Reply - jtimothyhoward JUNE 4, 2020 AT 5:51 PM
I had the same reaction about the content of the FHFA webinar;
there was nothing presented that hadn’t been in the rule
or the summary. But besides the detachment from reality
you noted (more on that in a bit),
the presenters made clear that those who read the proposal and said,
“It’s not really 4.0 percent capital; it’s 2.5 percent”
aren’t reading it correctly.
The deputy principal director, Adolfo Marzol, stated directly,
“The goal of the proposed rule is that we are at or below 25:1 leverage.”
That’s 4.0 percent capital or more.
(And remember, the 4.0 percent minimum capital required on Fannie and Freddie’s “adjusted” assets is about 4.25 percent on their reported balance sheet assets.) In addition, Ms. Tagoe went on at some length explaining why the risk-based capital percentage of 3.85 percent was unusually low (having to do with the very low mark-to-market LTVs as of September 30, 2019, as well as the very strong economy then), and that it’s likely to be above the minimum most of the time. So if the leverage requirement is 4.25 percent of actual (not adjusted) assets, the risk-based will on average be at least 4.5 percent of actual assets.
In response to a question about whether FHFA would raise guaranty fees as a consequence of these much higher required capital percentages, Adolfo first restated a point he’d made earlier (with which I strongly disagree)–that the rule was good for affordable housing borrowers, because it ensured that Fannie and Freddie would be around in bad times. He didn’t, though, answer the implied and obvious follow-up question, “but at what cost”? Instead, that’s where he said “it’s too early to speculate” about what would happen to guaranty fees, and that now that the rule is out FHFA will talk to its financial advisor and capital market participants about what returns are necessary to attract private capital.
That answer reinforced my view–which I stated in the current blog post–that this capital requirement is driven by Director Calabria’s ideological goal of redefining Fannie and Freddie roles in the mortgage market, and that FHFA wants to see whether this flies with the investment community.
Otherwise, how could FHFA not have tried to put at least a rough box around the issues of required returns and target guaranty fees before putting out a proposal that was dramatically more punitive on the companies than the 2018 proposal that “capital market participants” already had raised questions about? At 4.0 percent capital (and no higher), Fannie and Freddie’s guaranty fees are about 20 basis points below where they’ll likely need to be to provide a competitive return on equity. Even with today’s average net guaranty fee of “only” around 42 basis points, the FHFA pricing grids would set the target fee for the riskiest 20 percent of the companies’ business (mainly for lower-income borrowers) at nearly 100 basis points. If the average fee rises to 62 basis points, the fee for the riskiest 20 percent would be close to 150 basis points, per year. How many people–let alone low-income ones– could, or would, pay that for credit insurance on loans whose probable losses are a fraction of that amount? At some degree of overcapitalization the entity-based credit guaranty business model ceases to work, and I didn’t get the sense that any of the presenters at today’s webinar had given this notion a moment of thought.
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