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Statement of Melvin L. Watt
Director, Federal Housing Finance Agency
Before the U.S. Senate Committee on Banking, Housing, and Urban Affairs
An Update from the Federal Housing Finance Agency on Fannie Mae, Freddie Mac, and the Federal Home Loan Banks
November 19, 2014
Chairman Johnson, Ranking Member Crapo and members of the Committee, I am pleased to testify today about the activities of the Federal Housing Finance Agency (FHFA).
FHFA was established by the Housing and Economic Recovery Act of 2008 (HERA) and is responsible for the effective supervision, regulation, and housing mission oversight of the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Home Loan Bank System, which includes 12 Federal Home Loan Banks (FHLBanks) and the Office of Finance. The agency's mission is to ensure that these regulated entities operate in a safe and sound manner so that they serve as a reliable source of liquidity and funding for housing finance and community investment. Since 2008, FHFA has also served as conservator of Fannie Mae and Freddie Mac (together, the Enterprises).
In my statement today, I will provide a brief overview of FHFA's statutory responsibilities, an update on the Enterprises' financial condition and FHFA's supervisory and conservatorship activities related to the Enterprises, and an update on the FHLBanks' financial condition and FHFA's regulatory activities related to the FHLBanks.
FHFA's Statutory Responsibilities
I. FHFA's Regulatory Oversight of the Federal Home Loan Banks, Fannie Mae and Freddie Mac
As part of the agency's statutory authority in overseeing the Federal Home Loan Bank System (FHLBank System) and the Enterprises, the Federal Housing Enterprises Financial Safety and Soundness Act (the Safety and Soundness Act), as amended by HERA, requires FHFA to fulfill the following duties:
"(A) to oversee the prudential operations of each regulated entity; and"(B) to ensure that--
"(A) to oversee the prudential operations of each regulated entity; and
"(B) to ensure that--
(i) each regulated entity operates in a safe and sound manner, including maintenance of adequate capital and internal controls;(ii) the operations and activities of each regulated entity foster liquid, efficient, competitive, and resilient national housing finance markets (including activities relating to mortgages on housing for low- and moderate-income families involving a reasonable economic return that may be less than the return earned on other activities);(iii) each regulated entity complies with this chapter and the rules, regulations, guidelines, and orders issued under this chapter and the authorizing statutes;(iv) each regulated entity carries out its statutory mission only through activities that are authorized under and consistent with this chapter and the authorizing statutes; and(v) the activities of each regulated entity and the manner in which such regulated entity is operated are consistent with the public interest."
(i) each regulated entity operates in a safe and sound manner, including maintenance of adequate capital and internal controls;
(ii) the operations and activities of each regulated entity foster liquid, efficient, competitive, and resilient national housing finance markets (including activities relating to mortgages on housing for low- and moderate-income families involving a reasonable economic return that may be less than the return earned on other activities);
(iii) each regulated entity complies with this chapter and the rules, regulations, guidelines, and orders issued under this chapter and the authorizing statutes;
(iv) each regulated entity carries out its statutory mission only through activities that are authorized under and consistent with this chapter and the authorizing statutes; and
(v) the activities of each regulated entity and the manner in which such regulated entity is operated are consistent with the public interest."
12 U.S.C. § 4513(a)(1)II. FHFA's Role as Conservator of Fannie Mae and Freddie Mac
12 U.S.C. § 4513(a)(1)
II. FHFA's Role as Conservator of Fannie Mae and Freddie Mac
As part of HERA, Congress granted the Director of FHFA the discretionary authority to appoint FHFA as conservator or receiver of Fannie Mae, Freddie Mac, or any of the Federal Home Loan Banks, upon determining that specified criteria had been met. On September 6, 2008, FHFA exercised this authority and placed Fannie Mae and Freddie Mac into conservatorships. Since they were placed into conservatorships, Fannie Mae and Freddie Mac together have received $187.5 billion in taxpayer support under the Senior Preferred Stock Purchase Agreements (PSPAs) executed with the U.S. Department of the Treasury. FHFA continues to oversee these conservatorships. FHFA's authority as both conservator and regulator of the Enterprises is based upon statutory mandates enacted by Congress, which include the following conservatorship authorities granted by HERA:
"(D) …take such action as may be--
(i) necessary to put the regulated entity in a sound and solvent condition; and(ii) appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity."
