Another Mortgage Access Option

FHLBanks offer sometimes-overlooked options to access secondary mortgage market lending

By David Fisher

Much of the discussion on Capitol Hill with policymakers working to reform the housing finance system has centered on bringing private capital back to the mortgage markets. Currently, housing finance is dominated by a handful of large institutions in the origination process and by the federal government in the securitization process. The private mortgage securitization market has become mostly irrelevant, as nearly all loans are being sold to either Fannie Mae or Freddie Mac, or guaranteed by the Federal Housing Administration.

While the reliability of these secondary market outlets has helped move things in the right direction, questions remain on developing a framework that will broaden the number of originators and provide the right incentives to bring private capital back into the housing market.

Community banks would benefit from having a greater number of reliable secondary market options that complement their business model and simplify the process of originating and selling residential mortgages. Many of the Federal Home Loan Banks have been developing such programs over the past 15 years and now offer a variety of products that can meet the needs of member financial institutions and their customers.

Some of those products include credit-sharing features that allow FHLBank members to be rewarded for retaining some of the credit risk on originated mortgages, while other products are more traditional and allow credit risk to be shifted to outside investors. All of the products allow members to retain or sell the servicing of the loans while shifting interest rate risk and prepayment risk to the FHLBank or other investors.

Portfolio products

The secondary market products most familiar to FHLBank members are the portfolio products that pay fees to member institutions based on the performance of the sold loans. Instead of lenders paying fees (guarantee fees, adverse market fees, loan-level price adjustments, etc.), they are compensated for maintaining “skin in the game.” These products provide the proper incentive for lenders to originate high-quality mortgages, with the underlying loans performing much better than mortgages nationally throughout the credit crisis.

To appropriately evaluate the execution under the portfolio products, FHLBank member financial institutions need to understand the trade-off between possible credit losses and the fees paid for retaining a portion of the credit risk on the loans being sold into the secondary market. For example, Chart I illustrates the loss hierarchy of portfolio products in the Mortgage Partnership Finance Program that are offered by several FHLBanks.

The credit structure of these products includes an FHLBank-provided first-loss account that is intended to absorb normal and expected losses that exceed the borrowers’ equity and losses covered by primary mortgage insurance. Credit losses that exceed the first-loss account are typically covered under the credit enhancement provided by the member to support a specific pool of mortgages. Losses exceeding the member-provided credit enhancement are borne by the FHLBank.  

In exchange for the member providing the credit enhancement, the institution receives credit enhancement fees over the life of the loan. Historically, this risk-reward trade-off has performed well for members with paid fees of $35 million, exceeding credit losses by more than 23 times at the FHLBank Topeka.

MPF Xtra product

The MPF Program also offers a product that is designed to assist community financial institutions in selling loans to Fannie Mae. MPF Xtra product provides eased seller/servicer application requirements, competitive pricing, Web-based training programs and full access to customer service staff. Because the lender is not retaining any of the credit risk, the product does not provide credit enhancement fees and the typical loan level price adjustments are assessed based on the characteristics of the loans being sold.

Similar to the portfolio products, members should understand the impact of the price adjustments on the overall execution of loans being sold.

The information in Chart II is a pricing comparison of recent production between MPF products that illustrates the upfront price difference, loan-level pricing adjustment on MPF Xtra loans and the present value impact of future credit enhancement fees paid on portfolio products. Members are typically encouraged to access both products for more flexibility and to take advantage of pricing efficiencies associated with either product.

The FHLBank secondary market programs offer flexible terms that align well with community bank needs. FHLBank members can retain a portion of the credit risk and be rewarded for quality underwriting and providing private capital that supports the mortgage market. Those banks can also retain the servicing or, if they are not staffed to manage the mortgage payments, the servicing can be sold to an aggregator that will not compete for business. A recent enhancement to MPF Xtra provides members with the ability to lock delivery commitments on a best efforts basis, reducing the risk of pipeline fall-out and pair-off fees.

David Fisher is executive senior vice president and chief operating officer of the Federal Home Loan Bank of Topeka.