FHFA plan would make GSEs hold banklike capital amounts
WASHINGTON — Fannie Mae and Freddie Mac would be required to hold more than five times their current capital levels after being released from government control under a much-anticipated proposal from the Federal Housing Finance Agency.
The post-conservatorship capital plan for the mortgage giants offered by FHFA Director Mark Calabria is more aggressive than the now-shelved proposal written by his predecessor.
The plan unveiled Wednesday would align capital requirements for the government-sponsored enterprises with those of the large banks once the two companies are privatized, whenever that is. Under the proposal, the GSEs would have been required to hold a combined $234 billion in capital as of Sept. 30, 2019, representing 3.85% of their total assets and 13.9% of risk-weighted assets. Currently, Fannie and Freddie's retained earnings are capped at $45 billion combined.
“We must chart a course for the enterprises toward a sound capital footing so they can help all Americans in times of stress,” Calabria said. “More capital means a stronger foundation on which to weather crises. The time to act is now.”
Fannie and Freddie would also have to maintain a leverage capital buffer on top of the proposal's new leverage ratio requirement.
Comparatively, in the original 2018 proposal, drafted by former Director Mel Watt, the GSEs would have had a combined risk-based capital requirement of $180.9 billion, or 3.24% of the companies’ total assets. (The earlier plan was based on Fannie and Freddie’s 2017 book of business.)
Calabria said in November that his agency would revisit the post-conservatorship capital framework developed by Watt, in part due to the fact that the agency had raised the GSEs' retained earnings cap after the release of Watt's plan.
Of course, no capital regime for Fannie and Freddie would take effect until the two GSEs are privatized and their federal conservatorships end. The FHFA and Treasury Department have been developing a roadmap for releasing the companies from government control in the absence of legislative progress on housing finance reform.
Although the goals of the 2018 proposal were largely applauded by the industry, some commenters expressed concern that the framework was too procyclical and could leave the mortgage giants severely weakened in a crisis. Others urged the FHFA to require the GSES to hold larger capital cushions and expressed concern that the plan could result in higher mortgage costs for lower-income borrowers.
The new proposal largely seeks to address all of those concerns at once, all while preserving the risk-based foundation of the original framework.
Perhaps most notably, the new framework would boost the quality and quantity of both risk-based and leverage capital that the GSEs would be required to hold.
Under the new proposal, the FHFA would impose three levels of bank-like risk-based capital requirements, including a common equity tier 1 capital requirement.
The agnecy would also incorporate the spirit of several post-crisis bank regulations into its framework, including a stress capital buffer, a countercyclical capital buffer and a stability capital buffer that FHFA officials described as analogous to the capital surcharge imposed on global systemically important banks.
Taken together, those three requirements would comprise the “prescribed capital conservation buffer amount.” Fannie and Freddie would be required to hold excess regulatory capital in the amount of that buffer or would face limits on capital distributions and bonus payments, similar to the expectations for banks regulated by the Federal Reserve, Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency.
“These supplemental requirements mitigate the weaknesses in the Enterprises’ statutorily defined capital requirements that became evident in the 2008 financial crisis, ensuring that the Enterprises have a foundation of capital that can truly absorb losses,” the FHFA said in a fact sheet detailing the proposal.
Several of the new requirements would also make Fannie and Freddie hold thicker capital cushions. The framework would create a minimum leverage requirement of 2.5% of a GSE’s adjusted total assets, with an additional leverage buffer amount of 1.5% of adjusted total assets.
The new proposal would also beef up capital requirements on the amount of exposure a GSE retains through a credit risk transfer. Fannie and Freddie can enjoy capital relief by transferring some credit risk to investors. However, the plan makes clear they must still protect against losses from the amount of risk they retain.
The plan aims to allow Fannie and Freddie to dip into their capital buffers during periods of financial stress while enabling them to build up those cushions as the economy stabilizes, the FHFA said.
Several commenters in 2018 had also expressed concern that the framework’s use of mark-to-market loan-to-value ratios would contribute to the plan's procyclical nature.
While the new proposal would continue to use updated home values to establish mark-to-market LTVs, it would also incorporate a “countercyclical adjustment” to prevent Fannie and Freddie from holding too little capital during extreme economic conditions.
That adjustment acts as a circuit breaker: If home prices were to either increase or decrease by more than 5%, the FHFA would stop making further adjustments to prevent the GSEs from shedding capital at the peak of the cycle, senior agency officials said.
Although the new framework would result in higher capital requirements for Fannie and Freddie, the FHFA argued that it would not restrict affordable access to mortgage credit.
The agency said that the new components of the framework meant to promote procyclicality would result in more stable levels of capital, which it said in turn would actually expand access to credit and reduce borrowing costs.
The FHFA also reduced the risk-based capital requirements for low down payment loans with private mortgage insurance, and removed risk multipliers from the 2018 proposal that would have priced loans with one borrower as more risky than loans with multiple borrowers.
Moreover, the risk-based capital buffers under the new proposal would be based on a GSE’s adjusted total assets, rather than risk-weighted assets, “ensuring that these buffers do not fall disproportionately on higher-risk exposures,” the agency said.
The public will have 60 days to comment on the proposal from when it is published in the Federal Register, but the FHFA will have the proposed framework on its website for 30 days before it is officially published, which the agency says will effectively give commenters 90 days to review the proposal.
That timeline will almost certainly be met with pushback. The FHFA extended the comment period for its proposal in 2018 to 90 days, and even then commenters argued that they needed more time to review the details of the framework.
Now, as the coronavirus pandemic is rocking the economy and shifting attention and resources elsewhere, lawmakers as well as advocacy and industry trade groups have called on federal agencies to pause all rulemaking not related to the coronavirus.
Sen. Sherrod Brown, D-Ohio, the ranking member of the Senate Banking Committee, sent a letter March 17 to eight federal agencies, including the FHFA, urging an “immediate moratorium on rulemakings not related to the virus response or other imminent health and safety concerns,” adding that the public might not currently be able to provide thoughtful suggestions and comments on proposed rules.
The Independent Community Bankers of America also asked several financial regulators in a March 30 letter for a six-month halt in non-COVID-19 rulemaking to allow banks to focus on working through the fallout from the pandemic.
But senior FHFA officials said that now is the right time to debut the agency’s overhaul of the proposal, arguing that the pandemic has only highlighted the need to have adequate levels of capital during a downturn.
“This national health crisis has affirmed the importance of the enterprises’ mission to serve the American housing market during good times and bad,” Calabria said. “When credit dries up, low- and moderate-income households are hurt most.”