(i) necessary to put the regulated entity in a sound and solvent condition; and
(ii) appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity."
12 U.S.C. § 4617(b)(2)(D). Carrying on the business of the Enterprises in conservatorships also incorporates the above-referenced responsibilities that are enumerated in 12 U.S.C. § 4513(a)(1). Additionally, under the Emergency Economic Stabilization Act of 2008 (EESA), FHFA has a statutory responsibility in its capacity as conservator to "implement a plan that seeks to maximize assistance for homeowners and use its authority to encourage the servicers of the underlying mortgages, and considering net present value to the taxpayer, to take advantage of…available programs to minimize foreclosures." 12 U.S.C. § 5220(b)(1). FHFA, acting as conservator and regulator, must follow the mandates assigned to it by statute and the missions assigned to the Enterprises by their charters until such time as Congress revises those mandates and missions.
FHFA's Actions as Regulator and Conservator of Fannie Mae and Freddie Mac As regulator and conservator of Fannie Mae and Freddie Mac, FHFA has taken actions during 2014 to ensure their safety and soundness, to ensure that they provide liquidity to the housing finance market, and to preserve and conserve the assets of both Enterprises. The following sections provide information about the financial performance and condition of both Enterprises, FHFA's supervisory oversight of Fannie Mae and Freddie Mac, FHFA's work toward the objectives identified in the 2014 Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac, and other activities concerning the Enterprises that FHFA has undertaken in 2014.
I. Financial Performance and Condition of Fannie Mae and Freddie Mac
Since the establishment of the conservatorships in 2008, the financial performance of the Enterprises has improved significantly. They have gone from having to draw funds from Treasury under the PSPAs to no longer requiring such draws. Some of the improvement in performance relates to one-time or transitory items, such as the reversal of each Enterprise's deferred tax asset valuation allowance, legal settlements, and the release of loss reserves associated with rising house prices. But, part of the improvement is also attributable to other factors, including strengthened underwriting practices and increased guarantee fees.
While conservatorship of the Enterprises has helped stabilize their financial condition and the mortgage market, significant challenges remain. Serious delinquencies have declined but remain historically high compared to pre-crisis levels, and counterparty exposure remains a concern. While the risks from the Enterprises' mortgage-related investment portfolios are declining as their volume shrinks, revenues from these portfolios are also shrinking. And both Enterprises continue to work on maintaining the effectiveness and efficiency of their operational and information technology infrastructures.
Following are highlights of the financial performance of the Enterprises:
II. FHFA's Supervisory Activities
FHFA's supervision function evaluates the safety and soundness of Enterprise operations. Safety and soundness is a priority in the achievement of FHFA objectives, execution of Enterprise strategic initiatives, and in all business and control functions. FHFA takes a risk-based approach to supervision, which prioritizes examination activities based on the risk a given practice poses to a regulated entity's safe and sound operation or its compliance with applicable laws and regulations. FHFA conducts on-site examinations at the regulated entities, ongoing risk analysis, and off-site review and surveillance. FHFA communicates supervisory standards to the regulated entities, establishes expectations for strong risk management, identifies risks, and requires remediation of identified deficiencies.In 2014, FHFA has issued supervisory guidance to the Enterprises on topics related to mortgage servicing transfers, cyber risk management, operational risk management, and liquidity risk management. This guidance articulates FHFA's supervisory expectations related to those matters and informs examination activities.Counterparty risks are the focus of several FHFA documents providing supervisory guidance to the Enterprises. For example, in June of this year, FHFA issued Advisory Bulletin 2014-06, Mortgage Servicing Transfers. This bulletin articulated FHFA's supervisory expectations for the Enterprises with regard to transfers of servicing of mortgage loans that they hold or guarantee. Pursuant to contracts with their counterparties, the Enterprises must approve the transfer of servicing operations or servicing rights. FHFA has focused on Enterprise approval processes for these transactions, due in large part to the significant recent transfers of mortgage servicing operations from federally-regulated banks to non-bank entities that are generally subject to less regulation and are more concentrated in their operations. Heightened risks associated with these market developments were identified in the 2014 Annual Report of the Financial Stability Oversight Council. The Mortgage Servicing Transfers bulletin outlines the standards to be applied by the Enterprises in a risk-based approach to