirements based on whether an IMB is a large or a small servicer. This makes sense, since a small number of large IMB seller/servicers constitutes the overwhelming share of both the GSEs’ counterparty risk and industry systemic risk.

Unfortunately, by moving towards bank-like capital standards for all IMBs that sell loans to the GSEs, the proposal could undermine one of the GSEs’ greatest strengths: the important access to mortgage credit benefits that consumers enjoy due to participation by a large number of small and mid-sized IMBs. This translates into more competition, lower mortgage rates and fees, and more personalized service.

The FHFA requirements would significantly increase cash liquidity requirements for IMBs that originate GSE loans through a new 2% liquidity requirement on all hedged TBA loans in the pipeline — in addition to a 50% increase in the Capital Ratio from 6% to 9%. This could have a big impact on smaller IMBs.

So, Monday, CHLA submitted a detailed comment letter, calling on FHFA to eliminate this 2% TBA hedging requirement for smaller IMB seller/servicers. The new requirement would reduce the use of hedging, a practice that actually reduces risk. Applying the requirement to smaller IMBs could also cause many of them to stop selling loans to the GSEs and instead sell to the largest aggregators. This would create more concentration among the largest Fannie and Freddie seller/servicers, which is bad for consumers and increases risk for the GSEs.

Applying the 2% requirement to smaller seller/servicers is particularly inappropriate, since many smaller IMBs sell loans to the GSEs servicing released or use the actual servicing option that limits their advance burden. Since the main purpose of liquidity requirements is to ensure that servicers have the cash to make required advances, we don’t understand why the 2% provision applies at all to GSE seller/servicers that don’t service GSE loans.

CHLA also questions whether these liquidity requirements are warranted by a quantitative analysis of GSE counterparty risk. Unlike private mortgage insurers that are on the hook dollar for dollar for high loan-to-value loan losses, IMB counterparty risk to the GSEs is indirect, with a small financial impact, particularly for smaller IMBs: basically that an IMB won’t perform on repurchase agreements for improperly underwritten loans. For smaller IMBs that service GSE loans, there could also be a small cost if a servicer goes out of business, although the record is clear that it is easy to transfer servicing to a large servicer.

In our comment letter, CHLA argues that instead of focusing on ratcheting up liquidity requirements for smaller IMB seller/servicers, we should be looking for ways to increase their liquidity. Liquidity and confidence in banks are not lacking for the simple reason they have multiple federal backstops — FDIC insurance, Federal Home Loan Bank advances, the Fed discount window – and when all else fails, as we learned in 2008, TARP bailouts.

As we see articles about how the FHLB advance program for banks is shrinking, in no small part due to IMBs replacing banks as the dominant force in mortgage lending, CHLA is calling on the FHFA as regulator of the FHLBs to adapt the FHLBs’ role by creating an advance program for IMBs.

Since IMB servicers of GSE loans effectively act as bankers to borrowers that miss mortgage payments, why not have the FHLB help them do so, particularly in a stressed environment like two years ago? The risk on advances is extremely low, since advances are effectively backed by. . . the GSEs themselves!

Advances are ultimately recovered by a borrower resuming payments, undergoing loss mitigation, or being foreclosed with the GSEs already on the hook. The FHLB already makes advances to banks, so this program could be structured through advances to warehouse lenders to make loans to IMBs.

IMBs are replacing banks as the dominant force in mortgage lending, so it just makes sense to re-adapt the FHLB advance program to serve IMBs, starting with servicing advances (particularly in a crisis) and building towards advances to IMBs that just originate Fannie/Freddie loans.

CHLA’s comment letter also makes other constructive recommendations, such as restoring flexibility to count the unused portion of committed servicing lines of credit as assets eligible to meet liquidity requirements. Such lines of credit unquestionably have some liquidity value; the only question is the appropriate haircut to reflect their true liquidity value.

As homeownership affordability challenges grow in the face of spiraling home prices, with a generation of young families potentially being locked out of the housing market, our federal housing policies must make equitable housing and mortgage access to credit a top priority. When it comes to financial requirements to sell loans to the GSEs, the question should not just be how high – but how many families we can serve through a robust market that includes small and mid-size mortgage lenders.