WASHINGTON—The Federal Housing Finance Agency (FHFA) and Treasury Department have announced amendments to the Preferred Stock Purchase Agreements, allowing the government-sponsored enterprises (GSEs) to retain earnings until they meet capital rule requirements.
In the short term, the announcement makes clear the GSEs will not be exiting government conservatorship as quickly as some, including FHFA Direct Mark Calabria, had hoped. But it also indicates Treasury continues to move in the direction of allowing the GSEs to once again be privatized, after being taken over by the federal government in 2008 as a result of the financial crisis.
In the new announcement, Treasury and the FHFA said the GSEs will be permitted to raise private capital and exit conservatorship once certain conditions are met, in addition to restructuring the department's investment in each enterprise.
Getting ‘Closer’
The announcement was welcomed by NAFCU.
"The FHFA and Treasury's decision to allow the GSEs to continue to retain earnings to meet capital requirements, raise private capital, and meet other essential conditions moves the GSEs closer to exiting conservatorship," said NAFCU President and CEO Dan Berger. "NAFCU supports a robust capital framework. However, we encourage the FHFA to work with Congress to codify certain protections – including those to ensure credit unions have guaranteed and equal access to the secondary market and receive fair pricing based upon loan quality, not volume – before the GSEs are officially released from conservatorship. NAFCU looks forward to working with Congress, the Administration, the FHFA, and Treasury as credit unions play an important role in the housing market."
The FHFA released the final rule to establish capital requirements for Fannie Mae and Freddie Mac in November, marking an additional step toward removing the GSEs from conservatorship. Under the rule, the GSEs are required to hold total capital not less than 8% of their risk-weight assets, which amounts to roughly $280 billion in capital against their combined $6.6 trillion in assets.
The History of PSPAs
In the announcement the government noted Treasury entered into the Preferred Stock Purchase Agreements on Sept. 7, 2008, the day after FHFA placed the GSEs into conservatorship. Under the PSPAs, Treasury committed to invest in each GSE to the extent necessary to maintain a positive net worth. Treasury’s funding commitment was initially $100 billion for each GSE, but was subsequently increased in order to ensure a level of capital support that would provide confidence to financial markets and ensure the continued flow of mortgage credit. Today, $254 billion of the funding commitment remains available to the GSEs.
In return for its commitment, Treasury received from each GSE nonvoting senior preferred shares, warrants to purchase 79.9% of the GSEs’ common stock, and a right to a periodic commitment fee to be determined at a later date. The liquidation preference of the senior preferred shares increases by the amount of each draw on the PSPA funding commitment and, after $191.5 billion in combined draws and $37.2 billion in non-cash increases, the GSEs’ combined senior preferred liquidation preference now stands at $228.7 billion.
As of September 30, 2020, Fannie Mae and Freddie Mac had retained equity capital of approximately $21 billion and $14 billion, respectively.
The Key Terms
Key terms of the agreements are:
- Extend Capital Retention: Replace the variable dividend (i.e., net worth sweep) with alternative compensation to permit the GSEs to continue their recapitalization efforts. As compensation to Treasury, the liquidation preference will increase by the amount of retained capital until the GSE has achieved its regulatory minimum capital, including buffers (referred to as the capital reserve end date).
- Upon the capital reserve end date, the GSEs will resume quarterly dividend payments. The dividend amount at that time will be equal to the lesser of 10% of the liquidation preference of Treasury’s senior preferred stock, or the incremental increase in the GSE’s net worth in the prior quarter.
- Before the capital reserve end date, Treasury and the GSEs will determine a periodic commitment fee for Treasury’s remaining funding commitment, to compensate taxpayers for their risk in supporting the GSEs.
- Treasury Establishes No Exit From Conservatorship With Less Than 3% Capital: The letter agreements provide that there will be no exit until all material litigation relating to the conservatorship is resolved or settled, and the GSE has common equity tier 1 capital of at least 3% of its assets.
- Allow for Common Stock Issuance at Appropriate Time: Treasury will allow each GSE to issue common stock upon the achievement of future conditions: first, Treasury must have exercised in full its warrant to acquire 79.9% of the GSE’s common stock, and second, all material litigation relating to the conservatorship must have been resolved or settled. Treasury will permit up to $70 billion in proceeds of stock issuances by each GSE to be used to build capital.
- Limit Future Increases to the Retained Mortgage Portfolio: The PSPA cap on the GSEs’ retained mortgage portfolios will be lowered from the current cap of $250 billion to $225 billion by the end of 2022, aligning with the FHFA conservatorship cap the GSEs are required to comply with today, while providing the GSEs with flexibility to manage through the current economic environment. As of November 2020, Fannie Mae’s mortgage portfolio was $163 billion, and Freddie Mac’s mortgage portfolio was $193 billion.
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Provide Small Lender Protections: The letter agreements codify FHFA conservatorship directives that require the GSEs to purchase loans for cash consideration, and to operate this cash window with non-discriminatory pricing. Additionally, to ensure that the cash window is for the benefit of community lenders, each GSE will limit volume purchased through the cash window to $1.5 billion per lender during any period comprising four calendar quarters.
- Memorialize FHFA Multifamily Lending Caps: Each GSE will cap multifamily acquisitions at $80 billion over the trailing 52-week period and will require that 50% of these acquisitions are mission driven, as defined by FHFA.
- Limit Risk to the GSEs by Keeping Certain Higher-Risk Single-Family Mortgage Acquisitions at Current Levels: To safeguard Treasury’s funding commitment and to ensure the GSEs’ business activities are consistent with their mission and Treasury’s capital support, the GSEs will restrict the acquisition of higher-risk single-family mortgage loans.
- The GSEs will limit the acquisition of single-family mortgage loans with multiple higher risk characteristics at their current levels. A maximum of 6% of purchase money mortgages and maximum of 3% of refinancing mortgages over the trailing 52-week period can have two or more higher risk characteristics at origination: combined loan-to-value (LTV) greater than 90%; debt-to-income ratio greater than 45%; and FICO (or equivalent credit score) less than 680.
- The GSEs will limit the acquisition of single-family mortgage loans secured by second homes and investment properties to 7% of single-family acquisitions — aligned with their current levels — over the preceding 52-week period.
- The GSEs will limit the acquisition of single-family mortgage loans to (i) qualified mortgages, (ii) loans exempt from the CFPB’s ability-to-repay requirement, (iii) loans for investment property subject to the restrictions above, (iv) refinancing loans with streamlined underwriting for high loan-to-value ratios, (v) loans originated with temporary underwriting flexibilities due to exigent circumstances, and (vi) loans secured by manufactured housing.
- Require GSE Compliance with FHFA Capital Framework: The letter agreements provide that the GSEs will comply with FHFA’s recently finalized regulatory capital framework, consistent with the findings of the Financial Stability Oversight Council (FSOC) in a statement issued in September 2020.
- Outline a Plan to Develop a Proposal for Continued GSE Reform: To ensure a path for Treasury to resolve its investment in the GSEs in a manner that fairly compensates taxpayers for the support they have provided and continue to provide, Treasury, in consultation with FHFA, has begun work to establish a timeline and process for further GSE reform. Pursuant to this commitment, Treasury has identified key considerations that will inform this effort, as a part of its Blueprint on Next Steps for GSE Reform.