analysis of financial, operational, and legal and compliance risk factors. Specifically, the bulletin states that the Enterprises should only approve these types of transfers when they are consistent with sound business practices, aligned with each Enterprise's board-approved risk appetite, and in compliance with regulatory and conservator requirements. Transfers should also be subject to risk-based monitoring by the Enterprises to monitor the execution of the transfers so that all servicing transfers occur in a timely manner and in accordance with approved terms, servicing guide requirements, and applicable mortgage servicing transfer-related laws and regulations.Information security is another risk area of importance to the Enterprises and is addressed in Advisory Bulletin 2014-05, Cyber Risk Management Guidance, issued in May. This bulletin describes the characteristics of a cyber risk management program that the FHFA believes will enable the regulated entities to successfully perform their responsibilities and protect their environments. Assessment of system vulnerabilities, effective monitoring of cyber risks, and oversight of third parties that have access to Enterprise data are among the key expectations of FHFA.Standards set by FHFA are also reflected in guidance to examiners provided in FHFA's Examination Manual, which was publicly released in late 2013. The manual includes twenty-six modules that cover various operations of the Enterprises and present background on a range of credit, market, and operational risks. The manual is a valuable tool for implementing FHFA's risk-based approach to supervision of the Enterprises and is available on FHFA's website. FHFA maintains a team of examiners on-site at each Enterprise, and the examiners receive support from off-site analysts and subject matter experts. Examination teams perform targeted examinations of specific Enterprise operations and conduct ongoing monitoring of risk control functions and business lines. The examination work is performed in accordance with plans prepared at year-end for the following year for each Enterprise, taking into account factors such as analysis of existing risks, changes in business operations and strategic initiatives, and mortgage market developments. Where deficiencies are identified, examiners communicate recommendations and expectations for remedial action. Examiner risk assessments are updated during the year to ensure that emerging risks and Enterprise business changes receive appropriate examination coverage.
Findings from targeted examinations and ongoing monitoring conducted through the course of the year are relied upon by examiners in assigning ratings to each Enterprise under the ratings system adopted by FHFA in 2013. The system, known as CAMELSO, includes separate ratings for Capital, Asset quality, Management, Earnings, Liquidity, Sensitivity to market risk, and Operations. The examination findings are also incorporated into annual Reports of Examination, which capture FHFA's view of the safety and soundness of each Enterprise's operations. Information from the Reports of Examination is included in FHFA's annual Report to Congress.
III. FHFA's 2014 Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac and 2014 Initiatives
In May of this year, FHFA issued the 2014 Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac (2014 Conservatorship Strategic Plan), which outlines FHFA's conservatorship objectives for the Enterprises. At the same time, FHFA issued the 2014 Conservatorship Scorecard, which details activities and expectations for the Enterprises during 2014. Both the 2014 Conservatorship Strategic Plan and the 2014 Conservatorship Scorecard are centered around three strategic goals:
FHFA has worked to further these strategic goals during 2014, and highlights of these activities are detailed below.
A. Maintain, in a safe and sound manner, foreclosure prevention activities and credit availability for new and refinanced mortgages to foster liquid, efficient, competitive and resilient national housing finance markets.
Our first strategic goal, MAINTAIN, requires Fannie Mae and Freddie Mac to carry out and strengthen, where possible, three aspects of their core business operations. First, we expect them to take actions that improve liquidity in the present single-family housing finance market. Second, we believe they should continue to improve servicing standards and foreclosure prevention actions. Third, we think they have a critical, ongoing role in the multifamily sector, particularly for affordable multifamily properties. Our objective here has been to normalize the availability of credit within the Enterprises' approved credit box for borrowers who have the ability to repay a loan, to refine servicing and loss mitigation opportunities to address borrowers still in need of assistance, and to support financing for affordable multifamily housing.
Representation and Warranty Framework
FHFA is continuing the process of updating and clarifying the Representation and Warranty Framework (Framework) for the Enterprises. This Framework provides Fannie Mae and Freddie Mac with remedies – including requiring a lender to repurchase a loan – when they discover that a loan purchase does not meet their underwriting guidelines.
