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Written Testimony of Sandra L. Thompson
Federal Housing Finance Agency
Before the U.S. House of Representatives
Committee on Financial Services
“FHFA Oversight: Protecting Homeowners and Taxpayers”
Hearing Date: May 23, 2023
Chairman McHenry, Ranking Member Waters, and distinguished members of the Committee, thank you for the invitation to appear at today’s hearing.
Congress established the Federal Housing Finance Agency (FHFA or Agency) to protect the safety and soundness of the housing finance system and promote affordable and sustainable access to mortgage credit nationwide through the regulation and supervision of our regulated entities—Fannie Mae, Freddie Mac (together, the Enterprises), and the Federal Home Loan Bank System, which includes the 11 Federal Home Loan Banks (FHLBanks) and the Office of Finance. Together, the Enterprises and the FHLBank System provide more than $8.6 trillion in funding for the U.S. mortgage markets and financial institutions and perform a vital function in the American economy by providing liquidity and stability to the secondary mortgage market.
Housing affordability challenges present significant barriers throughout the country to both renters and those seeking to purchase a home. House prices have soared in recent years and mortgage rates have climbed well above their prior historic lows. The unusually low supply of homes for sale has exacerbated affordability issues, which disproportionately impact creditworthy potential first-time homebuyers who are struggling to achieve homeownership and who often lack the resources to make a large down payment.
While FHFA cannot directly control these dynamics, the Agency and its regulated entities are addressing these challenges, in part, by focusing on ways to responsibly reduce costs, harness technology and innovation to improve underwriting, and support efforts to increase housing supply.
As regulator and, in the case of the Enterprises, conservator, FHFA ensures that each of these steps is undertaken in a manner that furthers the safety and soundness of the regulated entities. FHFA examiners monitor a variety of risks across business lines, products, and other areas in which the regulated entities engage. FHFA’s regulations set requirements related to prudential standards, market activities, and corporate governance. The Enterprises have continued to build capital and now maintain a combined net worth above $100 billion. FHFA also requires the Enterprises to engage in stress testing to better ensure they can withstand market shocks.
More broadly, the safety and soundness of the regulated entities is a key component of all policy decisions and other actions taken by FHFA. Neither FHFA nor the Enterprises and the FHLBank System can achieve their missions without a continued and unwavering focus on safety and soundness. As we learned during the Great Recession, it is damaging to put a borrower in a home if they will not be able to stay in the home.
My testimony includes updates on a number of critical issues advanced by FHFA since I last appeared before this Committee. Among the issues discussed in greater detail below are FHFA’s updates to the Enterprises’ single-family pricing framework, notably including the upfront fees charged by the Enterprises. As Representative Cleaver rightly pointed out at last week’s subcommittee hearing on this topic, housing finance is a complex issue and the pricing grids underpinning this framework are not easily digestible.
Unfortunately, certain media reports have distorted basic facts by painting an incomplete and misleading picture of these pricing updates. These media reports often make the fundamental mistake of assuming that the pricing grids previously in place were perfectly aligned with the risks faced by the Enterprises. I would like to dispel that myth: in fact, the pricing grids in effect prior to these updates had not been updated in many years and were not fully reflective of the capital framework with which the Enterprises are required to comply.
I want to be very clear on one key point, and one that bears repeating: under the new pricing framework, borrowers with strong credit profiles are not being penalized to benefit borrowers with weaker credit profiles. That is simply not true.
Moreover, the Enterprises by law cannot purchase a loan with a loan-to-value (LTV) ratio greater than 80 percent unless there is an approved level and type of credit enhancement. In most cases, this credit enhancement takes the form of mortgage insurance (MI) provided commercially by private insurers. Borrowers pay for this insurance in addition to the guarantee fees that are passed on to them. If the borrower defaults on their mortgage, the MI provider absorbs the first loss, which limits overall losses for the Enterprises. In this way, MI protects the Enterprises from credit risk by transferring first loss risk to the private sector. The Enterprises’ capital requirements include recognition for loans with MI to reflect lower exposure to unexpected losses. This dynamic is also reflected in the Enterprises’ pricing framework. MI costs must be added to the guarantee fees charged by the Enterprises to fully understand the costs borne by the borrower. Factoring in MI costs and risk transfer is critical to the fee calculation.
