Watt Unveils FHFA’s 2014 Strategic Plan

Posted by Patrick Barnard on May 16, 2014 No Comments
Categories : Required Reading

15489_mel_watt Watt Unveils FHFA's 2014 Strategic Plan In his first major public address since his appointment in December, Mel Watt, director of the Federal Housing Finance Agency (FHFA), on May 13 unveiled the FHFA's revamped strategic plan for government sponsored-enterprises (GSEs) Fannie Mae and Freddie Mac.

As with last year's plan, which was introduced by former director Edward DeMarco, the 2014 strategic plan consists of the same basic three parts, only in a different order of importance: Maintaining credit availability and foreclosure prevention activities; reducing the GSEs' risk in terms of taxpayer exposure; and building a new infrastructure for the secondary mortgage market. In general, the new plan puts a stronger emphasis on bringing private capital back into the mortgage market but reduces the FHFA's focus on transitioning the GSEs out of conservatorship.

Before delving into the specific changes to the plan, Watt made it clear that housing finance reform is not part of FHFA's statutory mandate, therefore the agency will not be playing an active role in the development of housing finance reform legislation. He pointed out that the FHFA's main charge is managing the GSEs.

This is a fundamental change in philosophy compared to the previous iteration of the strategic plan, which included measures to reduce the GSEs' dominance in the marketplace. The 2014 plan, conversely, no longer includes measures to reduce the GSEs' combined footprint. Rather, the emphasis has been shifted entirely to reducing the level of taxpayer risk, mainly by increasing the role of private capital in the mortgage market.

"We have reformulated this goal so that it no longer involves specific steps to contract the enterprises' market presence, which could have an adverse impact on liquidity," Watt said. "Instead, the "reduce' goal focuses on ways to scale back Fannie Mae and Freddie Mac's overall risk exposure. This approach allows us to meet our mandates of upholding safety and soundness and ensuring broad market liquidity."

The approach to reducing risk is basically the same as the previous plan – only somewhat more aggressive. The FHFA has directed each GSE to triple the amount of risk transfers in 2014, with an aim of increasing unpaid principal balance transfers to approximately $90 billion, up from $30 billion in 2013. This includes both the GSEs' single family and multifamily credit guarantee businesses.

"On top of increasing the amount of credit risk transferred, we also expect each enterprise to try new risk transfer structures to assess sustainability in different market conditions," Watt said.

In addition, the FHFA has directed the GSEs to continue to make reductions in their retained portfolios. As Watt pointed out, the GSEs' senior preferred stock purchase agreements with the Treasury Department require that they reduce their portfolios to no more than $250 billion each by 2018, regardless of market conditions.

"We are also requiring them to prioritize selling their less liquid assets to reduce risk and take advantage of current investor interest," Watt said. "As their portfolios continue to decline, they are transferring interest rate risk and liquidity risk from these portfolios to the private sector."

In addition, the FHFA is working with private mortgage insurer counterparties to ensure Fannie Mae and Freddie Mac are able to provide adequate credit loss protection in times of market stress.

The agency is also directing the GSE's to continue with their project to build a common securitization platform – a task that is already underway. In October of last year, the FHFA announced that the GSEs had formed a joint venture to build and operate the new platform. In addition, it established a new technology company, Common Securitization Solutions, to develop and operate the new platform.

However, for practical reasons, the new platform it will initially be limited to supporting only the GSEs, instead of a wider constellation of securitizers, Watt said. The lofty goal of building a platform that would be truly universal and rolled out all at once was simply too risky, he explained, due to the potential disruptions to the market that could take place during the transition. What's more, with housing finance reform still unresolved, there could be challenges in developing a platform that would properly meet the needs of the future market.

"Moving forward, we will focus our efforts on creating a common securitization platform that can undertake Fannie Mae and Freddie Mac's current securitization operations," he said. "A successful outcome will be a seamless transition from the current in-house systems that issue new securities at each enterprise to a future joint venture owned by Fannie Mae and Freddie Mac that operates one system with updated technology."

This includes moving the enterprises toward a single common security, "which we believe will improve liquidity in the housing finance markets," he said. "It would also reduce costs to the enterprises, particularly Freddie Mac, since Freddie's securities have historically traded at a disadvantage compared to Fannie Mae."

The challenge, he said, would be defining the security's parameters along with shared contractual and disclosure requirements – an effort that, along with the build out of the platform, will take years.

Another significant change to the FHFA's strategic plan are new measures to reduce repurchase risk for lenders, which in turn should help free up credit for borrowers. Specifically, the FHFA has directed the GSEs to relax the payment history requirement for granting representation and warranty relief by allowing two delinquent payments in the first 36 months after acquisition.

"Lenders will also get loan level confirmations when mortgages meet this performance benchmark and when they pass a quality control review," Watt said, adding that the GSEs "will also eliminate automatic repurchases when a loan's primary mortgage insurance is rescinded."

Watt said the FHFA is also looking at the scope of life of loan exemptions.

"We know that lenders are concerned about how these exemptions apply to loans that have passed quality control reviews or have met the 36 month benchmark, and we will work toward clarity on this issue," he said, adding that the FHFA is considering establishing an independent dispute resolution program when lenders believe a repurchase is unwarranted. In addition, the agency is considering developing cure mechanisms for loan defects rather than relying solely on repurchases, as well as providing additional clarity on GSE underwriting rules.

With regard to loan limits, Watt said the FHFA won't be making any reductions anytime soon, out of concern that any adjustment could have a negative impact on the overall health of the housing finance market.

Finally, with regard to foreclosure prevention efforts, Watt said FHFA launching a Neighborhood Stabilization Initiative with Fannie Mae, Freddie Mac and the National Community Stabilization Trust that will work to stabilize communities hardest hit by the foreclosure crisis. Phase one of this initiative, he said, is a pilot program in Detroit, where the GSEs are pursuing pre-foreclosure and post-foreclosure strategies including deeper loan modifications and partnering with nonprofits earlier in the REO sales process.

"FHFA expects to use the experiences in Detroit to expand this initiative to other parts of the country," he said. "We believe this will be a win-win for hardest hit communities and for our conservatorship objectives."

To read Watt's speech in it's entirety, click here.

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