Over the last several years, FHFA has worked to refine the Framework and to have the Enterprises place increased attention and resources on upfront quality control reviews. These quality control improvements enhance the Enterprises' risk management processes to identify and correct problems with the loans they purchase. This progress builds on a foundation of work to improve the Enterprises' ability to detect potential loan defects, including work to improve their data standards. More recently, both Enterprises are developing tools to provide upfront feedback to lenders on appraisals even before they purchase a loan, which addresses a problem identified in a large number of repurchase demands in recent years. In addition, any fraud or significant noncompliance that the Enterprises discover across their mortgage purchases can always trigger a repurchase.
In addition to these efforts, FHFA has also worked to bring increased clarity to the Framework to encourage lenders to reduce their credit overlays and lend throughout the Enterprises' full credit boxes. We believe that the changes to the Framework will reduce lender uncertainty about when the Enterprises will require repurchase of a loan and, as a result, pave the way for lenders to lift some of their current credit overlays and reduce the cost of credit to borrowers.
FHFA launched its efforts to update the Representation and Warranty Framework in 2012, and the first improvements went into effect for loans sold or delivered on or after January 1, 2013. These improvements relieved lenders of representation and warranties obligations related to the underwriting of the borrower, the property or the project for loans that had clean payment histories for 36 months. In May of this year, FHFA and the Enterprises announced additional refinements that addressed revisions to the payment history requirement, written notification of relief to lenders, and treatment for mortgage insurance rescissions.
More recently FHFA announced an agreement in principle on how to clarify and define the life-of-loan exclusions applicable to the Framework. The current life-of-loan exclusions are open-ended and make it difficult for a lender to predict when, or if, Fannie Mae or Freddie Mac will apply one of them. The refinements will provide all parties with additional clarification about when these exemptions apply. Additionally, these revisions maintain and support the safe and sound operations of the Enterprises and are consistent with our broader efforts to place more emphasis on upfront quality control reviews and other upfront risk management practices.
Providing Targeted Access to Credit Opportunities for Creditworthy Borrowers
Part of the Enterprises' mission is promoting access to mortgage credit for creditworthy borrowers across all market segments. We know that in today's market, there are creditworthy borrowers who have the income to afford monthly mortgage payments but do not have the money to make a large down payment and pay closing costs. As a result, Fannie Mae and Freddie Mac will shortly announce purchase guidelines that allow for 3 to 5 percent down payments, which will improve opportunities for access to credit for some of these borrowers.
To appropriately manage the Enterprises' risk, the guidelines for these loans will be targeted in their scope and will include standards that support safety and soundness. We know that the size of a down payment – by itself – is not the most reliable indicator of whether a borrower will repay a loan. As a result, the guidelines will require that borrowers have "compensating factors" and risk mitigants – such as housing counseling, stronger credit histories, or lower debt-to-income ratios – in order to make the mortgage eligible for purchase by Fannie Mae or Freddie Mac. This approach builds on the Enterprises' experience using compensating factors and risk mitigants. It also meets the objective to develop guidelines that look at and assess a borrower's full financial picture and ability to repay, not just whether they have enough money for a big down payment. Additionally, like other loans with down payments below 20 percent, these loans will require credit enhancement, such as private mortgage insurance.
Working with Small Lenders, Rural Lenders and Housing Finance Agencies
During 2014, the Enterprises have continued to conduct outreach to small lenders, rural lenders and Housing Finance Agencies to strengthen their understanding of how the Enterprises might be able to better serve these institutions. These initiatives are important ones, because we know that community-based lenders and Housing Finance Agencies have a vital role in serving rural and underserved markets across the country. We also know that many community-based lenders could not be active in the housing market without access to a liquid secondary housing finance market. In recent years, the share of Enterprise acquisitions that are originated by smaller lenders has increased, and the cash window continues to be an important form of secondary market access for smaller and rural lenders. Additionally, the guarantee fees charged are by policy no longer based on volume delivered, and, as a result, ongoing guarantee fees for all lenders have converged.
Since entering conservatorship, the Enterprises have continued to focus on loss mitigation and borrower assistance activities. As of August 31, 2014, the Enterprises had conducted more than 3.3 million foreclosure prevention actions since the start of the conservatorships in September 2008. However, there are still areas of the country where the housing market recovery has lagged and groups of borrowers continue to need assistance.
