| Federal Housing Finance Board |
NEWS |
| For Immediate Release January 9, 1997 FHFB 97-01 |
Contact: Naomi Salus
202/408-2957 Bill Glavin 202/408-2546 |
FINANCE BOARD APPROVES PILOT ALTERNATIVE
FOR FINANCING HOME MORTGAGES
Washington, D.C.--The Federal Housing Finance Board today announced approval for the Federal Home Loan Bank of Chicago (FHLBank of Chicago) to conduct a pilot program with its members that offers a new alternative for financing home mortgages.
Under the Mortgage Partnership Finance Program (MPF), FHLBank of Chicago members will market and originate one-to-four family home mortgage loans and be responsible for all functions involving the customer relationship. The FHLBank of Chicago will fund and retain in portfolio the home mortgage loans originated, serviced and credit-enhanced by members.
"MPF channels funds into residential housing in a more sophisticated and targeted manner than regular advances. It's a new means of realizing the traditional housing finance mission of the FHLBanks," said FHFB Chairman Bruce A. Morrison in announcing the approval. "As an alternative to holding loans in portfolio or selling them in the secondary market, it offers FHLBank members a new competitive tool which should lower costs to homebuyers," Morrison said.
Under MPF:
"This means that each participant in the transaction contributes what it does best," said Alex Pollock, President of the FHLBank of Chicago. "MPF takes advantage of the strengths of each partner at the local level, where access to credit can be delivered flexibly and members have specialized knowledge about the credit quality of their borrowers," Pollock added.
Other provisions of MPF include:
A fact sheet on MPF is attached.
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Attachment
MORTGAGE PARTNERSHIP FINANCE
PILOT PROGRAM OF THE FEDERAL HOME LOAN BANK OF CHICAGO
Background
A financial institution making a single-family home mortgage loan in today's market has two choices:
1) It can hold the loan in portfolio; or
2) It can sell the loan in the secondary market.
Holding the loan in portfolio requires that the institution manage all of the risks involved in mortgage lending: on the customer relationship side, there are marketing, servicing and credit risks; on the funding side, there are liquidity, interest rate and options risks.
Financial institutions tend to pool loans they originate for sale into the secondary market. The originator in this case relinquishes control over what it does best (underwriting and managing credit risk) and pays a fee to the securitizer for performing these functions; at the same time, the originator retains risks it is less well-equipped to manage, such as the liquidity, interest rate and options risks associated with funding mortgage-backed securities.
As a result of this allocation of risks, capital requirements for a holder of loans in portfolio are higher than for a holder of MBS.
Mortgage Partnership Finance Pilot Program
The Federal Home Loan Bank of Chicago has received authority from the Federal Housing Finance Board to establish a pilot with its members, the Mortgage Partnership Finance Program (MPF), that constitutes a strategic alternative to holding loans in portfolio or selling them in the secondary market.
The Chicago pilot unbundles the risks associated with home mortgage lending and allocates them between the FHLBank of Chicago and its members in a manner that uses the cooperative structure of the FHLBank System to maximize their respective core competencies.
Under MPF:
*FHLBank of Chicago members will market and originate one-to-four family home mortgage loans, subject to guidelines agreed upon by the FHLBank and its members;
*All loans originated will be within the conforming loan limit applicable to the secondary market government sponsored enterprises (GSEs);
*Members would continue to be responsible for functions involving the customer relationship, including all aspects of mortgage marketing and origination.
*The FHLBank of Chicago would fund and retain in portfolio the home mortgage loans originated, serviced and credit-enhanced by its members.
Thus, rather than paying a guarantee fee to a secondary market securitizer, members would be compensated for managing the customer relationship and the credit risk, while the FHLBank would retain and be compensated for its expertise in managing the other risks of the loan -- liquidity, interest rate and options risks. In this way, the component risks involved in home mortgage lending would be optimally allocated.
In summary, under the Chicago proposal, funds would be channeled into residential housing finance in a manner functionally similar to, but technically more sophisticated and more targeted than when a FHLBank makes an advance to a member. For this reason, the Federal Housing Finance Board's Office of General Counsel has concluded that the Federal Home Loan Bank of Chicago is statutorily authorized to operate this program, with Finance Board approval, as an activity incidental to an express statutory authority.
Supervisory Considerations
MPF is designed to insulate the FHLBank from virtually all the credit risk associated with investing in home mortgage loans. First loss credit protection will be provided by a reserve established by the FHLBank of Chicago, to be funded by a share of the interest payments on MPF loans. The reserve will be established in an amount at least equal to the historical loss experience on the types of MPF loans originated by the members. (Based on historical data over the past five years, this first loss coverage is likely to range from two to five basis points of mortgage loan principal.)
In return for a fee, participating members will provide second loss credit enhancement at least equal to the level of subordination afforded double-A rated mortgage-backed securities, which will require them to hold risk-based capital equal to four percent of the amount of the credit enhancement. The FHLBank of Chicago will determine the amount of the required credit enhancement based on the characteristics of the mortgage loans and rating agency modeling methodology. A recent analysis has shown that over an eight year period, investors in mortgage loan pools rated double-A have had zero losses.
The program is limited initially to $750 million. All income, after operating expenses, will be retained by the FHLBank of Chicago and any other participating FHLBanks, with profits passed on to member financial institutions in the form of dividends.
Prior to program implementation, the Finance Board will undertake a supervisory review to ensure that appropriate monitoring and control policies and procedures are in place.
Benefits
*This cooperative venture should result in increased competition, efficiency and flexibility in the home mortgage loan market, which should lower costs to homebuyers.
*Participating members will be able to provide home mortgage loans to more customers on more flexible terms, while realizing fees for mortgage origination, credit enhancement and servicing.
*The program uses the unique cooperative characteristics of the Federal Home Loan Bank System to offer a housing finance alternative that maximizes the strengths of each participant at the local level, where access to credit can be delivered flexibly and in a customized way, and where members have specialized knowledge about the credit quality of their borrowers.
*Funding assistance will be available for mortgages which do not meet all secondary market requirements (except for the maximum loan limit).
*Member institutions, particularly community banks, will benefit from a tool which can make them more competitive in the marketplace.
*The FHLBank will continue to provide the capital market access that allows members to offer long-term housing finance in their communities, but in a more targeted manner.
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