Melvin L. Watt, appeared before the House Financial Services Committee on Tuesday, his first such appearance since he became director of the Federal Housing Finance Agency (FHFA) a year ago.  Watt, in his prepared remarks, recounted to committee members some of the efforts of FHFA over the past year and its plans for the next few.  FHFA is regulator of the Federal Home Loan Banks and both regulator and conservator of the two government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. 

The majority of Watt's testimony concerned the GSEs   He said his agency had acted consistently over the past year to ensure their safety and soundness and to make sure they both provide liquidity to the housing markets and meet their obligations to homeowners as specified by the Emergency Economic Stabilization Act of 2008 (EESA).

Since being placed in conservatorship in 2008 the financial conditions and operations of the GSEs has improved significantly.  Neither has made a draw from the Treasury since early 2012 although, Watt said, some of the improvement relates to one-time or transitory items such as legal settlements, tax benefits, and release of loan loss reserves as home prices have risen.  Some improvements however can be credited to responsible business practices, better underwriting, and increased guarantee fees.

There are still significant challenges.  Loan delinquencies while down are still high by historic standards and counterparty exposure remains a concern.  Risks from the mortgage-related investment portfolios are declining with the size of those portfolios but so are revenues.  Both GSE's are working to maintain and improve their operational and information technology infrastructures and each has the challenge of attracting and maintaining the best qualified workforce while the companies' futures remain in doubt.  

FHFA has taken a risk-based approach to supervising the GSEs.  In addition to regular on-site examinations, it communicates supervisory standards to the entities, establishes expectations for risk management, and identifies and requires remediation of identified risk deficiencies.  Over the last year Watt said FHFA had given supervisory guidance to the GSEs on counterparty risk management, mortgage servicing transfers, cyber and liquidity risk management.

While it came late in his prepared remarks, Watt raised a concern which appeared, while not a new, to be a risk that is gaining importance.  During 2014 FHFA has continued to monitor and assess two areas of state-level actions that "threaten the legal priority of single-family loans owned or guaranteed by Fannie Mae and Freddie Mac;" certain energy retrofit programs  structured as tax assessments and priority liens that are granted by many state laws to homeowner associations. 

Watt said FHFA is not opposed to programs that finance efforts to improve energy efficiency, but they must be structured so as not to undermine the first-lien status of GSE mortgages.  He singled out the Property Assessed Clean Energy (PACE) programs and said FHFA has reiterated that Fannie Mae and Freddie Mac's policies prohibit the purchase of a mortgage on property with an attached first-lien PACE loan.  Thus a homeowner with such a loan cannot refinance their existing mortgage with a Fannie Mae or Freddie Mac mortgage.  Second, anyone wanting to buy a home that already has a first-lien PACE loan cannot use a Fannie Mae or Freddie Mac loan for the purchase.  In addition to aggressive enforcement of these existing policies, FHFA is continuing to evaluate or explore other possible remedies and legal actions to protect the GSEs' lien position.   The agency has also taken legal action where unpaid homeowner association dues have been deemed senior to first mortgages owned or guaranteed by Fannie Mae or Freddie Mac. 

Watt said FHFA has developed and worked off of a set of Strategic Goals for each of the last several years along with a Scorecard of Objectives for conservatorship of the GSEs.  The 2015 version of goals has been published, building off of the 2014 goals.  Both the 2014 and 2015 Conservatorship Scorecards are centered on three strategic goals.  

Under the first goal, to MAINTAIN credit availability and foreclosure prevention activities.  FHFA and the GSEs have focused on a number of related objectives:

• Updating and clarifying the Representations and Warranty Framework. Substantial progress has been made. FHFA provided greater clarity around the life-of-loan exclusions used in the Framework during 2014, and further improvements were announced in November which 1) limit repurchase requests under the life-of-loan exclusions to significant matters that impact the overall credit risk of the loan; 2) incorporate a significance test for exclusions for misrepresentations and data inaccuracies; 3) clarify the requirements for requesting repurchase related to compliance with applicable laws and regulations; and 4) provide lenders a list of unacceptable mortgage products. Earlier in 2014, FHFA and the Enterprises also announced other Framework refinements that included revising payment history requirements, providing written notification of repurchase relief to lenders, and eliminating automatic repurchases for mortgage insurance rescissions.

FHFA also began development of an independent dispute resolution program that could be used as a last step to resolve disputes.  Lenders could challenge a repurchase request by requesting a neutral third party determine whether there was a breach of the selling representations and warranties justifying the repurchase request. 

