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Thursday, September 20, 2007

GSE Portfolio Caps

by Tanta on 9/20/2007 08:46:00 AM

OFHEO has issued authorization for Fannie Mae and Freddie Mac to increase their portfolio holdings, as most of us expected. The terms of the announcement have a number of people concerned, judging from my email traffic: are they up to some nefarious accounting here? My opinion, if you care about it, is it doesn't look like that to me.

The basic part:

With the ongoing concerns about the subprime mortgage market, both Fannie Mae and Freddie Mac have announced commitments to purchase tens of billions of dollars of subprime mortgages over the next several years. The portfolio cap flexibility plus their ongoing ability to securitize mortgages, sell assets, and replace maturing assets, will enhance each Enterprise’s ability to purchase or securitize, over the next six months up to $20 billion or more of subprime mortgages, refinanced mortgages for borrowers with lower credit scores, and affordable multi-family housing mortgages. These efforts should assist lenders in helping some subprime borrowers avoid foreclosure.
$40 billion in the next six months for Fannie and Freddie combined is not, in my view, such a huge number: it's probably less than some parties wanted and more than some parties wanted.

The part that concerns folks is this:
The specific flexibilities are as follows:

1. Change the portfolio measure from a GAAP number as reported on the balance sheet to Unpaid Principal Balance (UPB), which the Enterprises use in their publicly released monthly summaries. Under present market conditions, the GAAP value can fluctuate widely and we have concluded this adds unnecessary complexity for the Enterprises in managing to the portfolio cap. UPB, which reflects the original principal balance of mortgages and securities less repayments, is not subject to daily market fluctuations.

2. Set the new UPB portfolio cap at $735 billion on July 1, 2007 and apply it to the third quarter. On that date, the GAAP measured cap was $728.1 billion for Freddie Mac and $727.7 billion for Fannie Mae. (UPB often exceeds the GAAP value for the Enterprises. Due to market fluctuations over the first seven months of 2007, this difference has ranged from $0.1 billion to $9.4 billion.)
This does not mean that the GSEs will be allowed to use non-GAAP accounting on the actual balance sheets, whenever we end up seeing those. That's, actually, the issue: given how far behind Freddie and particularly Fannie are with getting financial statements up to date, to require the use of GAAP measures for monitoring these portfolio caps would be to force more resources off that project, if you wanted month-by-month current monitoring of the portfolio growth, which of course we do, or to end up with a several month lag between portfolio acquisition and the reporting thereon. That we don't want.

So OFHEO is simply changing the measurement used in the cap agreement from GAAP to UPB. We will still see the GAAP measurement on the financials, someday. In the meantime we will see monthly reporting on portfolio limits that uses a "raw" number that is almost always going to be larger than a GAAP number. (GAAP adjusts UPB for things like valuation allowances, discounts and premiums, and contingent liabilities. UPB is just what the borrower owes you since application of the most recent payment.)

As long as the new cap level is also expressed in UPB, not GAAP, then calculating additions to the portfolios in UPB doesn't constitute "cheating." On the contrary, it seems to me that OFHEO is being quite prudent here: by using simpler numbers, the cap monitoring is closer to real time. It will also mean that the numbers in play are closer to what we laypeople think of as "loan amounts," so if you're looking at them to get some sort of sense of how many loans to how many homebuyers are in question here, UPB is a better approximation than GAAP.

Personally, I am looking forward to seeing those monthly reports, to get a handle on how these acquisitions are changing the average characteristics of the GSEs' portfolios. I can live with UPB rather than GAAP if it means I can see those reports every month.