Although it may seem like all-calm on the housing-finance front, Treasury’s effort to revitalize the PLS market has sent shock waves through every sector in the financial-services industry engaged in residential-mortgage origination, securitization, and credit enhancement.  The latter industry is, in the view of Federal Financial Analytics, perhaps the one with the most at stake in this new effort.  If RMBS stay as is, high loan-to-value (HLTV) mortgages will go to the GSEs – ensuring a role for private mortgage insurance – and to the FHA, which will take renewed share if efforts to drop its premiums take hold under the new HUD Secretary.  If reform under current law advances as Treasury hopes, then recent FHFA and GSE efforts to construct new risk-share structures will take even greater hold and create new offerings that will change the landscape of mortgage credit enhancement.

As we assess current risk-share structures and their strategic impact, we see significant obstacles to large banks. First-loss tranches along lines included in the Johnson-Crapo bill and discussed by Treasury are subject to punitive bank regulatory-capital requirements.  Not so for insurance companies or reinsurers backing them up.  We have thus assessed the most recent GSE risk-share transaction in which Freddie Mac handed off risk positions in a $33 billion mortgage book to a group of U.S. and international insurance and reinsurance companies.  Collateral requirements are used in lieu of capital, and the tranche of risk shared – $285 million – is well below the $3.3 billion a ten percent first-loss tranche would have to take.  However, we think it an important precursor to more GSE risk-shares and possible Treasury-blessed RMBS structures.

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