During 2014, FHFA has worked to improve the Enterprises' foreclosure prevention efforts through targeted outreach. Examples of these efforts include the Neighborhood Stabilization Initiative under which the Enterprises are partnering with the National Community Stabilization Trust to develop pre-foreclosure strategies that include deeper loan modifications and timely and informed decisions about the best treatment of individual properties. FHFA has selected Detroit and Chicago for this pilot program. FHFA has also conducted targeted outreach activities to increase consumer awareness of the Home Affordable Refinance Program (HARP) as many borrowers could benefit from this program but may not fully understand that they qualify. Finally, the Enterprises developed Streamlined Modification programs to address documentation challenges associated with traditional modifications, including for deeply delinquent loans.
Moving forward, FHFA will continue to review loss mitigation options to help families stay in their homes, stabilize communities, and meet our conservatorship obligations.
For individuals and families who rent rather than buy, continuing to support affordable rental housing is also an ongoing priority for FHFA and the Enterprises. Under FHFA's 2014 Conservatorship Strategic Plan and the 2014 Conservatorship Scorecard, FHFA did not require a reduction in the Enterprises' multifamily production levels. Fannie Mae and Freddie Mac have historically played a key role in providing financing to the multifamily housing finance market throughout all market cycles and their multifamily portfolios have demonstrated excellent performance even through the recent financial crisis.
In addition, FHFA has continued to emphasize the Enterprises' important role in the affordable rental housing market, and FHFA provided the Enterprises with additional capacity to provide financing for affordable multifamily properties beyond the multifamily volume cap established in the 2014 Conservatorship Scorecard. In establishing this policy, the focus is not for the Enterprises to compete where there is private sector coverage of the multifamily market, but to ensure that affordable housing is available and that the housing needs of people in rural and other underserved areas are met, including areas that rely heavily on manufactured housing. On multifamily purchases, we are also requiring the companies to continue sharing risk with the private sector, which Freddie Mac does through a capital markets structure and Fannie Mae does through a risk sharing model. Both approaches transfer significant risk to the private market.
B. Reduce taxpayer risk through increasing the role of private capital in the mortgage market
FHFA's second strategic goal, REDUCE, is focused on ways to bring additional private capital into the system in order to reduce taxpayer risk. We have reformulated this goal so that it no longer involves specific steps to contract the Enterprises' market presence, which would risk having an adverse impact on liquidity. Instead, the REDUCE goal focuses on ways to scale back Fannie Mae and Freddie Mac's overall risk exposure. This approach allows us to meet our mandates of upholding safety and soundness and ensuring broad liquidity in the housing finance market.
Private Mortgage Insurer Eligibility Requirements
FHFA has continued to advance efforts to strengthen Fannie Mae and Freddie Mac's counterparty requirements for private mortgage insurers. When a borrower makes a down payment of less than 20 percent, these mortgages are required by statute to have a credit enhancement, including private capital standing behind the loan, in order to qualify for purchase by Fannie Mae or Freddie Mac. Private mortgage insurance has always played an important role in meeting this requirement and it is critical to make sure that claims can be covered in both good times and in bad times. To this end, FHFA released a Request for Input on draft Private Mortgage Insurer Eligibility Requirements. Our objective is to have the Enterprises strengthen their risk management by enhancing the financial, business and operational requirements in place for their private mortgage insurer counterparties thereby enhancing long-term claims paying ability.
FHFA is in the process of reviewing and considering the input we received as part of our comprehensive evaluation of this issue. Consistent with our statutory mandates, our assessments and policy decisions will take into account both safety and soundness considerations and possible impacts on access to credit and housing finance market liquidity.
Credit Risk Transfers and Retained Portfolio Reductions
FHFA and the Enterprises remain focused on increasing the amount of credit risk transferred from the Enterprises. FHFA increased the 2014 Scorecard target to achieve a meaningful credit risk transfer of $90 billion in unpaid principal balance, up from $30 billion in 2013. In addition, FHFA encouraged the Enterprises to test multiple types of credit risk transfer structures, which include securities-based transactions and insurance transactions.
As of November 1, 2014, Fannie Mae has transferred the credit risk associated with $183 billion in unpaid principal balance of single-family mortgages, and Freddie Mac has transferred credit risk associated with $169 billion in unpaid principal balance of single-family mortgages. In each transaction, the Enterprises retained a small first-loss position in the underlying loans, sold a significant portion of the risk beyond the initial loss and then retained the catastrophic risk in the event losses exceeded the private capital support. As a result, private capital is absorbing significant credit risk on much of Fannie Mae and Freddie Mac's new purchases, thereby substantially reducing risk to taxpayers from these purchases.