• Providing Targeted Access to Credit Opportunities for Creditworthy Borrowers. Last month the GSEs announced purchase guidelines for a mortgage with a three percent down payment. This will provide important - but targeted - access to credit opportunity for borrowers who are creditworthy but lack the funds for a traditional downpayment. These guidelines do not allow risk layering and include compensating factors and risk mitigants such as counseling or stronger credit historiesto evaluate a borrower's creditworthiness. The loans must be fully documented, not exceed a 30 year term, have a fixed rate, leverage the GSEs' existing automated underwriting systems and require private capital credit enhancement.
• Working with Small Lenders, Rural Lenders and Housing Finance Agencies. In the first quarter of 2014, the GSEs issued guidance clarifying a number of property and appraisal requirements for dwellings in small towns and rural areas. Fannie Mae cleared the way for more efficient lending under HUD and USDA guarantees and piloted expanded partnerships with county-level HFAs. FHFA expects the GSEs to continue outreach and initiatives with small lenders, rural lenders, and housing finance agencies in 2015, including exploring the feasibility of purchasing a greater number of manufactured housing loans that are secured by real estate.
• Loss Mitigation and Foreclosure Prevention Activities. As of October 31, 2014, the Enterprises had conducted nearly 3.4 million foreclosure prevention actions since the start of the conservatorships. Going forward the GSEs are expected to leverage and build on earlier activities including the Neighborhood Stabilization Initiative. FHFA has selected the City of Detroit and Cook County, Illinois for pilot programs to improve outcomes in hardest hit markets.
• Multifamily Support.  The 2015 Scorecard requires each GSE to continue multifamily purchases not exceeding a volume cap of $30 billion each although they can provide financing for affordable rental housing beyond this cap.  The focus is to support the financing of affordable housing and the housing needs of people in rural and other underserved areas, including areas that rely heavily on manufactured housing. 

On multifamily purchases FHFA will continue to require the GSEs to share risk with the private sector.  Freddie Mac does this through a capital markets structure and Fannie Mae through a risk sharing model. 

In the 2015 Conservatorship Scorecard, FHFA also expressed an expectation that the GSEs address other priorities, such as assessing the reliability and the operational feasibility of alternate or updated credit score models.

FHFA's second strategic goal, REDUCE, is focused on ways to bring additional private capital into the system in order to reduce taxpayer risk.  FHFA's objectives include ongoing requirements for the GSEs to conduct single-family credit risk transfers, reduce the retained portfolio of each, and update private mortgage insurance eligibility requirements. 

• Credit Risk Transfers. The target for these transfers increased in 2014 to $90 billion in unpaid principal balance (UPB) from $30 billion in 2013 and the targets in 2015 are $150 billion for Fannie Mae and $120 billion for Freddie Mac and each is expected to execute at least two different types of credit risk transfer transactions. All activities undertaken in fulfillment of these objectives must be conducted in a manner consistent with safety and soundness.

Retained Portfolio Reductions.  Both Fannie Mae and Freddie Mac have developed plans to meet their 2018 targets of reducing their portfolios down to $250 billion each.   As their portfolios continue to decline, they are transferring interest rate risk, credit risk on securities and liquidity risk from these portfolios to the private sector.  As of September 30, 2014, Freddie Mac's portfolio stood at $414 billion, and Fannie Mae's at $438 billion. 

• Private Mortgage Insurer Eligibility Requirements. FHFA is in the process of reviewing requested public input on Private Mortgage Insurer Eligibility Requirements. The agency's objective is for the GSEs to strengthen their risk management by enhancing the financial, business, and operational requirements in place for these counterparties, thereby enhancing insurers' ability to pay claims over the long-term.

The third Strategic Goal is to BUILD a new single-family securitization infrastructure (CSP) for use by the GSEs and adaptable for use by other secondary market participants in the future.  The first objective for the CSP is to make sure that it works for the benefit of Fannie Mae and Freddie Mac and FHFA is requiring that the CSP leverage the systems, software and standards used in the private sector wherever possible so that it will be adaptable for use by others. In addition, FHFA has worked with the GSEs to leverage the CSP in order to develop a Single Security, which Watt said could improve liquidity in the housing finance markets. 

Watt said his agency and the GSEs have made significant progress on both the CSP and the Single Security in the past year including employment of a Chief Executive Officer for Common Securitization Solutions (CSS) - the entity expected to house and operate the CSP.  There was also considerable progress made on the design-and-build phase of the CSP with GSE staff designated to work at the CSS location.  Work has been done to incorporate the Single Security into the development of the CSP and the GSEs have reorganized their staffs with business operations and information technology experts to develop the systems and processes needed to integrate with the CSP. 

The agency issued a Request for Input on FHFA's proposed Single Security structure last year as the first step in a multiyear process and is working with the GSEs to process the feedback received.  It is an objective of the 2015 Scorecard that the GSEs would finalize the Single Security structure during 2015 and begin the process of planning to implement it in the market.

In addition to the activities outlined above, FHFA continues to work on a number of other matters and initiatives that impact Fannie Mae and Freddie Mac.  Among these are increases in guarantee fees.  Watt suspended announced increases in the fees upon assuming the directorship and is now reviewing responses to a Request for Input that provided further details on how the GSEs set their fees and how fee levels affect various aspects of the mortgage market.  During the Q&A portion of the testimony, he indicated that no decisions have been made yet.

The agency is also reviewing public comment on a proposed rule setting goals for GSE single and multifamily loan purchases from 2015 through 2017.

FHFA recently notified the GSEs to begin setting aside funds to be allocated to the Housing Trust Fund and the Capital Magnet Fund.  These allocations were temporarily suspected by FHFA under the authority of HERA in 2008.  These letters notifying the GSEs of the reversal of the suspension established prudent safeguards in the event of adverse changes in the Enterprises' financial condition or draws under their Treasury agreement.