FHFA Rule Requires GSEs to Align Policies to Facilitate Single Security

The Federal Housing Finance Agency (FHFA) earlier today released a final rule requiring the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac to align their policies and procedures that could impact the prepayment speeds of their mortgage-backed securities (MBS) in the to-be-announced (TBA) market. The purpose of the rule is to better facilitate the GSEs’ transition to using a common MBS.

The common security, known as the Uniform Mortgage-Backed Security (UMBS), will replace the GSEs’ current MBS and will be traded through a Common Securitization Platform (CSP) jointly owned and developed by both firms. The GSEs are expected to begin using and trading UMBS on the CSP June 3. As part of the transition, Freddie Mac has been utilizing the CSP since November 2016 to sell its current single-family MBS, known as Participation Certificates.

One of the goals of the UMBS and CSP is to increase liquidity in the market for GSE securities by eliminating the price disparities between Fannie Mae MBS and Freddie Mac Participation Certificates. Historically, Freddie Mac’s securities have sold at about a half-point discount to Fannie Mae securities. This is because the volume of Freddie Mac MBS traded is significantly smaller than the volume of Fannie Mae MBS and because the loans contained in Freddie Mac securities have higher prepayment rates than loans in Fannie Mae securities.

FHFA has long contended that, for the UMBS to be successful, investors must consider the securities issued by Fannie Mae and Freddie Mac to be interchangeable. Consequently, FHFA has worked to ensure Fannie Mae and Freddie Mac securities have prepayment rates that do not diverge by more than two percent for mortgages in the same cohort by directing them to adopt common policies.

The final rule officially codifies the requirement that the GSEs work to align those policies that impact the prepayment rates of mortgages in their securities, including product features. FHFA believes this will signal to the market its intention of ensuring the GSEs maintain consistent prepayment rates. Specifically, the proposed rule directs the GSEs to consult each other on any potential changes to their standards that could impact prepayment speeds and report to FHFA any time the prepayment speeds on their securities differ by more than two percent, or when prepayment speeds for loans in the fastest paying quartile of their securities differ by more than five percent.

The rule will take effect 60 days after it is published in the Federal Register, which is expected to be shortly.