The Implications of Limiting the GSEs Cash Window

Given the recent announcement by the U.S. Department of Treasury (Treasury) and the Federal Housing Finance Agency (FHFA) to amend the Preferred Stock Purchase Agreements between Treasury and each of Fannie Mae and Freddie Mac (the GSEs), we look at the potential impact of limiting the cash window to $1.5 billion per lender.

The Importance of the GSEs

Fannie Mae and Freddie Mac are federally backed home mortgage companies created by the U.S. Congress. Neither organization originates or services loans. Instead, they buy mortgages from lenders to hold or repackage as mortgage-backed securities that they can sell. Together, these agencies make the mortgage market more liquid, stable, and affordable by providing liquidity and guarantees to thousands of banks, savings and loans, and mortgage companies in the U.S.

Lenders use the money they get from selling mortgages to Fannie Mae and Freddie Mac to originate more loans, which helps individuals, families, and investors access a stable supply of mortgage money.

Fannie Mae’s and Freddie Mac’s congressional charters give them government-sponsored enterprise (GSE) status and they operate with certain ties to the U.S. federal government that provide a financial backstop. In September 2008, and with the consent of both Fannie Mae’s and Freddie Mac’s board of directors, FHFA used its authorities to place each enterprise into conservatorship in response to a severe deterioration in the financial condition of both agencies because of the financial crisis, which left them unable to fulfill their missions without government intervention. Both remain in conservatorship today.

The FHFA regulates, enforces, and monitors Fannie’s and Freddie’s capital standards and limits the size of their mortgage investment portfolios. HUD is responsible for the general housing missions of Fannie and Freddie.

Fannie’s and Freddie’s GSE status has created certain perceptions in the marketplace of safety. One was that the federal government would step in and bail out these organizations if either firm ever ran into financial trouble, as was seen in 2008. This is known as an implicit guarantee.

Because the market believed in this implicit guarantee, Fannie Mae and Freddie Mac were allowed to borrow money in the bond market at lower yields than other financial institutions could.

Cash Window

As recently reported by Inside Mortgage Finance, most of the single-family mortgage-backed securities pools formed by Fannie Mae and Freddie Mac are based on loan acquisitions from multiple sellers, and most come from cash purchases.

The two GSEs issued a combined $2.2 trillion of UMBS backed by generic 30-year and 15-year fixed-rate mortgages last year. And 81% of those MBS were multi-lender-pools formed by buying whole loans for cash and, in some cases, sellers swapping loans for interests in the MBS.

The GSEs acquire loans via cash purchases (the cash window), whole-loan swaps, and single-issuer guarantor executions.

Big banks focused most of their Freddie UMBS business on single-seller guarantor transactions. These banks also had significant multi-lender swap activity, as well as some whole-loan cash deliveries.

But several sellers, mostly non-banks, both large and mid-sized, focused exclusively on the cash window.

Smaller sellers tend to utilize the cash window and the loans sold by them through this channel are pooled with those from other small lenders. The pooling process for cash window MBS is fully under the control of the GSEs, in effect, they are behaving like a whole loan conduit.

Prior to the great recession of 2007, this aggregation role was played by banks. However, as banks have exited the correspondent lending business because of rep and warranty risk, the punitive capital treatment of large servicing portfolios by Basel III and the general profitability of this business vs. other ways big banks can invest and utilize their capital, smaller sellers who once sold to these banks now go directly to the cash window.

Change in Strategy

On January 14, as part of an agreement between Treasury and FHFA to amend the PSPAs between Treasury and each of Fannie Mae and Freddie Mac to facilitate getting the GSEs out of conservatorship, part of the amendment limits volume purchased through the cash window to $1.5 billion per lender during any period comprising four calendar quarters.

This new limit on cash purchases is likely to affect many mortgage originators.

Freddie Mac recently said the cash restriction could “increase our counterparty risk and operationally impact our customers by requiring them to seek additional sources of funding.” Per Inside Mortgage Finance, in 2020 there were 62 Freddie sellers with more than $1.5 billion in cash sales to the GSE involving generic UMBS pools.

The Fannie market is bigger, but also a little more difficult to decipher. Both GSEs identify multi-lender MBS in how they assign pool identifiers. Fannie has a cash-only label that totaled $326 billion in volume last year, about 27% of its UMBS issuance covered by this analysis. There were 34 sellers with over $1.5 billion in sales in this category.

But Fannie has a separate identifier for Majors transactions that includes both whole-loan cash and swaps in multi-lender pools. Majors totaled $655 billion, or 54% of Fannie’s most common UMBS issuance.

Including both categories, some 105 sellers delivered over $1.5 billion to Fannie last year.

What It Could Potentially Mean

The bottom line? This is potentially a big deal, particularly to non-bank and smaller originators who rely on the cash window for liquidity and certainty. Non-bank originators are not just constrained operationally through available capacity but also financially through warehouse line availability, i.e. if they had infinite operating capacity, they don’t have infinite warehouse availability and so the ability to convert loans to cash quickly is important.

Furthermore, following all the mortgage IPOs, the next shoe to drop will be the boards of these newly public companies asking the respective management teams how they intend to keep growing in a declining mortgage market that is shifting from being refinance heavy to purchase heavy. The obvious answer is it will lead to more mortgage M&A activity as it will be almost impossible for these companies to grow organically at the necessary velocity.

Given this M&A activity, access to liquidity is going to be extremely important, and if the industry does consolidate, it means there will be fewer players originating more of the overall market, meaning a cash window cap of $1.5 billion per originator is not going to go very far.

The Flagstar Advantage

Here at Flagstar, we have been in the third-party origination business for more than 30 years, and when other bigger banks exited, we never waivered and maintained our commitment to the correspondent and broker businesses. We’re also the third-largest warehouse lender in the country and so can help both from a funding and loan purchase point of view. Given the cap on the cash window starting in January 2022, we believe we’re well positioned to fill any voids created through our third-party origination and warehouse lending businesses. Our commitment to great service and being a great partner is unparalleled and if you would like to learn more feel free to email me at: [email protected]

Sources:

• Inside Mortgage Finance - February 12, 2021