In addition, both Enterprises continue to reduce the size of their retained mortgage portfolios consistent with the terms of the PSPAs, which require them to reduce their portfolios to no more than $250 billion each by 2018. Fannie Mae and Freddie Mac have developed plans to meet this target even under adverse market conditions. As their portfolios continue to decline, they are transferring interest rate risk, securities credit risk and liquidity risk from these portfolios to the private sector.
C. Build a new single-family securitization infrastructure for use by the Enterprises and adaptable for use by other participants in the secondary market in the future
FHFA's final strategic goal is to BUILD a new infrastructure for the Enterprises' securitization functions. This includes ongoing work to develop the Common Securitization Platform (CSP) infrastructure and to improve the liquidity of Enterprise securities. We have clarified that FHFA's top objective for the CSP is to make sure that it works for the benefit of Fannie Mae and Freddie Mac. We are also requiring that the CSP leverage the systems, software and standards used in the private sector wherever possible. This will ensure that the CSP will be adaptable for use by other secondary market actors – including private-label securities issuers – in the future. In addition, FHFA has also worked with the Enterprises to leverage the CSP in order to develop a Single Security, which we believe will improve liquidity in the housing finance markets.
Common Securitization Platform
Important progress has been made in 2014 concerning the multiyear process of developing the CSP. This includes the announcement of a Chief Executive Officer for Common Securitization Solutions (CSS) – the joint venture owned by Fannie Mae and Freddie Mac – which is the corporate entity that we expect ultimately to house and operate the CSP. Additionally, this also includes finalizing the governance structure and operating agreements between Fannie Mae and Freddie Mac concerning the CSS.
In addition, FHFA and the Enterprises have also made considerable progress on the design-and-build phase of the CSP. Each Enterprise has designated staff to work on the project at the CSS location and during 2014 this team has been developing the technology and infrastructure of the CSP platform. This includes work to incorporate the Single Security into the development of the CSP. Furthermore, Fannie Mae and Freddie Mac have reorganized their staffs with business operations and information technology experts to develop the systems and processes needed to integrate with the CSP. As this work continues, Fannie Mae and Freddie Mac staff will engage in continuous testing and will develop operating policies and procedures to ensure a smooth transition to the CSP. FHFA, Fannie Mae, and Freddie Mac are committed to achieving a seamless CSP launch, and the actions taken so far are moving us in the right direction toward this multiyear goal.
FHFA's top priority in pursuing the Single Security is to deepen and strengthen liquidity in the housing finance markets. In today's market, the mortgage-backed securities issued by Fannie Mae and Freddie Mac trade in separate "to-be-announced" (TBA) markets. The forward-trading that takes place in TBA securities allows borrowers to lock-in a mortgage rate. The TBA market also adds efficiencies to the process, which reduces transaction costs and results in lower mortgage rates for borrowers. In today's TBA market, there is a price disparity between Fannie Mae and Freddie Mac securities largely due to greater trading volumes of Fannie Mae securities. This price disparity imposes an additional cost on Freddie Mac to remain competitive. We believe a Single Security can further strengthen market liquidity by reducing the trading disparities between Fannie Mae and Freddie Mac securities.
We have asked for public input on FHFA's proposed Single Security structure, and this Request for Input is the first step in a multiyear process. The deadline for feedback was October 13, 2014, and FHFA is working with the Enterprises to process the feedback we received and will move forward in a deliberative and transparent manner.
IV. Additional Initiatives Impacting Fannie Mae and Freddie Mac
In addition to the activities outlined above, FHFA continues to work on a number of other initiatives that impact Fannie Mae and Freddie Mac, several of which are highlighted below.
One of the first decisions I made as Director of FHFA was to suspend increases in guarantee fees that had been announced by FHFA in December of 2013. Given the impact of these fees on the Enterprises, the housing finance markets, and on borrowers, I believed that it was critical to evaluate this issue and to get feedback from stakeholders. After additional work at FHFA, we issued a Request for Input that provides further details on how the Enterprises set these fees. The request also posed a number of questions to prompt substantive feedback about how guarantee fee levels affect various aspects of the mortgage market.
