What do CRT and G-fees have in common other than being strange acronyms? Well, one can give us significant insight into the other.
Credit risk transfer (CRT) tells us that Freddie Mac’s Single-Family guarantee fees, or G-fees, are in line with what the private market would charge for the mortgage credit risk we take, although to a lesser extent for higher-risk loans. Moreover, CRT indicates that our G-fees are more stable than private-sector pricing.
The appropriate level of fees is an important issue to the housing-finance policy community. Using CRT to calculate a market-implied guarantee fee, or the market price of mortgage credit risk, provides information about what the private capital markets would charge for operating a credit guarantee business such as Freddie Mac’s and offers a key benchmark to policy discussions.
So let me tackle G-fees first. Freddie Mac retains a fee from the payments received on mortgages sold to us by banks and other sellers, commonly referred to as a G-fee. In return, we guarantee payment of principal and interest on the pass-through securities that we issue to our customers, or Gold PCs. We do so to protect taxpayers from potential losses and to help provide liquidity and stability to the mortgage market.
The G-fee essentially covers the cost of providing the credit guarantee – both the non-credit costs, such as administrative costs, and credit costs, which are the expected costs plus the cost of unexpected losses.
These are costs we would expect to incur if we retained all the credit risk on the loans in our mortgage securities, but for the last four years we have been transferring a significant portion of credit risk to the private market through our Single-Family CRT program. CRT is fundamentally changing how the U.S. residential mortgage market is funded. To date, we’ve transferred a portion of risk on more than $760 billion in residential mortgages. Because of our work in CRT, we have gained valuable insight into the G-fees that Freddie Mac retains.
Based on the cost of Freddie Mac Structured Agency Credit Risk (STACR®) transactions over the past year, we can calculate the market-implied G-fee for the lower range of what the private sector would pay to operate a credit guarantee business such as ours. This is calculated in much the same way as our G-fees are. The non-credit costs of CRT are about 20 basis points (bps) – those are more or less fixed. As with our G-fees, the biggest cost of the market-implied G-fee is the credit-cost component, especially for riskier loans. Let me point out that this calculation assumes that Freddie Mac sells 100 percent of STACR notes so we can capture 100 percent of the risk (although we traditionally retain a portion of this risk) and is based on the current volumes of CRT.
In 2016, the lower range of a market-implied G-fee was 53 bps for our medium-risk, 60-80 percent loan-to-value (LTV) STACR transactions. For our higher-risk STACR transactions of more than 80 percent LTV, it was 62 bps. In comparison, last year Freddie Mac’s average G-fee on newly acquired loans was 55 bps.
CRT tells us that our actual G-fees on newly acquired loans in 2016 were in line with the estimate of what the private market would charge for medium-risk loans (between 60-80 percent LTV), although to a lesser extent than what the private market would charge for higher-risk loans that still fall within our guidelines (more than 80 percent LTV). In addition, the market-implied G-fee shows that Freddie Mac’s G-fees are more stable than private-sector pricing would likely be – validating conventional wisdom on the issue. While private investors adjust their return requirements and move to other traded instruments in different markets, we, as a monoline government-sponsored enterprise (GSE), continuously fulfill our singular mission to support the mortgage market.
CRT is not only shifting risk away from taxpayers and creating new asset classes for investors, it is a key benchmark for policy discussions by providing information about what the private capital markets would charge for absorbing the credit risk generated by the credit guarantee business of a GSE.