Under the MPF Program, a fixed-rate mortgage is treated as a bundle of risks that can be split into its component parts. Each risk can be assigned to the institution best situated to administer it. For example, experience has demonstrated that local lenders know their customers better than any third party. The MPF Program recognizes this and allocates the primary responsibility for managing the credit risk (the risk that the homebuyer will be unable to repay the loan) to the lender with respect to the loans it originated. Similarly, the participating financial institution (PFI), as a local lender, is better situated to handle all functions involving the customer relationship, which it does under the MPF Program.

Federal Home Loan Banks (FHLBs) are responsible for managing the interest rate risk, prepayment risk, and liquidity risk of the fixed-rate mortgages in MPF transations due to 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 FHLBs provide the funding for MPF loans (the liquidity risk) and manage the interest rate risk and prepayment risks of the loans held in their portfolios.

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 in the secondary market, private mortgage insurance (PMI) is required for MPF loans with loan-to value ratios greater than 80%. Losses greater than the PMI layer are absorbed by the FHLBs up to the amount of the FHLBs' first loss account (FLA). PFIs assume or retain a portion of the credit risk on the loans they deliver to the FHLBs by providing credit enhancement to cover losses on the loans in excess of the FLA. As compensation for managing this risk, PFIs receive monthly credit enhancement fees from the FHLBs. The PFI’s credit enhancement obligation is calculated to equal the difference between the amount needed for the pool of loans (Master Commitment) to have a rating equivalent to an “AA” rated mortgage-backed security and the FHLB’s initial FLA exposure. In other words, the FHLB has a very remote probability of any such loss from a very high quality mortgage asset.

Two Methods: Flow or Closed Loans
PFIs can take advantage of the MPF Program either by originating loans on a "flow" basis (table funded) or by selling closed loans to the FHLBs. In both cases, the partnership created by the MPF Program to jointly manage the risks of mortgage loans remains the same. A number of MPF products have been developed to meet the unique and varying needs of FHLB members, but they are all premised on the same risk-sharing concept.

For MPF loans created on a flow basis, the PFI manages all originating functions as agent for the FHLB, for which it may be paid paid agent fees in addition to normal origination fees. Prior to the mortgage closing, the loan characteristics are evaluated by the MPF system software to determine the amount of credit enhancement required for each loan.

Loans originated on a flow basis are closed in the PFI's name. However, the FHLB provides the funds for the loan and legally owns the loan from the first moment it is created. The loan never appears as an asset on the balance sheet of the PFI. After closing, the member continues to service the loans and handles all subsequent contacts with the homebuyers. The servicing fees members receive under the MPF Program are the same as those paid by other investors.

Alternatively, mortgage loans that have already closed can be sold to the FHLB through the MPF Program in a similar manner to secondary market sales to other GSEs or investors. A key distinction is that the PFI does not pay guarantee fees to the FHLB as it does to other agencies. Instead, the PFI is paid 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.

PFIs using the MPF Program also retain more underwriting control than in other comparable secondary market sales. They are free to manually underwrite the loans or use another GSE's automated underwriting system. While MPF loans generally conform to agency criteria, each loan is funded or sold only if the lender is willing to manage the credit risk of that loan. The MPF system software analyzes the risk characteristics of each loan and determines the amount of credit enhancement required; but the decision whether to deliver the loan into the MPF Program is made only by the PFI. PFIs choose which loans to make and which loans will be delivered under the MPF Program.

Risk-Based Capital
In general, risk-based capital rules for depository institutions encourage lenders to sell their loans into the secondary market. The rules require 4% risk-based capital to be held against ordinary residential loans held in portfolio. However, by selling mortgages to other GSEs, and then buying back those same mortgages in securitized form, lenders can significantly reduce the amount of risk-based capital they must hold.

For PFIs concerned about the risk-based capital treatment of their mortgages, the MPF Program's MPF 100 product is structured to limit the amount of risked-based capital PFIs have to hold in connection with flow loans delivered to the FHLBs. A joint ruling of the four Federal banking regulatory agencies (the Federal Reserve Board, FDIC, OCC, and OTS) allows PFIs that deliver loans on a flow basis under the MPF 100 risk-sharing structure to hold 8% risk-based capital against the amount of their credit enhancement, rather than 4% risk-based caital 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 PFI delivering the same mortgage to the FHLBs 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).

Dispersion of Credit Risk
As previously discussed, when other GSEs 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 continues to climb each year, the nation's mortgage credit risk becomes increasingly concentrated in these two entities. The MPF Program counters this trend by dispersing the credit risk of its loans among hundreds of community-based lenders throughout the country and provides an alternative for participating lenders.


Risk-based capital treatment depends on the risk paramaters of a given Master Commitment. 8% risked-based capital is available for almost all MPF 100 Master Commitments. The MPF Program is not providing accounting or legal advice with respect to the accounting treatment of MPF Program assets and liabilities. The PFI is expected to consult with its own accountants and attorneys for advice on this matter.