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https://www.fitchratings.com/site/pr/10088673

Fitch Ratings: U.S. Treasury Takes the Long Road on GSE Reform

Fitch Ratings-New York-06 September 2019: The U.S. Treasury's recently issued plan to reform housing Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac is likely to take meaningful time to come to fruition, according to Fitch Ratings. As such, even if the administrative actions outlined in the plan are acted on, Fitch does not expect any impact to the GSEs' credit ratings in the short-to-medium term.

Recap and Release as Model
Treasury's reform plan most closely resembles the "Recapitalize and Release" option as outlined in Fitch's "U.S. Housing Finance: Potential Paths of Reform for Fannie Mae and Freddie Mac" report from April 2018. 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.

Amendment to PSPA Sought
Importantly, Treasury and the Federal Housing Finance Agency (FHFA) are expected to amend the Treasury's Senior Preferred Stock Purchase Agreement (PSPA); however, the number of steps to be completed prior to amending the PSPA would require a moderate level of time and resources.

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.

Amending the PSPA to replace the net worth sweep with a periodic commitment fee would allow Fannie and Freddie to start building capital and prepare them for a post-conservatorship world. Treasury's plan calls for continued support through continuation of the PSPA after the GSE's would be released from conservatorship to the extent that Congress does not enact an explicit guarantee on the mortgage-backed securities (MBS). Although Fannie is larger than Freddie, Fannie's availability under the PSPA is significantly less. Fitch expects that while there may be some changes the availability to the GSE's under the PSPA, availability will remain sizeable.

Capital Adequacy and Liquidity Requirement Proposals to be Re-examined
The plan contains over 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 estimates 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.

GSEs Prominent Role in Housing Finance Key to Ratings
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 questions 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.

Many Hurdles Still to Clear
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. 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.


Contact:

Michael Shepherd, CPA, CFA
Associate Director, Financial Institutions
[phone]
Fitch Ratings, Inc.
300 West 57th Street
New York, NY 10019

Christopher Wolfe
Managing Director, North American Banks
[phone]

Bain K. Rumohr, CFA
Senior Director, North American Banks
[phone]

Media Relations: Hannah James, New York, Tel: [phone], Email: [e-mail]

Additional information is available on www.fitchratings.com