In its request for input on single-family credit risk transfer RFI, FHFA expresses a strong preference for large, economically efficient, repeatable transactions, as well as programs that create a level playing field for both large and small lenders. FHFA also expresses an openness to pilot transactions that have the potential to be repeatable. The FHFA RFI discusses other issues as well, including critical TBA considerations. We have chosen the following salient matters to highlight at this time.

What Matters to FHFA

• Size matters – "Transactions should transfer a meaningful amount of credit risk to private investors."

"The vast scale of the Enterprises' mortgage securitization business requires that credit risk transfer transactions be of substantial size."

• Economics matter – "The program should consist of transactions in which the cost to the Enterprise for transferring the credit risk does not meaningfully exceed the cost to the Enterprise of self-insuring the credit risk being transferred."

"It is possible that some transactions could still be considered economically sensible if they cost slightly more than Enterprise self-insurance. The market for credit risk transfer transactions is still developing, and pricing may fluctuate until liquidity increases over time. The Enterprises may also choose to execute credit risk transfer transactions at higher costs during periods of market turmoil to maintain program continuity."

"Ideally, a credit risk transfer transaction should not materially increase the operational costs of the Enterprises . . . .."

• Regularity matters – "Whenever possible, transactions should be part of a regular program of similar transactions."

• Small originators matter – "guarantee fee concessions will not favor large mortgage originators over small ones."

General Structure Considerations

• Basis Risk – "In 2015, both Enterprises began to transition many of their credit risk transfer structures so that they would be reimbursed for actual losses rather than fixed losses, significantly reducing basis risk."

• Reimbursement Risk – "If a transaction has less than full collateralization, the counterparty's financial strength and creditworthiness of the counterparty must be sufficient to adequately mitigate reimbursement risk. Insurance and reinsurance counterparties are typically rated by a rating agency based on their financial strength and degree of business diversification. The Enterprises require different amounts of collateral for insurance and reinsurance counterparties, depending on their rating and other considerations. . . . . All front-end credit risk transfers completed to date have been fully collateralized."

• Correlated Business Risk – "for companies that are focused primarily on mortgage loans, the Enterprises expect those counterparties to offset this exposure. Enterprise counterparties can do so by posting substantial collateral, with full collateralization being the best mitigant. Alternatively, counterparties can also either demonstrate sufficient financial strength or conduct their own transactions to transfer credit risk."

Front-End CRT

• Lender Transactions – "Collateralized recourse agreements with lenders are front-end credit risk transfer transactions in which a lender or special purpose vehicle (SPV) agrees to reimburse the Enterprises for a certain percentage of credit losses on loans sold to the Enterprise."

"While Freddie Mac has not participated in structures similar to L Street, it has conducted collateralized recourse transactions with lenders.

• L Street Structure - Alignment of Interests – "If the lender holds the bonds, the alignment of interest occurs as in a traditional collateralized recourse transaction. If it decides not to hold the credit risk transfer bonds, although the recourse contract remains in place, the credit risk is transferred to the purchasers of the bonds. In this case, the lender's interests are less aligned with the Enterprise."

• Future of Collateralized Recourse Transactions – "While there may be a modest increase in the level of collateralized recourse transactions in the future, FHFA does not expect collateralized recourse transactions to constitute a large percentage of the Enterprises' overall credit risk transfer programs."

Input Sought by FHFA on Front-End CRT Proposals

• Question A1 Are there CRT and structural principles and risks in addition to those enumerated

Principles

• Reduce taxpayer risk
• Economically sensible
• Continuity of core business
• Repeatable
• Scalable
• Counterparty strength
• Broad investor base
• Stability through economic and housing cycles
• Transparency
• Level playing field
• Counterparty risk
• Pilot transaction considerations

Risks

• Credit Risk
  • Expected Loss
  • Unexpected Loss
  • Catastrophic Loss
• Credit-Related Risks
  • Model risk
  • Basis risk
  • Structure risk
  • Pipeline risk
• Counterpary and Related Risks
  • Reimbursement risk
  • Correlated business risk
  • Concentration risk
  • Market risk
• Other Risks
  • Interest rate risk
  • Financial reporting or timing risk

• Question A2 How would proposed structures meet and balance the enumerated principles and risks

• Question A3 How should counterparty risk be managed

• Question A4 What issues or characteristics should be tested in pilot transactions

Input Sought by FHFA on Equal Playing Field for All Lenders

"It may be possible that smaller lenders could participate in collateralized recourse transactions through an aggregator that would pool the loan production of several small lenders to take advantages of efficiencies of scale, though this approach introduces several challenges. In addition, smaller lenders could engage in collateralized recourse transactions on loans they originate that do not involve the creation of securities representing the credit risk on the loans. Finally, smaller lenders could participate in recourse transactions if their deliveries are allowed to grow over time (i.e., a "fill up" period) to a sufficiently large pool size, potentially with collateralization requirements commensurate with the risk, in order to make the transaction economically sensible.

• Question B1 What CRT strategies work best for small lenders

• Question B2 Do front-end CRT structures other than collateralized recourse work best for small lenders

Written input on the questions asked by FHFA, as well as on topics discussed in the RFI that are not directly responsive to these questions, is due no later than August 29.