An Era of Transformation

The depth and impact of the 2007-08 financial crisis, rooted in residential finance, have been apparent for some time. There has never been doubt that its aftermath would transform the way mortgage lending operates in the United States.

Though some aspects of the transformation are far from clear even now – most notably how housing finance will be restructured statutorily – one has crystalized: the retreat of commercial banks from home lending and servicing. This was not a pre-ordained event; at the height of the crisis, it would have been reasonable to envision a future state in which mortgage lending was regulated in such a way that it would become even more exclusively the province of traditional banking institutions. But this is not what has developed. Instead, banks have weighed the costs and benefits of these business lines and concluded that less exposure is the more prudent course.

Originally published in The Government National Mortgage Association on September 23, 2014.

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Using monthly principal and interest advances as collateral presents particular challenges un-
der the Ginnie Mae program, relative to the GSEs. Under the Ginnie Mae model, loan level
credit risk is separate from counterparty failure risk. Under the GSE model, the GSEs are li-
able for reimbursing advances as the master servicer. Hence, the creation of a separation of
advance reimbursement from the responsibility to service the MSR is of comparatively little
Under the Ginnie Mae model, the organization acts as a third party loan guarantor responsible
for paying the reimbursement. In the case of an issuer default in which ownership of the MSR
asset changes hands, the possibility of advance reimbursement being transferred to an entity
other than the new servicer is of significant consequence and could inhibit the marketability of
the MSRs and/or increase Ginnie Mae losses. For this reason, advances on government-insured
mortgages are not currently accepted as eligible collateral for financing in the marketplace
(advances cannot be separated as collateral from the MSR itself).
Ginnie Mae also interprets “market liquidity” as a market that will permit the ownership of
Ginnie Mae MSRs to change hands. Ginnie Mae’s mission to attract global capital into the U.S.
housing markets could be thwarted if there were an insufficient supply of institutions ready
and willing to service the securities and underlying loans Ginnie Mae guarantees. Perceived
difficulty associated with the transfer of servicing responsibilities to other entities should fu-
ture conditions change could make institutions less willing to invest in these assets. Moreover,
as noted, Ginnie Mae has far fewer resources to apply to, and less control over, the servicing of
pools and loans as compared to the GSEs, rendering it more reliant on the existence of a deep
pool of qualified servicers.
Market liquidity is at the forefront of this transformation. Large actors – both bank and non-
bank – are not reducing their footprint merely through adjusting levels of origination via ser-
vicing portfolio run-off. Rather, they are opting for accelerated reallocations in the form of MSR
transfers. The dramatic increase in Ginnie Mae MSR transactions, as shown in the chart below,
illustrates the trend:
Ginnie Mae’s approval rights over the transfer of the MSRs of the securities it guarantees and
its guarantor function make the acquiring servicer’s ability to fulfill its obligations under the
MBS program critically important. Decisions to decline a transfer are likely the result of con-
cern that the proposed transaction presented the possibility of undue risk of losses, which
could inure to Ginnie Mae in the event of a future default by an issuer.
This counterparty risk decision, though, is made amidst the backdrop of a larger concern for
the maintenance of a liquid market for MSRs – a state of affairs that has great value to Ginnie
Mae. This stems from the point made above: Ginnie Mae’s mission, achieved through global
sales of the securities it guarantees, depends upon a sufficient appetite for investing in MSRs.
The perception of MSR illiquidity would dampen this demand, to the potential detriment of
housing finance as a whole. Ginnie Mae’s actions with respect to servicing transfers are there-
fore mindful of both counterparty risk at the micro level and market liquidity at the macro level.
Notably, the existing structure of the Ginnie Mae program itself impedes market liquidity in
that it is denominated strictly in terms of pools of loans. Ginnie Mae issuers may wish to trans-
fer servicing of specific loans within a pool are unable to do so today. Upgrading systems to
provide for loan level servicing and bond administration is an important strategic initiative for
Ginnie Mae.
With regards to liquidity concerns MSR strips, the segmentation of cash flows into narrower
streams that can be owned by investors completely removed from the operational aspects of
producing them. Such streams may be established through private market arrangements or
take the form of tradable securities. A plausible future may involve increasing levels of eco-
nomic ownership of MSRs by passive investors.
FY2011 FY2012 FY2013 FY2014YTD*
*YTD = as of July 2014Y; Fiscal Year = Oct.-Sept.
Ginnie Mae is generally supportive of developments such as these that make way for additional
liquidity into the business of servicing mortgage loans. These cash flow instruments depend on
the identification of one stream of cash flow to compensate for the operations of servicing, and
another stream to remain available for passive investors. Ginnie Mae remains focused on en-
suring that any of its counterparty entities will have the adequate capacity to make all required
pass-through payments to security holders, even with a portion of the MSR cash flows being
diverted to other parties.
Accordingly, Ginnie Mae will consider MSR strip arrangements, though it has not yet committed
to develop a securitized product. The development of loan level servicing capability is a higher
priority initiative.
Ginnie Mae must consider, as one implication of the transition to a markedly larger universe of
active Ginnie Mae non-bank issuers, an increase in instances of issuer failures. In charting its
strategic direction for the foreseeable period ahead, Ginnie Mae has given consideration to the