Any narratives that ignore these simple facts are harmful to borrowers who could misunderstand the steps they should take to best position themselves for homeownership. The purchase of a home is a complicated transaction, and homebuyers should have accurate information to make the best decisions possible.
Given the admittedly complex nature of the pricing grids, it is important to offer some context so that the general public can better understand the changes FHFA made to the outdated pricing grids. FHFA updated the Enterprises’ pricing framework to both help creditworthy first-time homebuyers limited by income and wealth and to enhance safety and soundness by better aligning upfront fees with the risk exposures and the capital required to be held against these exposures. The updated pricing framework will enable the Enterprises to continue building capital, thereby reducing the risk to taxpayers who have borne the financial burden of supporting them since they were placed into conservatorship in 2008.
In fact, the updated pricing framework accomplishes both of the objectives highlighted in the title of today’s hearing. First, the updated pricing framework supports American homeowners by eliminating the upfront fees for many creditworthy borrowers—first-time homebuyers with lower incomes, for example—and does so by increasing the fees on products that are less central to homeownership, such as second homes or vacation homes. These targeted changes promote homeownership that is both attainable and sustainable. Second, the updated pricing framework enables the Enterprises, both of which are taxpayer-supported, to build capital in a safe and sound manner.
The Committee’s focus on protecting American homeowners and taxpayers is important for another reason. Housing comprises 16 percent of U.S. gross domestic product. And for most Americans, their home is their largest asset, and homeownership is the primary way in which families build wealth and pass it on to their children and grandchildren. The updated and improved pricing framework makes homeownership more attainable for creditworthy first-time homebuyers, which strengthens communities.
In addition to the updated Enterprise pricing framework, FHFA has announced a series of important initiatives since I last appeared before this Committee in July 2022 that I would like to highlight. These actions are consistent with FHFA’s statutory mission of ensuring the safety and soundness of the regulated entities and promoting access to affordable and sustainable housing, including for first-time homebuyers and underserved communities.
Federal Home Loan Bank System at 100: Focusing on the Future
On August 31, 2022, FHFA announced the launch of a comprehensive review of the Federal Home Loan Bank System (the System). The purpose of the review was to ensure the FHLBanks remain positioned to meet the needs of the communities they serve—today and well into the future. FHFA began the review with no pre-determined outcomes and encouraged all stakeholders to participate in a robust public engagement process.
The project began with a three-day listening session followed by 19 regional roundtable discussions and, most recently, a wrap-up listening session. FHFA concluded the public input phase of the review earlier this year and is now working on a report, expected to be published in the second half of the year, which will summarize the feedback received and detail the Agency’s recommendations.
FHFA asked for public feedback on a range of topics, including the mission and purpose of the System, the efficiency of its organization and operations, and its effectiveness in supporting affordable, sustainable, and equitable housing. In addition, we examined the System’s role in community and economic development, including addressing the unique needs of rural and financially vulnerable communities. Finally, we looked at the System’s member products, services, and collateral requirements, as well as its membership eligibility requirements.
FHFA is still analyzing the feedback received, but I am happy to share some recurring themes heard throughout the public engagement portion of the review. Overall, FHFA heard that the System has been a stable and reliable source of liquidity for housing finance for its member institutions. Many stakeholders noted that the System has been serving this function well for the past 90 years, particularly for smaller members and during times of market stress.
This was made clear earlier this spring during a period of heightened volatility in the banking sector, when the FHLBanks provided a record amount of advances to ensure their members had the liquidity they needed in an uncertain market. To support this demand for advances, the System issued more debt than it has ever issued in a single day. Through this period of market stress, the FHLBanks remained in a safe and sound condition and continued to serve their critical role. The System’s resiliency in the face of significant market volatility showed the effectiveness of the standards FHFA established for the FHLBanks to ensure they are appropriately prepared for stress events.
The FHLBanks also have the responsibility to support affordable, sustainable, resilient, and equitable housing and economic development, especially in underserved and financially vulnerable communities, including rural areas, tribal areas, and communities of color.