FHFA is in the process of reviewing and considering the input we have received as part of our comprehensive evaluation of this issue. Consistent with our statutory mandates, our assessments and policy decisions will take into account both safety and soundness and possible impacts on access to credit and housing finance market liquidity.
Fannie Mae and Freddie Mac Housing Goals
On August 29, 2014, FHFA issued a proposed rule to set the Enterprises' housing goals for 2015 through 2017 for both single-family and multifamily housing. While HERA changed the structure of the Enterprises' housing goals, the goals remained a component of the mission requirements of the Enterprises. This proposed rule raises questions for public comment about how best to set Fannie Mae and Freddie Mac's housing goals to encourage responsible lending that is done in a safe and sound manner, while serving the single-family and rental housing needs of lower-income families as outlined in HERA. FHFA is in the process of evaluating the comments submitted to the agency.
FHFA's Actions as Regulator of the Federal Home Loan Banks
The FHLBanks continue to play an important role in housing finance by providing a reliable funding source and other services to member institutions, including smaller institutions that would otherwise have limited access to these services. In addition, the FHLBanks have specific statutory requirements related to affordable housing, and, as a result, the FHLBanks annually contribute funds toward the development of affordable housing.
I. Financial Performance and Condition of the Federal Home Loan Banks
The financial performance and condition of the FHLBank System remains strong. Led by growth in advances, the aggregate balance sheet of the FHLBanks has increased over the past two years, but remains considerably smaller than in peak years. Advances totaled $545 billion as the end of the third quarter of 2014, up from $499 billion at year-end 2013, but down 50 percent from a peak of $1.01 trillion in the third quarter of 2008. The overall decline in advance volume from the peak is a result of increased market liquidity from deposits and sluggish economic growth.
Following are highlights of the financial performance of the FHLBanks:
II. FHFA's Supervisory and Regulatory Activities
FHFA conducts annual safety and soundness and affordable housing policy examinations of all 12 FHLBanks and the Office of Finance based on well-defined supervisory strategies. Similar to the approach described concerning supervision of the Enterprises, FHFA uses a risk-based approach to conducting supervisory examinations of the FHLBanks, which prioritizes examination activities based on the risks given practices pose to a regulated entity's safe and sound operations or its compliance with applicable laws and regulations. Additionally, FHFA's FHLBank supervision also utilizes the CAMELSO ratings system and incorporates these ratings into each FHLBanks' Report of Examination. Information from the Reports of Examination is included in FHFA's annual Report to Congress. Over the last few years, FHFA's supervisory work has included assessments of: FHLBank mortgage purchase programs which have been expanding, the substantial increase in advances to a few very large member institutions, the FHLBanks' changing capital composition in light of their increasing retained earnings and reduced activity stock requirements, and their management of unsecured credit. We are also currently conducting reviews of FHLBank enterprise risk management structures and approaches to vendor management.FHFA also provides the FHLBanks with supervisory guidance, in the form of Advisory Bulletins that outline the agency's regulatory expectations. In 2014, FHFA issued Advisory Bulletin 2014-02, Operational Risk Management, and Advisory Bulletin 2014-05, Cyber Risk Management, that applied to the FHLBanks. Other Advisory Bulletins applicable to the FHLBanks have covered such areas as model risk management, collateral valuation and management, and the classification of risky assets.
FHFA's supervision of the FHLBanks' expanding mortgage programs involves oversight of the significant operational issues required by two new products – Membership Partner Finance (MPF) Direct and MPF Government MBS – that the FHLBank of Chicago is likely to begin offering in late 2014 or early 2015. Under MPF Direct, participating members would sell non-conforming and conforming, single-family, fixed-rate mortgage loans to the Chicago Bank, which would concurrently sell the loans to a third-party private investor that would accumulate the loans for securitization. The Chicago Bank expects, at least initially, that loans sold will be "jumbo conforming" loans – capped at $729,750 for single unit loans in the contiguous United States.
Under the MPF Government MBS program, the Chicago Bank would purchase government guaranteed or insured loans, accumulate the loans on its balance sheet as held for sale, and eventually pool the loans in securities guaranteed by the Government National Mortgage Association (Ginnie Mae). The Chicago FHLBank would then sell the securities to other Federal Home Loan Banks, members approved to participate in the mortgage programs, and external investors. Initially, this product will be available only to participating members in the Chicago FHLBank's District.
