Credit risk transfer (CRT) or sharing is the process in which the government-sponsored enterprises bundle up the mortgages they buy from lenders and sell a portion of the risk to private investors. Instead of the GSEs shouldering the loan risk alone, selected investors help offset any potential risk from loan defaults. CRT began as a test in 2012 and is now quickly ramping up as investor interest and governmental oversight grows. Governmental oversight makes sense—we don’t want another 2007. But why are more investors becoming so interested in CRT?
Mortgage activity approached $2 trillion in 2016. Long-term, housing is the single biggest wealth builder in America. Treated like a 401K, it is a stable growth engine, and mortgage loans are relatively low risk. Mortgage pools—where thousands of loans are combined—help offset individual loan issues and the “G-fees,” which all lenders must pay when they sell loans to the GSEs, help to even further offset the risk. Mortgage pools’ low risk and steady growth have attracted hundreds of investors. Investors get solid returns, and taxpayers benefit from the security that, if mass loan defaults occur, they won’t get hit with the bill (at least not all of it).
Introducing the Front-end Risk Transfer
CRT typically refers to “back-end” risk transfer where investors take on risk after the loan is sold. “Front-end” risk transfer per the Federal Housing Finance Agency (FHFA) is “risk transfer [that] occurs prior to, or simultaneous with, the acquisition of residential mortgage loans by an Enterprise.” In plain English, it is how you reduce risk when a loan is created before it can pollute the water downstream.
“Front-end risk transfer” is the biggest area of change currently. To further help explore ideas in this area, the FHFA initiated a Request for Information (RFI) in 2016 with the goal to “Transfer a meaningful portion of credit risk on at least 90 percent of the unpaid…