FHFA has received valuable feedback on how a number of FHLBank initiatives could be made more effective. Numerous responses focused on the FHLBanks’ affordable housing and community investment programs, and the need for the FHLBanks and their members to conduct outreach efforts to ensure those who could benefit from the System’s programs and products have greater awareness of these offerings. Some stakeholders also noted a need to clarify the mission and purpose of the FHLBanks.
This review has been an in-depth and far-reaching initiative, and FHFA is now in the process of analyzing these and other suggestions and preparing our report for publication later this year.
Credit Score Model Validation and Approval
When I last appeared before the Committee, I highlighted that FHFA supports the use of fair and accurate credit score models by the Enterprises, and that we were actively reviewing credit score models along with the Enterprises pursuant to the solicitation and approval process set forth by the law and our regulations. Last year, FHFA advanced two changes that I would like to note.
On October 24, 2022, FHFA announced the validation and approval of both the FICO 10T and the VantageScore 4.0 credit score models for use by the Enterprises. This policy represents an update to the use of the Classic FICO model, which the Enterprises have required for nearly 30 years. At the same time, FHFA also announced that the Enterprises will require two, rather than three, credit reports from the national consumer reporting agencies. These changes are expected to reduce costs and encourage innovation, without introducing additional risk to the Enterprises. FHFA expects a multiyear transition, as credit scores interface with many elements of the mortgage ecosystem, including loan application and underwriting, risk management, capital, pricing, mortgage insurance, and investor disclosures, and many different stakeholders will be impacted, including borrowers, lenders, mortgage insurers, technology service providers, and investors.
The validation and approval of FICO 10T and VantageScore 4.0 was the result of a thorough and publicly inclusive effort which began in 2014 and followed legislation enacted in 2018 that required FHFA to create a process for validating and approving credit score models.
As a result of FHFA’s announcement, borrowers, lenders, investors, and other stakeholders can expect:
Additionally, on March 23, 2023, FHFA announced proposed implementation timelines for the use of FICO 10T and VantageScore 4.0 and for the Enterprises’ requirement to transition to a bi-merge credit report requirement. This announcement marked the beginning of a public engagement process to inform these changes and timelines. The public engagement process will allow stakeholders to provide critical feedback and input on the implementation process and to work with FHFA and the Enterprises to further refine the proposed implementation plan.
Prior Approval for Enterprise Products
The Enterprises, while continuing to serve their public missions, may seek out technological advances and pursue innovations to create opportunities to provide the public, the Enterprises’ counterparties, and the market more access to, and options for, new products. However, in doing so the Enterprises may be exposed to additional risks or could alter the risks faced by other market participants, and the impact on achieving their missions should be carefully balanced against the risks that are introduced by any new activity or product.
On December 20, 2022, FHFA published a final rule that requires the Enterprises to provide advance notice to FHFA of new activities and obtain prior approval before launching new products. The rule was enacted after extensive public engagement. To facilitate implementation, the rule defines “activity” and clarifies which categories of activities would be considered to be “new.” The rule establishes that FHFA will determine which new activities merit public notice and comment, and therefore should be treated as new products and subject to prior approval. In addition, the rule establishes a public disclosure requirement for FHFA to publish its determinations on new activity and new product submissions. The rule took effect on April 28, 2023.
This process will promote safety and soundness as well as transparency, while balancing the importance of innovation with the need to ensure the Enterprises’ actions remain consistent with their charters and the public interest.
Updates to the Enterprises’ Single-Family Pricing Framework
As I discussed earlier, FHFA is first and foremost a safety and soundness regulator, and the Enterprises were chartered by Congress with a mission to support liquidity, stability, and affordability by facilitating responsible access to mortgage credit through their activities in the secondary market. To achieve this mission, the Enterprises charge fees to compensate them for guaranteeing securities collateralized by the mortgages they acquire, which in turn attracts investors across the globe to provide liquidity for the U.S. mortgage market and, ultimately, reduces interest rates for homeowners.
Since 2008, a portion of the Enterprises’ single-family guarantee fees have been “upfront” fees that are based on risk characteristics of the borrowers and the loan and property attributes. Accordingly, the Enterprises engage in risk-based pricing to, among other things, better ensure their safety and soundness, protect taxpayers, and serve their missions.
