Key Topics & Takeaways
- Credit Risk Transfer (CRT): The brief hearing dealt primarily with CRT’s ability to offload credit risk from the GSEs and reduce the exposure of taxpayers to problems in the mortgage finance industry. Canter and other panelists discussed the merits of CRT and argued that Congress should codify CRT in statute. Canter also used his testimony to draw attention to the broker dealer capital charge on CRT, and to argue that CRT should not be used to cover risks to mortgages from natural disasters.
- Michael Canter, Director, US Multi-Sector and Securitized Assets, AllianceBernstein (AB)
- Dr. Susan Wachter, Professor, Wharton School, University of Pennsylvania
- Jeffrey Krohn, Managing Director, Guy Carpenter & Company
- Andrew Rippert, CEO, Global Mortgage Group, Arch Capital Group
- Patrick Sinks, CEO, Mortgage Guaranty Insurance Corporation, on behalf of the U.S. Mortgage Insurers.
Subcommittee Chairman Sean Duffy (R-Wis.)
In his opening statement, Duffy introduced the hearing and asked the panel to examine how credit risk transfers (CRT) might be involved in any restructured housing finance system. Duffy talked about the success of CRT in offloading mortgage credit risk thus far, and discussed FEMA’s recent announcement that it will claim $1.042 billion in reinsurance coverage under its reinsurance program.
Subcommittee Ranking Member Emanuel Cleaver (D-Mo.)
In his opening statement, Cleaver discussed the conservatorship of the government-sponsored enterprises (GSEs, collectively, Fannie Mae and Freddie Mac) and the importance of providing clarity about their status with legislation. Cleaver noted that that since 2013 the GSEs have transferred a portion of credit risk to private markets on $1.8 trillion of unpaid principal balance. Cleaver asked the panel to discuss how different kind of risk transfers will affect the housing finance system.
Michael Canter, Director, US Multi-Sector and Securitized Assets, AllianceBernstein
In his testimony, Canter discussed the current state of the CRT bond market and said that CRT is “crucial” for mortgage financing today. Canter said that CRT has no counterparty risks, unlike mortgage insurance, and that mortgage insurance’s viability in an economic downturn is questionable, and that CRT is a more effective way of dispersing risks across financial markets. Canter then outlined several principles for preserving and improving CRT in a reformed housing finance system, including ensuring underwriting and servicer standards managed by the GSEs are accepted by investors. Canter also called for a healthy competition in CRT markets from different guarantors. Canter closed by suggesting the broker dealer capital charge (currently at 100%) for holding CRT is too high, and said that CRT should not cover natural disaster risk.
Dr. Susan Wachter, Professor, Wharton School, University of Pennsylvania
In her testimony, Wachter discussed the 2008 financial crisis and said any new system should be focused on identifying risks to the housing finance system. Wachter said that CRT could help the market, and if priced accurately could help determine risks to the market. Wachter said that standardization in the mortgage market is necessary to keep the CRT market functional, and that CRT must be structured so that funds are available automatically if credit losses occur. Wachter also said that CRT instruments must trade with publicly disseminated prices and not over-the-counter, and that CRT use should be discretionary, so that prices do not impact guarantee fees on mortgages. Wachter described mandatory CRT as counterproductive and possibly procyclical.
Jeffrey Krohn, Managing Director, Guy Carpenter & Company
In his testimony, Krohn said that the GSEs and private mortgage insurers carried all the credit risk of borrowers in 2008, but that since then material reforms have taken place. Krohn said that reinsurance markets are a “significant and attractive” source of private capital for the GSEs and that CRT prices were not impacted by the damaging hurricanes and wildfires, and these products should remain an important product for investors and the GSEs for years to come.
