How the MPF® Program Works
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 and assigns 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 of New York 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 FHLBNY 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
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 FHLBNY. 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 FHLBNY. 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 investment grade security. In other words, the FHLBNY has a very remote probability of any such loss and a very high quality mortgage asset.
MPF® Program Flow Chart
Mortgage lenders can take advantage of the MPF® Program by selling loans to the FHLBNY which have previously closed. The partnership created by the MPF® Program to jointly manage the risks of mortgage loans provides a variety of MPF products developed to meet the unique and different needs of FHLBNY members, but they are all premised on the same risk-sharing concept.
Mortgage loans which have already closed and then sold to the FHLBNY through the MPF® Program are executed in a similar manner to secondary market sales to Fannie Mae or Freddie Mac. However, a key distinction is that the lender does not pay annual guarantee fees to the FHLBNY, as it does to Fannie Mae or Freddie Mac. Instead, it receives credit enhancement fees for continuing to manage the credit risk of the loans. In addition, 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
Regulatory capital rules for mortgage lending require lenders who sell their loans using one of the MPF® products offered by the FHLBNY to hold risk based capital equal to the amount of the credit enhancement on mortgages sold.
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® products offered by the FHLBNY is required to hold risk-based capital equal to the amount of the mortgage’s credit enhancement, typically 3% to 4% of the face value. Thus, rather than holding $4,000 if the mortgage is held in portfolio, the lender is required to hold risk-based capital of $3,000 to $4,000 if the mortgage is sold using one of the MPF® products offered by the FHLBNY.
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. The recent history of Fannie Mae and Freddie Mac has taught us that concentration of credit risk has had disastrous results as the financial crisis has demonstrated.
The MPF® Program 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.
Allocation of Credit Losses/Steps to Recover
|Allocation of Credit Losses/Steps to Recover|
|Primary Loss Coverage||Mortgage Insurance|
|– First Tier Loss||FHLBNY First Loss Account (product specific)|
|– Second Tier Loss||PFI Credit Enhancement (CE)|
|– Third Tier Loss||FHLBNY Remaining Losses|