As required by law, FHFA publishes an annual Guarantee Fee Report which analyzes the guarantee fees charged by the Enterprises, including the average guarantee fee by year. The report also provides detailed information on guarantee fees by product type, loan purpose, LTV ratio, borrower credit score, and seller size. The most recent report includes a timeline of changes to guarantee fees spanning the period from 2008 to 2021 (see Table 1). Taken together, this information provides additional transparency to the public regarding the level and structure of the guarantee fees charged by the Enterprises.
Table 1: Timeline of Changes in Guarantee Fees from 2008 to 2021
It has been over eight years since FHFA undertook a comprehensive review of the Enterprises’ pricing framework, and since that time, FHFA adopted and implemented a new capital regulation for the Enterprises—the Enterprise Regulatory Capital Framework (ERCF). Much of the updated pricing framework, as discussed below, is calibrated to the ERCF to help ensure that the Enterprises’ capital requirements and pricing framework are more closely aligned.
For over a year, FHFA, as conservator of the Enterprises, has been conducting a holistic review of the Enterprises’ guarantee fee pricing framework with a special focus on upfront fees. FHFA’s objectives in updating the framework were expressed in both the 2022 and 2023 Conservatorship Scorecards for Fannie Mae, Freddie Mac, and Common Securitization Solutions. These objectives include increasing pricing support for many creditworthy first-time homebuyers, while ensuring a level playing field for small and large lenders, fostering capital accumulation at the Enterprises, and achieving viable returns on capital over time, which combine to help protect taxpayers.
FHFA, as conservator, has taken a series of steps since January 2022 to accomplish these goals. First, FHFA announced targeted fee increases for second and vacation home loans, high-balance loans, and, later, cash-out refinances. Next, FHFA announced the elimination of upfront fees for many creditworthy low- and moderate-income first-time homebuyers, as well as certain borrowers purchasing homes in rural communities or purchasing manufactured housing. While many loans made through the Enterprises’ flagship affordable mortgage programs (HomeReady and Home Possible) already had zero upfront guarantee fees, upfront fees were fully eliminated for the following borrowers and programs:
These fee eliminations were primarily offset by the increased fees on second and vacation home loans, high-balance loans, and cash-out refinances.
In January 2023, FHFA announced a recalibration of the upfront fees for most purchase and rate-term refinance loans. The updated fee matrices increased transparency by separating the base grids across three loan purposes (i.e., purchase loans, rate-term refinance loans, and cash-out refinance loans), rather than combining purchase and rate-term refinance loans, as was the case with the prior grids. The redesigned matrices also further refined the credit score distribution to include more granular categories at the upper end of the spectrum (i.e., providing more categories than the prior grids, in which all borrowers with a credit score of 740 or greater were grouped together). These changes better reflect the risks associated with various types of loans acquired by the Enterprises.
To ensure mortgage pipelines were not impacted, these updated fees took effect for loan deliveries to the Enterprises beginning on May 1, 2023. Notably, this means that most lenders began implementing these updated fees into the pricing offered to borrowers months earlier to ensure they delivered closed loans that aligned with the new framework by May 1, 2023.
A substantial part of the January 2023 fee recalibration is to align fees with the ERCF. As was noted in the Agency’s 2022 Annual Guarantee Fee Report and in the request for input (RFI) on the Enterprises’ single-family pricing framework published on May 15, 2023, the transition to the ERCF changed capital requirements across credit characteristics. The flatter risk gradients embedded in ERCF result in a lower and flatter return profile across the credit risk spectrum. Several features of the ERCF, including a minimum risk-weight floor for all mortgage exposures, and risk-insensitive capital buffers for stability, stress, and leverage, are applied evenly across all loans acquired by the Enterprises and thereby set a higher minimum level of capital that must be held against these loans.1 This dynamic results in loans with stronger credit characteristics receiving more significant capital increases than loans with weaker credit characteristics, relative to the prior proposed capital requirements. This, in turn, impacts the return-on-capital targets set by FHFA for the Enterprises and served as the basis for much of the recalibration in the January 2023 updates.
