How the MPF® Program Works
Taken from the MPF Website
A key insight of the MPF Program is to view a fixed-rate mortgage as a bundle of risks which can be split into its component parts. Each risk can be assigned to the institution which is best situated to manage it. For example, experience has demonstrated that local lenders know their customers better than any agency based in Washington, D.C. The MPF Program recognizes this fact to assign the mortgage lender the primary responsibility for managing the credit risk (the risk that the homebuyer will be unable to repay the loan) of the loans it originates. Similarly, the local lender is better situated to handle all functions involving the customer relationship, which it does under the MPF Program.
By contrast, the Federal Home Loan Banks are responsible in an MPF transaction for managing the interest rate risk, prepayment risk and liquidity risk of the fixed-rate mortgages because of their expertise at properly hedging such interest rate risks and their ability as a GSE to raise low-cost, long-term funds in the global capital markets. The FHLB provides the funding for MPF loans (the liquidity risk) and manages their interest rate and prepayment risks of the loans held in their portfolio.
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Allocation of Risks
Credit Enhancement
- The credit risks of MPF loans are managed by structuring possible losses into several layers. As is customary for conventional mortgage loans sold to Fannie Mae or Freddie Mac, private mortgage insurance (PMI) is required for MPF loans with downpayments of less than 20% of the original purchase price. Losses beyond the PMI layer are absorbed by a "first loss" account established by the FHLB. If "second losses" beyond this layer are incurred, they are absorbed through a credit enhancement provided by the participating member. The credit enhancement layer ensures that the lender retains a credit stake in the loans it originates. For managing this risk, participating lenders receive monthly "credit enhancement fees" from the FHLB. The size of each lender's credit enhancement is calculated so that any losses in excess of the second layer are equivalent to those of an investor in a "AA"-rated security. In other words, the FHLB has a very remote probability of any such loss and a very high quality mortgage asset.
MPF Program Flow Chart
Two Methods: Flow or Closed Loans
- Mortgage lenders can take advantage of the MPF Program either by originating loans on a "flow" basis or by selling loans to the FHLB which have previously closed. In both cases, the partnership created by the MPF Program to jointly manage the risks of mortgage loans remains the same. A variety of MPF products have been developed to meet the unique and different needs of FHLB members, but they all premised on the same risk-sharing concept.
- For MPF loans created on a flow basis, the participating lender handles all marketing functions as agent for the Home Loan Bank, for which it is paid agent fees in addition to normal origination fees. Prior to the mortgage closing, the loan characteristics are evaluated by the MPF software to determine the amount of credit enhancement each loan would require.
- If the lender decides to originate the loan through the MPF Program, the loan closes in the member's name. However, the FHLB provides the funding for the closing and legally owns the loan from the first moment it is created. The loan is never on the balance sheet of the participating lender. This results in all of the interest rate and prepayment risks being held by the FHLB. After closing, the member continues to service the loans and handles all subsequent contacts with the homebuyer. The servicing fees members receive under the MPF Program are the same as those paid by Fannie Mae and Freddie Mac.
- Alternatively, mortgage loans which have already closed and then sold to the FHLB through the MPF Program are executed in a similar manner to secondary market sales to Fannie Mae or Freddie Mac. However, as mentioned earlier, a key distinction is that the lender does not pay annual guarantee fees to the FHLB, as it does to Fannie or Freddie. Instead, it receives credit enhancement fees for continuing to manage the credit risk of the loans. As with flow loans, standard servicing fees are paid to servicers of MPF loans.
- Lenders using the MPF Program also retain more control than in secondary market sales. They are free to use whichever underwriting system they choose - Fannie Mae's, Freddie Mac's or their own. While MPF loans generally conform to agency criteria, each loan is created or sold only if the lender is willing to manage the credit risk of that loan. The MPF software analyzes the risk characteristics of each loan and determines the amount of credit enhancement required, but the decision whether or not to deliver the loan into the Program is made only by the lender. Lenders are free to make every loan which they believe should be made.
Risk Based Capital
- In general, regulatory capital rules for mortgage lending tend to encourage lenders to sell their loans into the secondary market. The rules require a certain amount of capital to be held in reserve against the loans. By selling mortgages to Fannie Mae or Freddie Mac, then buying back those same mortgages in securitized form, however, lenders can more than halve the amount of risk-based capital they must hold.
- For lenders concerned about the risk-based capital treatment of their mortgages, the MPF Program has a product -- MPF 100 - which permits lenders to receive an appropriate capital treatment for MPF flow loans. A joint ruling of the four Federal banking regulatory agencies (the Federal Reserve Board, FDIC, OCC, and OTS) has determined that MPF lenders which create loans on a flow basis must hold risk-based capital against the amount of their credit enhancement rather than against the full amount of the loan.
- For example, a lender originating a $100,000 mortgage and holding it in portfolio is required to hold 4%, or $4,000, of risk-based capital. By contrast, a lender creating the same mortgage using the MPF 100 product is required to hold 8% risk-based capital against the amount of the mortgage's credit enhancement, typically 2% to 3% of the face value. Thus, rather than holding $4,000, the lender is required to hold risk-based capital of $160 to $240 (8% of $2,000 to $3,000). This ruling ensures lenders are required to hold capital in proportion to the amount of credit risk they bear in MPF transactions. It makes MPF lenders more competitive by reducing the capital pressure lenders face to sell their loans to the secondary market.
Dispersion of Credit Risk
- As previously discussed, when Fannie Mae and Freddie Mac purchase mortgages, they assume all the risks of those loans, including the credit risk. According to their regulator, the Office of Federal Housing Enterprise Oversight, the two entities now manage the credit risk of more than $2 trillion of residential mortgages, or roughly 1.5 times the residential mortgage credit risk managed by the entire bank and thrift industries combined. As the amount of their obligations continue to climb each year, the nation's mortgage credit risk becomes increasingly concentrated in these two entities. Should either entity ever fail, the American taxpayers ultimately might bear the costs.
- The MPF Program reduces this likelihood. It counters this trend by dispersing the credit risk of its loans among hundreds of community-based lenders throughout the country, thereby adding to the nation's overall economic stability.
Advantages of the MPF Program
- The MPF Program:
- Adds much-needed competition and balance to the secondary mortgage market. Local mortgage lenders and American homebuyers benefit as a result. Increased competition creates a more level playing field.
- Is more a profitable and efficient alternative for lenders than selling mortgages to a secondary market agency. Instead of paying costly guarantee fees, lenders participating in the MPF Program receive monthly credit enhancement fees for managing the credit risk of the loans they create.
- Combines the respective strength of the Federal Home Loan Banks and their financial institution members. Each partner is responsible for what it does best.
- Allows lenders to retain their customer relationships. Rather than selling their credit relationships to a secondary market agency, the MPF Program allows lenders to continue handling all aspects of their customer relationships.
- Lets lenders control the underwriting process. Every MPF loan is made only if the lender decides to share the credit risk of their own customer.
- Ensures mortgage lenders receive an appropriate risk-based capital treatment on the MPF loans they create on a flow basis.
- Disperses credit risk among hundreds of community-based lenders throughout the country rather than concentrating the risks in two secondary market enterprises.
- Adds value to FHLB member institutions by fulfilling the housing finance mission of the Home Loan Banks.
- Is 100% consistent with the mission of the Federal Home Loan Banks to promote economical housing finance. Every dollar of an MPF mortgage directly helps an American family purchase a new home or lower the cost of their existing home.
- By strengthening the mortgage finance system, the Mortgage Partnership Finance Program is a better deal for FHLB member financial institutions, their homebuying customers and American taxpayers.