Andrew Rippert, CEO, Global Mortgage Group, Arch Capital Group
In his testimony, Rippert argued that a continued conservatorship of the GSEs creates market uncertainty. He also called for the GSEs to continue to innovate in CRT products, and said legislation is needed to lock in the gains to-date from the success of CRT. Rippert also said that legislation will create certainty in the market for CRT, which would then be available even in downturns. Rippert praised CRT for reducing taxpayer exposure, though he conceded that the GSEs still retain large amounts of first-loss exposure to mortgages on their “highly leveraged balance sheets” and are relying on an implicit government guarantee. Rippert called for an explicit government guarantee at the security level.
Patrick Sinks, CEO, Mortgage Guaranty Insurance Corporation, on behalf of the U.S. Mortgage Insurers.
In his testimony, Sinks discussed the importance of the mortgage insurance (MI) industry, though he did say that CRT and other sources of private capital could play a role in a future housing finance system. Sinks gave an overview of MI (which is conducted at the loan level) and noted that private mortgage insurance is compatible across markets and with other CRT programs. Sinks also defended the monoline structure of many MI firms and said that MI firms have an economic interest in remaining in markets, paying claims, and providing insurance, even in downturns. Sinks also defended the MI industry’s payment of claims from the 2008 financial crisis.
Question & Answer
Credit Risk Transfer
The brief hearing dealt primarily with CRT’s ability to offload credit risk from the GSEs and reduce the exposure of taxpayers to problems in the mortgage finance industry. Duffy asked about the GSE’s retaining first-loss credit positions. Canter noted that the GSEs began retaining first-loss risk in 2017, and that this activity no longer counts as risk-offloading, as the GSEs are not offloading as much as possible, instead trying to get a return on their capital.
Duffy also asked how to improve the market for CRT, and multiple panelists argued that legislation that makes the CRT program permanent will tell investors that the program is not an “experiment.” Rippert argued that CRT markets would stay viable even in downturns, not unlike how insurance, reinsurance, and mortgage insurance markets function.
There was some discussion about the relative merits of mortgage insurance compared to CRT. Canter argued that CRT is more than traditional mortgage insurance, as in periods of market stress mortgage insurers are uniquely exposed to problems in the industry. Rippert argued that mortgage insurers provide first-loss credit risk at the start of the life of a loan, before the loan is transferred to the GSEs. Sinks argued that mortgage insurers did not (and do not today) have payment issues and noted that they have paid out most claims from the 2008 housing market collapse.
Rep. Nydia Velazquez (D-N.Y.) asked the panel about the merits of expanding the investor profile of CRT market participants to include real estate investment trusts (REITs). Canter noted that the GSEs have already begun exploring expanding access to CRT by REITs, which should push costs down for CRT and possibly keep the guarantee fees on mortgages lower than otherwise.
Rep. Ed Royce (R-Calif.) asked the panel for their views on the merits of expanding the CRT program to Ginnie Mae and all other government lending programs. Krohn agreed that policymakers should look at expanding credit risk transfer programs to other mortgage programs.
Natural Disaster Risk
Rep. Blaine Luetkemeyer (R-Mo.) asked Canter to elaborate on the points he made in his testimony about natural disaster risks to CRT. Canter said that losses due to natural disasters could jeopardize the continued functioning of the CRT market. Canter argued that the CRT market should focus on the credit risk of mortgages only, and not be used to absorb risks that are properly covered by insurance.
Velazquez asked the panel for their thoughts on how to keep private capital flowing into the housing market during downturns. Rippert said that responsible lending and product guidelines are important for encouraging lending, and called on lenders to cautiously extend credit to low-income borrowers in overpriced or overheating markets. In response to a question from Cleaver, Wachter argued that competitive lending standards would be unhelpful and destabilizing. Wachter also noted as an aside that CRT informs the market about risks and risk appetite, and if CRT was tied to a specific entity, dueling CRT would not be as liquid.
Cleaver asked the panel about a series of papers written by the Milken Institute that proposed a Ginnie Mae-centric alternative to the GSE guarantor model. Canter said he thinks highly of the Demarco/Bright plan, though he argued that while any system needs more than two guarantors to create competition, the market could probably not sustain ten (or more_ guarantors.
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