“I said I thought Fannie and Freddie’s attempts to transfer some mortgage guarantee credit risk to the private sector, were probably not in their financial interest (and ours, as the U.S. is still their conservators), but I didn’t have any facts,…
…beyond economic theory and my business acumen, to back that up. Now I have some. PennyMac Mortgage Investment Trust (NYSE:PMT) filed its Q32015 10-Q and an earnings report power point presentation with the S.E.C. on November 4, 2015. In the power point presentation on page 8, they say they expect their Credit Risk Transfer Transactions (CRT) with the GSEs to have Targeted Unlevered Yields (after expected credit losses) of 6% to 7.5% (11% to 14% levered at about 1.6 to 1). A conforming 30-year mortgage is currently about 4%, so investors taking on no credit risk in traditional Fannie/Freddie 30-year MBS would earn about 3.5% today. So, PennyMac expects to earn 71% to 114% more (after-credit losses), for taking on a layer of theoretical credit risk on some of the mortgages they sell to Fannie Mae. I am not sure how the credit risk is structured on the particular PennyMac CRT’s with Fannie Mae (I couldn’t find any disclosure), but from what I read about CRT, Fannie Mae generally takes a first loss position of 0.50% and it looks like PennyMac is taking on the next layer of about 3.375% to 3.67% and PMT says plainly their investment is the limit of their risk. Step back for a minute and think about this. As I recall, in normal times of stable-to-rising home prices, Fannie Mae and Freddie Mac don’t generally suffer even 0.50% in lifetime losses on their MBS guarantees. And that’s the environment we have now, but given how close we are to the recent once-or-twice-in-a-century crisis, I believe the private sector is still factoring in (in their financial models) another occurring during their investment period. A crisis like 2008 is extremely unlikely to occur in the next ten years. So why in the world would Fannie and Freddie want to lay off a credit-risk tranche to the private sector right now and at such high (after expected credit loss) private sector yields? It looks to me like Fannie Mae is giving up a material portion of their guarantee fee income, to purchase a mostly “form-over-substance” re-insurance collar from the private sector. Fannie Mae takes 100% of the first 0.50% of pool losses. My rough guess is that means Fannie takes 100% of all losses in say 19 out of 20 years or so. The private sector takes 100% of the next 3.5% or so of credit losses. My rough guess is that would occur 1 out of 20 years or so and would come nowhere close to wiping out this 3.5% tranche. And Fannie Mae still would be on the hook for 100% of any catastrophic credit losses (the once or twice in a century Great Recession or Great Depression) above 4% or so in pool losses. Post-crisis, isn’t the only reason the private sector is willing to invest in these credit risk bonds is that Fannie is giving up too much of the economics to purchase re-insurance, because the government (as a result of Dodd Frank) told them they had to do it now? I’m still not 100% sure about this, because the disclosures from firms like PMT and Fannie Mae don’t provide me enough to be that certain, but I know I should be right economically and logically and mathematically, based on actual PMT CRT transactions with Fannie Mae, I am now pretty certain I am right. P.S. I also don’t understand how you can sell the loan and credit risk and then re-invest in some of the credit risk and still get “sale” accounting treatment? I thought those types of transactions, especially post-financial crisis, were verboten? Maybe it’s because PMT’s accountants and auditors know that Fannie Mae still retains the real credit risk? Please Note: I mostly refer to Fannie Mae, because that’s who PennyMac transacted CRT’s with, but the same logic likely applies to Freddie Mac’s CRT’s.”, Mike Perry, former Chairman and CEO, IndyMac Bank
“Excerpt from PennyMac Mortgage Investment Trust 3Q15 10-Q filed with the S.E.C. and available at www.sec@gov:
Credit Risk Transfer (“CRT”) Transactions
The Company, through its wholly-owned subsidiary, PennyMac Corp. (“PMC”), entered into CRT arrangements with Fannie Mae, pursuant to which PMC, through subsidiary trust entities, may sell pools of mortgage loans into Fannie Mae-guaranteed securitizations while retaining a portion of the credit risk underlying such mortgage loans (the “CRT Agreements”).
Transfers of mortgage loans subject to CRT Agreements receive sale accounting treatment upon fulfillment of the criteria for sale recognition contained in the Transfers and Servicing topic of the FASB’s ASC.
The Company retains a portion of the credit risk underlying such mortgage loans by issuing a credit guarantee to Fannie Mae in exchange for a portion of the guarantee fee normally charged by Fannie Mae for mortgage loan securitizations that it guarantees. The mortgage loans subject to the CRT Agreements are transferred by PMC to subsidiary trust entities which sell the mortgage loans into Fannie Mae mortgage loan securitizations and issue the credit guarantees to Fannie Mae.
The Manager has concluded that the Company’s subsidiary trust entities are VIEs. The Manager concluded that the Company is the primary beneficiary of the VIEs as it is the holder of the primary beneficial interests which absorb the variability of the trusts’ results of operations. Consolidation of the VIEs results in the inclusion on the Company’s consolidated balance sheet of the credit guarantees, including the cash pledged to fulfill the guarantee obligation, on the Company’s consolidated balance sheet in the form of a net derivative and the restricted cash deposited to secure the guarantee obligation. The restricted cash represents the Company’s maximum contractual exposure to claims under its credit guarantee and is the sole source of settlement of losses under the CRT Agreements. Gains and losses on net derivatives related to CRT Agreements are included in net gain on investments in the consolidated statements of income.
Following is a summary of the CRT Agreements:
|Quarter ended||Nine months ended|
|September 30, 2015 (in thousands)||September 30, 2015|
|During the period:|
|UPB of mortgage loans transferred and sold under CRT Agreements||$1,660,280||$2,400,433|
|Restricted cash deposited to fund guarantees||$59,841||$87,891|
|Gains recognized on net derivatives related to CRT Agreements|
|Resulting from valuation changes||626||626|
|Payments made to settle losses||$-||$-|
|At period end:|
|UPB of mortgage loans subject to guarantee obligation||$2,400,433|
|Current-89 days delinquent||$2,400,433|
|90 or more days delinquent||–|
|Carrying value of CRT Agreements:|
|Restricted cash included in Other assets||$87,891|
|Net derivative assets included in Derivative assets||626|