In December 2016, FHLBank Topeka realigned the Credit Enhancement (CE) model associated with the Mortgage Partnership Finance® Program. This realignment was designed to lower the risk accumulated by members selling under the MPF Program to better reflect the actual losses experienced over the Program’s history as well as potential losses in adverse scenarios.
Model realignment has benefited many of our members, reducing their overall exposure in the Program and thus, minimizing the impact to their risk-based capital. The changes to the risk model suggest institutions should re-evaluate their criteria for identifying the loans they sell under the MPF Program.
Prior to the realignment, loans were credit enhanced to a AA credit rating with an average risk score for loans sold under the Program of 5.79%, meaning members were accepting this amount of credit risk on each loan delivered. Since realignment, loans are being credit enhanced to a BBB credit rating, which has lowered the risk score to 2.83% (a 51% reduction in risk across the board). Average risk on purchase activity was previously 8.3% and is now only 3.65%, a 56% reduction in the risk associated with these loans. The corresponding reduction in risk for cash-out and rate-term refinances sold under the
program also reduced by 50%, a similar amount.
For institutions that have created their own parameters for what they sell under the MPF Program, the numbers suggest they should revisit their guidelines.
In the first table below, purchase loan activity since the model alignment is below the blue line, but reductions in risk percentages are shown across the board. It’s also important to note that other mortgage investors assess loan level price adjustments (LLPAs) based on the loan-to-value (LTV) and FICO score tied to the loans you originate and sell. Because the MPF Program doesn’t assess LLPAs, you could sell more volume under the MPF Program and receive larger gains without taking on large amounts of risk.
As an example, the CE percentage on purchase mortgages with LTVs up to 85% and FICO scores above 660 stays below 4%. The MPF Program offers a significant price advantage on these loans because other investors assess an LLPA of up to 2.75% based on these characteristics. As a result, if you previously excluded loans with mortgage insurance coverage from your MPF loan sales, you may want to reconsider. Similarly, borrowers with FICO scores 701 or better receive risk scores below 5% with an LTV up to 90%. When you take into account the normal LLPA for this loan, which would be at least 1%, the MPF Program creates another strong execution advantage.
Looking at a cash-out refinance, we can really demonstrate the execution advantage the MPF Program provides, in relation to the risk assessed.
An 80% LTV loan with a 661 FICO score results in a CE percentage of under 5%. The standard LLPAs assessed on this loan scenario would total 4.63%. This means you could generate over 4% in additional execution delivering this loan under the MPF Program while taking on a reasonable contingent liability amount through the CE Obligation.
Let’s say you would implement a minimum credit score of 700 for cash-out refinances at your institution (see second table at left). At that level, with the 80% LTV, the CE percentage averages just over 4% while the total LLPAs would be 2.375%. This means you have the ability to make roughly 2% more in execution with the MPF Program while taking on minimal CE Obligation.
The significant reductions in the risk held by our members, while not influencing the execution, have created numerous scenarios where the income benefits are strong and maintain reasonable risk allocations.
If your institution is identifying the loans you sell under the MPF Program based on credit characteristics determined prior to the model change, you should consider using lower FICO and higher LTV thresholds based on the new model requirements.