The mission focus of the FHLBank System is an important component of FHFA's regulatory activities. FHFA has undertaken three recent efforts to oversee the housing finance mission of the FHLBanks. First, in early September, FHFA released a proposed rulemaking involving membership requirements for the FHLBanks. Congress established the FHLBank System in 1932 as a government sponsored enterprise with a focus on housing finance. Over time, Congress has expanded the membership base, expanded the types of assets that are eligible collateral for advances, and made other incremental changes to the System. However, over eighty years later, the FHLBanks are still grounded in supporting housing finance.
Under the current membership rule, institutions may gain access to the benefits of FHLBank membership by meeting a one-time test showing a minimal amount of housing finance assets at the time of application. FHFA has proposed eliminating this one-time test and, instead, requiring that FHLBank members maintain a minimal amount of housing finance assets on an ongoing basis. In addition, FHFA has proposed defining insurance company in such a way that captive insurers would no longer be eligible for FHLBank membership. Captive insurance companies only provide benefits for their parent company, which may not be eligible for FHLBank membership. While captive insurers may in some cases be involved in housing finance, their access to the FHLBank System raises a number of policy questions that we discuss in the proposed rule.
Given the importance of the issues surrounding the membership rule, FHFA extended the initial 60-day comment period for another 60 days, until January 12, 2015. As I have consistently emphasized since becoming Director of FHFA, getting input and feedback from stakeholders is a crucial part of FHFA's policymaking process, and we will strongly consider comments made by members of this Committee as well as the public in determining our final rule.
Second, FHFA has continued a dialogue with the FHLBanks on core mission assets. This also relates to the fundamental issue of how the FHLBanks use the benefits of their status to support their housing finance mission. In partnership with the FHLBanks, I believe we are making progress in developing a framework for the fundamental characteristics of what a FHLBank's balance sheet should look like in order to demonstrate a satisfactory mission commitment.
Finally, among our current regulatory initiatives is a review of FHFA's Affordable Housing Policy (AHP) regulation. The AHP program provides funding for both single-family and rental affordable housing – including housing affordable to very low-income individuals and families. In 2013, the FHLBanks allocated $297 million to their AHP programs for the purchase, construction, or rehabilitation of over 37,800 housing units. FHFA is committed to working with the FHLBanks to make this program more efficient.
Another area of ongoing regulatory work involves the merger of the FHLBanks of Des Moines and Seattle. There has been considerable change in our Nation's financial system, in the membership base of the FHLBanks, and in market conditions across the various FHLBank districts since the FHLBank System was established in 1932. As a result, the FHLBanks have seen changes in advance demand and membership composition, which in turn has affected the fundamental franchise values of some of the FHLBanks.
As a result of these changes, the Boards of the FHLBanks of Des Moines and Seattle have determined that a combined entity would better serve the needs of their members. The Boards of both Banks voted to approve this merger on September 25, 2014. There remain additional steps in order to complete this merger, including approval by FHFA upon reviewing the Banks' formal merger application and ratification by the members of both FHLBanks. FHFA has and will continue to work with the Banks throughout this process, and we will review and evaluate the merger application to ensure that the proposed transaction will be accomplished in a safe and sound manner and will result in a financially strong FHLBank that supports the interests of all its members.
None of these activities or initiatives would be possible without the dedication of the staff at the Federal Housing Finance Agency. Since beginning my time at FHFA in January, it has been a pleasure getting to know the very qualified staff at FHFA and working with them toward our common priorities, and I want to thank them for their service. In addition, I also want to recognize the hard work of the staff at Fannie Mae, Freddie Mac and the FHLBanks, who continue to provide important contributions to the housing finance system.
In the coming year, FHFA will continue to work to achieve the agency's statutory mandates to ensure the safe and sound operations of the regulated entities and to ensure that they provide liquidity in the national housing finance market. In addition, FHFA will continue to advance its Office of Minority and Women Inclusion responsibilities, which include furthering diversity in management, employment and business activities at FHFA, as well as at our regulated entities.
Thank you again for having me here this morning, and I look forward to answering your questions.
Corinne Russell (202) 649-3032 / Stefanie Johnson (202) 649-3030
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