FHFA Issues Proposed Rule on GSE Capital Requirements

The Federal Housing Finance Agency yesterday issued a proposed rule on capital requirements for Fannie Mae and Freddie Mac, which would implement a new framework for risk-based capital requirements and a revised minimum leverage capital requirement for the government-sponsored enterprises.

The proposal (https://www.fhfa.gov/SupervisionRegulation/Rules/Pages/Enterprise-Capital-Requirements.aspx) marks the first major restructuring of the GSEs’ capital requirements since Fannie Mae and Freddie Mac went into receivership in 2008. At that time, FHFA suspended the GSEs’ regulatory capital requirements.

FHFA Director Mel Watt said while the capital requirements in this rule would also be suspended while the Enterprises remain in conservatorship, it is “appropriate to communicate the Agency’s views as a financial regulator about capital adequacy” and to allow market participants and all stakeholders to comment on the proposed capital requirements.

“We think it is important for FHFA, as the prudential regulator for Fannie Mae and Freddie Mac, to articulate our views on capital requirements and to start a healthy discussion about the amount of capital the Enterprises should have to appropriately shield taxpayers from assistance,” Watt said. “In addition, feedback on this proposed rule will inform FHFA’s views as conservator in making possible refinements to our assumptions about capital as we evaluate the Enterprises’ business decisions during conservatorship.”

Under the proposed rule, FHFA offered a regulatory capital framework for the Enterprises that would implement two components: a new framework for risk-based capital requirements and a revised minimum leverage capital requirement specified as a percentage of total assets and off-balance sheet guarantees. The proposed rule uses concepts from the Basel framework with “appropriate modifications” for the Enterprises.

The framework “recognizes that the Enterprises are monoline businesses with assets and guarantees heavily concentrated in residential mortgages with risk profiles that differ from large diversified banks,” FHFA said. “In order to fulfill their charter responsibilities of providing stability to the secondary mortgage market, the Enterprises must remain as functioning entities both during and after a period of severe financial stress.”

To achieve this objective, the proposed risk-based capital framework targets a risk-invariant minimum capital level after surviving a stress event, referred to as the going-concern buffer that would address the key exposures by explicitly covering credit risk, including counterparty risk, as well as market risk and operational risk. The proposed framework would define the requirements by risk factor for each key group of the Enterprises’ assets and guarantees.

FHFA also seeks to ensure that the two sets of requirements complement one another. For the risk-based capital requirements, FHFA is proposing a framework that provides a detailed assessment of the Enterprises’ risk of incurring unexpected losses. Instead of applying the Basel standardized approach of a 50 percent risk weight for all mortgage assets regardless of different product features or terms, FHFA’s proposed risk-based capital requirements would use a series of approaches, which include base grids, risk multipliers, assessments of counterparty risk and capital relief due to credit risk transfer transactions, to produce tailored capital requirements for mortgage loans, guarantees, and securities. These asset-specific capital requirements would then be applied across each Enterprise’s book of business to produce total risk-based capital requirements.

FHFA also proposed two alternative minimum leverage capital requirements. Each of these alternatives would update the existing minimum leverage requirements established by statute for the Enterprises. Under the first alternative, the “2.5 percent alternative,” the Enterprises would be required to hold capital equal to 2.5 percent of total assets (as determined in accordance with generally accepted accounting principles (GAAP)) and off-balance sheet guarantees related to securitization activities, regardless of the risk characteristics of the assets and guarantees or how they are held on the Enterprises’ balance sheets. Under the second alternative, the “bifurcated alternative,” the Enterprises would be required to hold capital equal to 1.5 percent of trust assets and 4 percent of non-trust assets, where trust assets are defined as Fannie Mae mortgage-backed securities or Freddie Mac participation certificates held by third parties and off-balance sheet guarantees related to securitization activities, and non-trust assets are defined as total assets as determined in accordance with GAAP plus off-balance sheet guarantees related to securitization activities minus trust assets. The Enterprises’ retained portfolios would be included in non-trust assets.

The proposed rule is open for comment for a 60-day period following publication in the Federal Register.