GSE post-crisis upgrades improved mortgage quality: Fitch

The post-crisis operational improvements at both Fannie Mae and Freddie Mac have resulted in stronger mortgage loan performance, a Fitch Ratings report said.

"The financial crisis revealed operational weaknesses at most mortgage lending institutions, and led to substantial credit losses related to manufacturing defects and misrepresentation," said a Fitch press release that accompanied the report.

"Since the crisis, the government-sponsored enterprises have taken a number of significant steps to improve loan quality. The improvements include establishing streamlined datasets for delivery of loan and collateral data, establishing processes to independently validate certain underwriting loan components, and leveraging growing proprietary appraisal databases and tools to identify appraisal risk prior to loan acquisition."

Fannie Mae and Freddie Mac purchase 65% of the mortgages originated. But after the crisis, there was a big shift in where they purchase the majority of their loans. "Nonbank origination volume has increased to roughly 55%, up from less than 35% precrisis, due to bank portfolio strategy and the leveling of guarantee fees across sellers by the FHFA," the report said.

And there is a diversity of sources that further mitigates risk as each company has only one seller contributing more than 10% to their respective volume as of Nov. 30, 2018.

"While there are specific areas where one entity has an advantage over the other in operational risk controls, Fitch rates both GSEs as 'above average' in their operational risk controls," the press release said. "Fitch reduces projected mortgage losses on loans acquired by either Fannie Mae or Freddie Mac relative to other aggregators of loans, and currently applies the same credit to both GSEs."

A hot topic has been the use of valuation alternatives by the GSEs instead of full-fledged appraisals for certain loans.

"Fitch believes the automated valuation tools and validation processes employed by the GSEs mitigate credit risk associated with appraisal waivers," the report said. "Fitch expects the use of appraisal waivers to continue to be limited due to program restrictions, borrower preference for traditional appraisals in purchase transactions, and a seller preference for traditional appraisals to maintain flexibility of delivery to either of the GSEs or other investors."

Both Fannie Mae and Freddie Mac were required by their regulator, the Federal Housing Finance Agency, to create credit risk transfer programs in order "to reduce their credit exposure to their guaranteed portfolios," the report said.

"This is in contrast to the precrisis era when the GSEs were exposed to substantially all of the credit risk for the loans in their guaranteed portfolio. CRT transactions have shown very good performance to date reflecting the GSEs' strong operational controls and a favorable economic environment."