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US CRT prospects discussed

The US CRT market – as with every other area of society – was tested by the Covid-19 fallout. But the sector arguably finds itself in a stronger position now, according to a new SCI Special Report.

The levels of quality, innovation and negotiation involved in the private capital relief trade and mortgage insurance-linked note markets stepped up as parties sought to address the impact of the coronavirus crisis. And policymaker support for agency credit risk transfer has also strengthened, after a period of great uncertainty.

Indeed, the change of administration in the White House has seemingly precipitated a reversal in fortunes for the US agency CRT market. The appointment in June by President Biden of Sandra Thompson as the new acting director of the FHFA, following his dismissal of Mark Calabria from the post, signals a radical change of direction for the agency - one that is anticipated to result in an enhanced role for credit risk transfer.

First, the Biden administration has made it clear that extending affordable housing to lower income borrowers is a principal policy aim. This would suggest that Fannie Mae and Freddie Mac will be encouraged to accept mortgages for which the credit quality is potentially less secure and the LTV ratios are higher than has been the case historically. As such, the role of credit risk transfer in mitigating risk is likely to come into even sharper focus.

Second, official disdain for CRT will also become a thing of the past. Given the change of guard at the FHFA, Calabria’s Enterprise Regulatory Capital Framework (ERCF) – which was released at the end of May 2020, with the objectives of preparing the GSEs for re-entry to the private sector and reducing their footprint in the housing market – is also being overhauled.

The ERCF rules are considerably less friendly to CRT mechanisms than the previous 2018 rules and had the effect of forcing Fannie Mae to withdraw from the CRT market, issuing its last transaction in 1Q20. However, with the absence of Fannie Mae, Freddie Mac stepped up the pace of its STACR issuance, reaching US$11bn of issuance in 2020.

Furthermore, Freddie Mac’s combined STACR and ACIS programmes attained record half-yearly issuance of US$9.9bn in the first six months of 2021. The GSE completed five STACR deals and seven ACIS deals during this period, which included the two largest STACR transactions ever sold.

Following its change in leadership, the FHFA in September issued a request for comment on a notice of proposed rulemaking (NPR) that would amend the ERCF. The proposed amendments would refine the prescribed leverage buffer amount (PLBA) and the capital treatment of credit risk transfer to “better reflect the risks inherent in the enterprises’ business models and to encourage the distribution of credit risk from the enterprises to private investors”.

Tim Armstrong, md at Guy Carpenter, remarks: “The NPR moves the ERCF closer towards establishing the leverage ratio as a credible backstop to the risk-based capital requirements and reduces much of the harmful and distortive CRT disincentive embedded in the 2020 ERCF. We believe the NPR moves CRT decision-making more in line with its economic and risk management benefits.”

Less than a week after the FHFA issued the NPR, Fannie Mae announced its plans to recommence issuance of CAS bonds in October. The GSE priced its come-back CAS 2021-R01 transaction on 19 October, meeting with strong investor demand, and intends to bring a high-LTV deal in November.

So, in terms of both the important role that Fannie Mae and Freddie Mac are set to play in facilitating affordable housing and the philosophical trajectory of the FHFA, agency CRT is front, back and centre from a policy perspective once more.

Meanwhile, a number of developments in the US private capital relief trades market have also put the sector in the spotlight over the last two years, since JP Morgan Chase completed its ground-breaking Chase Mortgage Reference Notes 2019-CL1 transaction in October 2019. Not only has the application of capital relief trades technology broadened to include other asset classes, but it has also been embraced by regional banks, beginning with Texas Capital Bank in March 2021.

Sponsored by Arch MI and Guy Carpenter, SCI’s US CRT Report 2021 examines how the sector has weathered the Covid-19 fallout, innovation in the mortgage insurance-linked note market, the role of GSE CRT in the mortgage market and growth prospects for the private CRT sector. Click here to download a complimentary copy of the report.