On April 25, 2023, FHFA issued a public statement in response to several misconceptions that had been reported in certain media coverage of these updates. In this statement, FHFA made clear that no borrowers are being charged higher upfront fees based on their credit score in order to allow other borrowers to be charged lower upfront fees based on their credit score. The recalibrated upfront fees announced in January 2023 were set based on the capital required by the ERCF (as well as the return-on-capital thresholds set by FHFA), which in turn is predicated on the expected financial performance of each category of loan. Further, FHFA clarified that there is no incentive for borrowers to seek a lower credit score due to the updated fee structure. Risk-based pricing remains in effect, and the upfront fees are now more closely aligned with the return-on-capital targets set by FHFA.
Similarly, there is no incentive for borrowers to make a smaller down payment as a result of the new fee structure. The Enterprises’ congressional charters require credit enhancement—primarily in the form of private MI—for loans with a down payment of less than 20 percent. As discussed earlier, this MI coverage absorbs first losses and reduces the total loss exposure of the Enterprises because the approved insurance providers bear much of these losses in the event of default. Absent MI, the Enterprises would assume a far greater proportion of the losses associated with defaults on these loans. For borrowers making a down payment smaller than 20 percent of the home’s value, the costs of the required credit enhancement, such as MI, contribute to the overall cost of their loan. As such, any analysis of guarantee fees without consideration of MI or other credit enhancement costs is incomplete—both from the perspective of the borrower and from the perspective of the Enterprises.
FHFA has continued to engage with stakeholders on specific issues related to the pricing framework to ensure it meets our stated objectives of fostering capital accumulation at the Enterprises, achieving viable returns on capital, and increasing support for creditworthy first-time homebuyers. FHFA received numerous comments, for example, related to operational and other challenges associated with an upfront fee based on a borrower’s debt-to-income ratio and subsequently removed the fee on May 10, 2023. In addition, and as noted above, to promote transparency and ensure stakeholders can share their perspectives on a variety of issues related to the Enterprises’ pricing framework, FHFA published a public RFI on May 15, 2023.
Since entering conservatorship in 2008, the Enterprises have remained undercapitalized, and taxpayers, through the Treasury Department, continue to provide a financial backstop should the Enterprises confront significant losses. The updated pricing framework will better protect taxpayers in the long term and put the Enterprises on more durable footing, which will allow them to support affordable, sustainable mortgage credit across the economic cycle to the benefit of all Americans. And they will do so with a pricing framework that is more accurately aligned to the expected financial performance and risks of the loans they back.
Updated Minimum Financial Eligibility Requirements for Enterprise Seller/Servicers
An important tool for counterparty risk management at the Enterprises is the use of minimum financial eligibility requirements for approved seller/servicers. These requirements promote safety and soundness by strengthening the capacity of seller/servicers to meet the financial responsibilities associated with originating and servicing mortgages acquired by the Enterprises.
Beginning with proposed updates in early 2020, FHFA and the Enterprises have been examining the framework for issues related to seller/servicer net worth, capital, and liquidity requirements. This work was further informed by the experience of both the Enterprises and seller/servicers in managing challenges that arose as a result of the COVID-19 pandemic. FHFA has worked closely with Ginnie Mae throughout this process, as many Enterprise seller/servicers are also approved Ginnie Mae issuers.
On August 17, 2022, after multiple rounds of public comment, FHFA and Ginnie Mae jointly announced updates to their respective minimum financial eligibility requirements. These updates improve upon the prior framework by strengthening seller/servicer net worth, capital, and liquidity requirements and better tailoring the minimum requirements associated with different types of loans and risk exposures. Most of the updated requirements for Enterprise seller/servicers will take effect in late 2023.
Equitable Housing Finance Plans and Duty to Serve Update
On April 5, 2023, FHFA announced updates to the Enterprises’ Equitable Housing Finance Plans for 2023. The updates build upon the inaugural plans first announced in 2022 and include adjustments based on initial research and findings. The Equitable Housing Finance Plans are designed to complement the initiatives outlined in FHFA’s strategic plan that promote the Enterprises’ safety and soundness and foster housing finance markets that provide equitable access to affordable and sustainable housing.