posture it will take toward issuer infractions under the program, including the grave issue of
addressing issuers that prove unfit for participation or demonstrate outright failure. As future
market conditions and participants are likely to differ from the recent past’s, Ginnie Mae has
begun to adapt its approach to issuer non-compliance.
As stated in earlier passages, the narrowly-defined nature of Ginnie Mae’s responsibility is a
driver of its perspective on this subject. Ginnie Mae’s primary function is to administer a gov-
ernment guaranty. In the context of this paper’s focus on the changing face of the residential
finance industry, the most serious threat to this function would be a spate of issuer failures suf-
STRATEGIC VIEW IV. Much of Ginnie Mae’s strategic efforts over the near future will be
directed at providing for market liquidity:
• Enhanced standards for issuer liquidity and increased attention to MSR valuations and
• Continued provision of liquidity through the recognition of MSRs as collateral (via the
Acknowledgment Agreement).
• Recognition of the importance of entities that finance servicing activities and incorpo-
ration of that role into the standards and procedures that govern the execution of the
MBS program.
• Continued exploration of how advance financing can be provided for in the realm of
government-insured loan servicing.
• Development of the ability to support loan level servicing, so that Ginnie Mae issuers
are no longer constrained by the need to service or transfer an entire pool.
• Attention to the development of MSRs as an alternative asset class, divorced from
servicing operations, and consideration of program modifications that might appro-
priately support this trend
ficient to introduce doubt surrounding the long-term rationale for and soundness of the MBS
program (such as have become a normal part of the conversation where the GSEs and even
the Federal Housing Administration are concerned).
At the same time, this narrowly-defined responsibility has the advantage of making it possible
to describe with succinctness what is most essential on the part of issuers: they must report
accurate and timely data about their securitized pools, and manage and pass-through funds
on behalf of security holders. Ginnie Mae securities represent an obligation of the U.S. govern-
ment to security-holders that must be met absolutely without fail. Tolerance of issuer failures
to meet these essential requirements – particularly in a climate of increasing numbers of new
issuers, many of them small with limited capitalization – could lead to a “slippery slope” in
which incidences of non-compliance strain Ginnie Mae’s ability to manage its risk.
The ultimate failure, of course, is the inability of an issuer to pass through payments to securi-
ty-holders or to otherwise demonstrate a lack of compliance so significant to render it unfit to
maintain its nominal ownership of the MSRs. Historically, such failures have resulted in Ginnie
Mae’s declaration of a default, with the accompanying extinguishment of an issuer’s rights to
the MSRs and termination of approval status. In such cases, the MSRs become government
property and are serviced on behalf of Ginnie Mae by a third party subservicer.
The long aftermath of the 2009 failure of Taylor, Bean & Whitaker (which resulted in the con-
fiscation of a $25 billion government MSR portfolio by Ginnie Mae) has demonstrated the
inherent difficulties of making a small government agency designed to administer a security
guaranty program also an asset manager, particularly when the need to enter into and perform
asset management functions is almost completely unpredictable in terms of timing and scale.
Mindful of these inherent difficulties, while also mindful of the future possibility of the failure of
similarly large or even larger institutions, Ginnie Mae’s strategic direction will be toward foster-
ing the maximum possible potential for MSRs from failed institutions to be absorbed by other
private market firms, without requiring administration by the government.
STRATEGIC VIEW V. Because a spiraling series of compliance failures could pose a threat
to the continued viability of the MBS program, institutions that clearly demonstrate diffi-
culty complying with essential program terms will be deemed unacceptable risks and will
be removed from the MBS program.
In situations where issuer failure necessitates the transfer of MSRs elsewhere, Ginnie Mae’s
preferred course of action will be to place such MSR assets in the hands of a more suitable
Ginnie Mae-approved private sector owner, rather than to seize and manage them itself.
This strategic approach is another manifestation of Ginnie Mae’s need to focus on the mortgage
finance marketplace and the institutions that participate within it.
Ginnie Mae’s central challenge – adapting to changing circumstances, while preserving the in-
tegrity and strength of its MBS program – must be performed as a delicate balancing act in an
increasingly complex environment. As described herein, the organization’s particular makeup,
including its compact size, limited scope of operation and unique position as a guarantor only,
leads it toward a notably market-focused and private sector-oriented approach.
This paper lays out areas in which Ginnie Mae will be aggressive about changing its program
and infrastructure to meet the evolving needs of the market. It also points to areas where the
organization will be increasingly vigilant about upgrading standards and practices to meet the
challenges posed by today’s evolving market presents.
In this balancing act, Ginnie Mae’s overriding goal will be to protect and preserve the utility,
relevance and remarkably successful track record of the Ginnie Mae MBS program. The agency
has held a pioneering role in the creation of a securities market for mortgage loans, its ability
in the ensuing period to refine the MBS program as needed to maintain its currency and, espe-
cially, its maintenance of an unblemished record of profitable operation over four decades of
market change and disruption. This record of accomplishment is testament to the power of a
well-conceived and executed government effort to support the healthy functioning of a sizable
and critical private sector function.
550 12th Street, SW, Third Floor
Washington, DC 20024
(202) 708-1535

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