FHFA Proposes Capital Standards for Fannie and Freddie

The Federal Housing Finance Agency (FHFA) on June 12 proposed new capital requirements for the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. The proposal would establish a new minimum leverage ratio for the GSEs and a new framework for measuring the amount of risk-based capital the GSEs would have to maintain for the various mortgages and other assets they hold. FHFA will hold a webinar on the proposed rule on June 19 at 1:30 p.m. Eastern Time.

FHFA suspended the GSEs’ capital requirements when it took them both into conservatorship in September 2008. The standards outlined in the proposed rule would not apply as long as the GSEs remain in conservatorship. Rather, FHFA is establishing what it believes to be appropriate capital standards for the GSEs should Congress decide through legislation to release the GSEs from conservatorship and allow them to remain in business as freestanding entities. FHFA explains in a fact sheet released with the proposal that it is not attempting, by releasing the proposed rule, to take a position on housing finance reform or the future of the GSEs.

The proposed rule advances two alternatives for a new minimum leverage ratio for the GSEs and seeks input on which it should select. One option, which FHFA refers to as the "2.5 percent alternative," would require the GSEs to hold capital equal to 2.5 percent of total assets and off-balance sheet guarantees. The "bifurcated alternative" would require the GSEs to hold capital equal to 1.5 percent of trust assets, which includes GSE mortgage-backed securities (MBSs) held by third-party investors, and 4 percent of non-trust assets, which includes the GSEs’ retained portfolios.

FHFA also proposes to develop a new framework for measuring the amount of capital the GSEs would need to maintain, including by measuring the credit risk associated with various assets held by the GSEs, including single-family and multifamily loans. The framework would determine how much capital the GSEs would have to hold for each asset. For new single-family home purchase loans, the amount of credit risk depends on both borrower credit scores and loan-to-value (LTV) ratios. The highest risk factors are assigned to those loans with LTVs of 97 percent or above. The risk factor on such loans would range from 331 to 1,357 basis points of total loan value. The rule does not appear to differentiate between loans originated through special GSE HFA lending products, such as Fannie Mae’s HFA Preferred and Freddie Mac’s HFA Advantage, and other GSE loans.

For the GSEs’ multifamily business, the rule would set up a framework for measuring credit risk that applies to multifamily whole loans, guarantees, and related securities the GSEs hold for investments. The framework would take into account, among other features, loan debt-service-coverage ratios, LTV ratios, payment performance, term, and total size.

In addition to the credit risk capital requirements, the proposed rule would put in place an eight-basis-point operational risk capital requirement and a 75-basis-point risk-invariant going-concern buffer for all assets. Each specific asset class would also be assigned a market risk capital requirement that reflects the likelihood the value of such an asset will fluctuate over its lifetime. The GSEs would be able to lower the credit risk on individual assets through the use of credit risk transfers.

The proposed rule would also apply capital requirements to the GSEs’ municipal bond investments, which largely consist of Housing Bonds issued by the HFAs. Because of the low default rate of municipal bonds, such investments would have no credit risk capital requirements. However, the proposed rule would assign to municipal bond investments a market risk capital requirement of 760 basis points, an operational risk capital requirement of 8 basis points, and a going-concern buffer of 75 basis points. FHFA explains it decided to apply uniform standards to all of the GSEs’ municipal bond investments because such investments represent a small and shrinking portion of the GSEs’ assets. The GSEs ceased purchasing Housing Bonds after the housing crisis and are currently prevented from doing so via the terms of their Senior Preferred Stockholder Agreements with the U.S. Department of Treasury.

FHFA will accept comments on the proposed rule until 60 days after it is published in The Federal Register, which is expected to be shortly.

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