Article: Risk Sharing Transactions: Front End vs. Back End

USMI president Lindsey Johnson recently sat down for a Q&A discussion on risk sharing with DS News. Below is a portion of her discussion.

Lindsey Johnson currently serves as U.S. Mortgage Insurers (USMI) President and Executive Director. Johnson previously served as a Director on PwC’s public policy team, where she engaged policymakers on key public policy issues that impacted the firm. Prior to joining PwC, Lindsey was a former member of the Senate Banking Committee staff as the Minority Staff Director for the Senate Banking Committee’s National Security and International Trade and Finance (NSITF) Subcommittee, and served as Senior Policy Advisor to Senator Mark Kirk (R-Illinois), focusing on noteworthy banking, housing finance reform, and insurance legislation.

What is the difference between front-end risk sharing and back-end risk sharing?

The biggest difference is the fact that upfront risk sharing transactions de-risk the GSEs, or transfer the credit risk from the loans, before they hit the GSE’s balance sheets. Back-end CRTs require the GSEs to warehouse that risk for a period of time, and the GSEs decide what credit risk they’re going to offlay and who the counterparties will be. USMI members have done both, so we would not say that back-end transactions are bad. We actually are very supportive. However, one of the drawbacks or distinctions between the two, specifically back-end CRTs, is that the risk is on the balance sheets on the GSEs is subject to credit swings, which is partially what happened with the widening of the credit spreads at Freddie Mac last month when they experienced a loss.

Other challenges and drawbacks to the back-end transactions is that there is not a lot of pricing transparency to date. Also, smaller institutions have not been able to participate in the transactions. Front-end transactions provider a lot greater pricing transparency and can be accessible for the vast majority of lenders of all types and sizes, so that’s one of the benefits of front-end transactions.

Why do you think the GSEs have engaged in mostly back-end risk sharing to this point?

The FHFA reported in their white paper back in August that since 2012, the GSEs have purchased approximately $3 trillion in mortgage loans, of which just over around 20 percent of the loans—about $667 billion in unpaid principal balance—has been transferred via riskshare, but out of that, less than 1 percent of the risk has been transferred via front-end risk sharing. I think part of the reason, and it’s pretty understandable if this is the case, is that the GSEs can control the process in the entire back-end transfer process. Especially when you consider early versions of STACR (Structured Agency Credit Risk) and CAS (Connecticut Avenue Series) transactions, where they were really designed to move large portions of unexpected loss from the GSEs balance sheet, it makes sense because they were experimenting in the beginning.

Today, the GSEs are a lot better at risk transfer. The products and the markets themselves have started to evolve, and the GSEs are starting to transfer both expected loss and catastrophic loss. The products have evolved and the market players themselves are able to transfer this risk pretty seamlessly. It’s becoming a part of their everyday routine. So at least in the beginning, it seems, they were experimenting and trying to control the entire process.

Now that we have a much better sense of how this works operationally and how credit risk transfer can work both on the back end and the front end, I think we should start focusing on transactions that are scalable and repeatable just as FHFA continues to say they want to do. Also, they should lay the groundwork for a system that is accessible to a majority of market players. It doesn’t make sense to return to a system that advantages some market players over others. Knowing that comprehensive housing finance reform isn’t coming in the near term, we think it’s imperative that FHFA and the GSEs adhere to principles that nearly every industry and consumer group, as well as policy makers, have said are really critical to the housing finance system going forward. They need to begin laying the groundwork now. Those principles are very broad, of course: having greater private capital, which they are very focused on; greater transparency on pricing, and demonstrating the impact to the borrower; and then equitable access for smaller lenders, and lenders of all sizes and types in mortgage finance. So having a greater balance of front-end transactions is something that we are really pushing FHFA and the GSEs to experiment with in 2016.