FHFA’s reason for requiring the Enterprises to develop Equitable Housing Finance Plans is clear. Even after passage of the landmark Fair Housing Act of 1968, the racial homeownership gap persists, with homeownership rates for households of color more than 24 percentage points lower than the rate among white households. Accordingly, the Enterprises developed and published plans to identify and address barriers to sustainable housing opportunities, as well as the Enterprises’ goals and actions to advance equity in housing finance, for the next three years.
Updates to the Enterprises’ 2022-2024 Plans include, but are not limited to:
All plan activities are subject to FHFA's review and oversight of any risks to, or impacts on, safety and soundness.
In addition, the Enterprises released performance reports that outline progress made under their Equitable Housing Finance Plans during 2022 and actions they are taking to advance equity in their automated underwriting systems, such as the inclusion of rental payments and cash flow underwriting and the use of advanced statistical techniques to improve model fairness. In total, the Enterprises, through programs associated with their Equitable Housing Finance Plans, have helped more than 834,000 American families.
FHFA also recently released a proposed rule that would codify the process and standards for the Equitable Housing Finance Plans in the future. The proposed rule addresses many of the questions from stakeholders on the initial program, and FHFA welcomes public comments from all stakeholders.
Later this year, FHFA will conduct a public engagement session to build on last year’s listening session and request for input. The initial engagement with the public yielded thoughtful responses that were incorporated into the Enterprises’ final plans. In future years, I expect the Enterprises will focus on other underrepresented communities, such as Asian American and Pacific Islander communities.
Other issues affect many underserved communities’ access to affordable and sustainable housing throughout the country, such as the availability of small balance loans. There is limited access to mortgage credit for small balance loans on modestly priced homes. This is a barrier to homeownership for many Americans, and unfortunately the void is often filled with non-mortgage products that do not offer an affordable and sustainable path to homeownership. It is also a barrier to refinancing in low interest rate environments. The fixed costs associated with a refinancing often make it uneconomical to refinance lower balance loans, even though that opportunity could reduce monthly costs for owners of modestly priced homes. I believe this is an area in which further work is needed to develop solutions that make small balance mortgage loans more affordable and available to support all communities throughout the Nation.
Many challenges to affordable and sustainable homeownership exist for tribal lands in Native American communities throughout the country. These challenges include legal complexities, infrastructure for housing development, and a lack of access to mortgage products, especially conventional loan products. As a result of these long standing and serious issues, fewer than 1,000 mortgage loans are made annually on tribal lands. Under the Duty to Serve program, the Enterprises are working to develop new solutions to some of these challenges through the expansion of access to conventional loans and the provision of support to Native Community Development Financial Institutions (CDFIs).
The multifamily market experienced volatility in 2022 and the first half of 2023, but fundamentals have remained strong. Throughout this period, the Enterprises have continued to serve as a consistent source of liquidity without compromising credit standards. This year, FHFA instructed the Enterprises to develop and implement strategies to support and advance the multifamily market by identifying ways to facilitate greater affordable housing supply, exploring options to expand energy efficiency and resiliency, exploring the feasibility of expanding tenant protections at Enterprise-backed properties, and increasing Enterprise support for workforce housing.
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We at FHFA will continue to focus on our safety and soundness mission and on the mission that Congress gave the entities that FHFA regulates and supervises: providing liquidity for the secondary mortgage market across the Nation, including underserved markets such as rural and tribal areas, manufactured housing, the preservation of affordable housing, and other underserved populations such as communities of color. This mission extends not only to homeownership, but also to affordable rental housing.
Thank you again for the opportunity to testify before you today, and I look forward to working with the Members of this Committee and answering any questions you may have.
1For loans with stronger credit profiles, the presence of a risk-weight floor will generally increase the amount of capital the Enterprises must hold against those loans. In contrast, for loans with weaker credit profiles, the Enterprises generally were already required to hold capital against those loans in excess of that necessitated by the minimum risk weight floor. Therefore, the risk weight floor is more likely to be binding for loans with stronger credit profiles.
Adam Russell Adam.Russell@FHFA.gov
© 2023 Federal Housing Finance Agency