After the passage of the Temporary Payroll Tax Cut Continuation Act of 2011 (H.R. 3765), the Federal Housing Finance Agency (FHFA) stated there will be a 10 basis point GSE g-fee increase effective April 1, 2012.
The Dec. 23 payroll tax cut extension bill that was passed by Congress requires the GSEs to charge an average g-fee in 2012 of at least 10 basis points more versus the 2011 amount.
According to Credit Suisse analysts, this is in line with their expectations that the GSEs will be beginning the process of gradually raising g-fees this year.
"We expect g-fees to increase by up to 25 basis points in 2012 followed by additional increases of 25 basis points to 50 basis points over the next two to three years," they said.
This is probably going to follow the completion of a couple of GSE t programs scheduled for early 2012 and aimed at selling credit risk to private buyers. The core objectives of these programs will be to look at the market pricing of credit risk.
The result, Credit Suisse analysts said, can be used as an input by GSEs to know what the g-fee fair value is and to find a channel to offload credit risk. The aim is to reduce the government’s involvement in U.S. housing, they said.
However, under current market conditions, analysts think that the output from these pilot programs might overstate the price of credit risk, and there will be political pressure to implement higher g-fees based on these results. It will also be hard for the FHFA to overlook these results considering its role as GSE conservator.
"We believe the most likely outcome will involve implementation of the findings with some hair-cut," analysts wrote. The FHFA, they said, is also probably going to spread out g-fee increases over the two-year window to prevent market disruption. A weak economic or housing environment can delay the implementation.
Analysts recommended scaling into IOS 4.5 2009 hedged with FNMA 3.5s. They also suggested utilizing a 135% hedge ratio to carry out this view.
They are in favor of purchasing $25 million of IOS 4.5 2009 at 13-25 and $33.75 million of FNMA 3.5s at 102-22. They think that IOs 4.5 are the best positioned to benefit from the g-fees rise.
They also favor 2009 vintage over 2010 because of its cheapness driven by Home Affordable Refinance Program (HARP) 2.0 concerns. However, analysts are only putting on half of their target trade size at this juncture because of the potential near-term, HARP 2.0-related volatility. This trade provides a positive carry of close to eight ticks, they said.
What the Law Says
H.R. 3765 stated that the GSE regulator should phase in g-fee increases in the next two years subject to market conditions based on risk of loss and cost of capital allocated to similar assets held by other private regulated financial institutions.
But, notwithstanding the considerations just mentioned, this law requires g-fees to rise by at least 10 basis points for each origination year from the average g-fees charged by the agencies in 2011 on single-family MBS, Credit Suisse analysts explained.
The US Treasury will take in the proceeds from the increases under this law rather than them being retained as GSE reserves.
The FHFA will have to annually submit to Congress an analysis of pricing/risk changes as well as an assessment of how the g-fee changes will meet the above requirements. Aside from this, there will be penalties for the GSEs for non-compliance, including preclusion from providing any guarantee for a minimum one-year period, analysts said.
FHFA has announced that early this year it would further analyze if added g-fee increases were necessary to meet the new requirements. But, considering that the law requires a minimum 10 basis point rise in the average g-fee for each origination year beginning 2012, the FHFA will have to increase g-fees by at least five basis points to meet the minimum requirement. This on the assumption that any more increases are implemented effective July 2012.
The law also requires the Federal Housing Administration to increase the annual mortgage insurance premium by 10 basis points over a two-year period.