To read the entire Q&A discussion with USMI president Lindsey Johnson click here

Op-Ed: How Mortgage Insurance Can Improve Credit Access

USMI Co-Chairs Rohit Gupta and Adolfo Marzol talk about how MI can improve access to credit in this op-ed published in the American Banker this month:

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 How Mortgage Insurance Can Improve Credit Access

headshots of USMI Co-chairs Rohit Gupta and Adolfo Marzol
By Rohit Gupta And Adolfo Marzol

October 10, 2014

Policymakers, consumer advocates and housing industry experts are coming to a consensus that the credit pendulum has swung too far in the aftermath of the housing crisis. Many credit-worthy borrowers — especially first-time homebuyers — are having a hard time gaining access to affordable homeownership opportunities.

In order to improve mortgage credit access while avoiding the risks that led to the last crisis, we must recalibrate the status quo. Private mortgage insurance offers one effective way to make mortgage credit available to more people.

The mortgage insurance industry is vitally important for customers facing prohibitive down payments — one of the biggest hurdles to homeownership for many families. According to the Center for Responsible Lending, middle-income workers such as firefighters and teachers would need to save for approximately 20 years for even a modest 10% down payment on a $158,100 home — the median price in 2010.

For many prospective homebuyers, private mortgage insurance offers real help. It accounts for one of every three recently insured low-down-payment loans. And 43% of all private mortgage insurance loans to purchase a home go to first-time homebuyers, according to data from our trade group, U.S. Mortgage Insurers.

If economic conditions turn adverse, insurance coverage provides lenders with significant protection. And if the loan was sold to the GSEs, private mortgage insurance is in the first-loss position in the event of a default — before taxpayers are put at risk. In fact, since Fannie Mae and Freddie Mac entered conservatorship, private mortgage insurers have covered approximately $43 billion in claims, resulting in a substantial savings to taxpayers.

Recent regulatory changes put the industry in an even stronger position to support our nation’s housing finance priorities.

On Oct. 1, revised master policies developed to meet standards set by the GSEs under the oversight of the Federal Housing Finance Agency went into effect. These policies offer new assurances about mortgage insurers’ consistent handling and payment of claims and greater transparency about the contractual protections for lenders and investors with regards to representations and warranties. These enhanced contracts will give lenders greater confidence to offer home loans backed by private mortgage insurance.

The FHFA is also directing the adoption of updated standards that determine when a mortgage insurance company is eligible to insure loans that the GSEs purchase or guarantee. When finalized, these tougher standards will require insurers to have a minimum of $400 million in liquid assets on hand to pay claims on defaulted mortgages. Ultimately, by establishing more rigorous financial standards and comprehensive business, risk management and operational requirements for mortgage insurance companies, the changes will confirm the long-term value of private mortgage insurance for borrowers, lenders and taxpayers. Members of U.S. Mortgage Insurers are also working with state insurance regulators as they update state insurance laws to incorporate lessons learned from the downturn.

Looking forward, there are even more opportunities for reform. One way to improve housing affordability is for the FHFA to ensure that mortgage insurance is fully recognized when GSE guarantee fees are calculated. We believe that the current fees fail to fully take into account the risk-reducing impact of private mortgage insurance. As a result, consumers are overcharged, putting low- and moderate-income and first-time homebuyers at a disproportionate disadvantage.

Another way to promote responsible homeownership would be for FHFA to restore widespread consumer access to prudently underwritten 97% loan-to-value fixed-rate mortgages made by lenders and sold to the GSEs with private mortgage insurance. Responsibly underwritten low-down-payment loans have a long track record of good performance, and they play a critical role in ensuring broad access to affordable options for qualified borrowers.

Finally, Congress should permanently restore the longstanding tax-deductible treatment of mortgage insurance premiums, which expired at the end of 2013. These premiums are the economic equivalent of mortgage interest payments, which remain deductible.

Ultimately, Congress and regulators should work together to further expand sustainable access to credit while increasing the industry’s reliance on private capital. This latter effort will help protect taxpayers, who bear substantial exposure to mortgage credit losses through the GSEs. Private mortgage insurance is already expanding homeownership access and protecting taxpayers, but there is still more work to be done.

Rohit Gupta, president and chief executive of Genworth Mortgage Insurance, and Adolfo Marzol, executive vice president of Essent, are co-chairs of U.S. Mortgage Insurers.

Click here to download the full op-ed as a PDF.