Traditional MPF Credit Enhanced products, Original MPF and MPF 125, are comprised of fixed rate mortgages that bundle risks into component parts. Each risk can be assigned to the institution best suited
to administer it. For example, community lenders typically know their customer better than a third-part aggregator. The MPF Program recognizes that relationship and allocates the primary responsibility
for managing the credit risk (the risk that the borrower may be unable to repay the loan) to the originator of the loan. Participating Financial Institutions (PFIs),
all local lenders, are better situated to
handle the customer relationship, which they do under the MPF Program.
The Federal Home Loan Banks (FHLBanks) provide the funding for the MPF Credit Enhanced product; managing the interest rate risk, liquidity and prepayment risks of the loans purchased and held in their
portfolios. FHLBanks are able to fund MPF transactions due to their expertise at hedging the risks inherent in long term fixed rate invesments and their ability as a GSE to raise low-cost, long-term funds in
the global capital markets.
The credit risk of MPF Credit Enhanced 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%. Any losses greater than the PMI coverage are absorbed by the FHLBank up to the amount of the FHLBank’s
established First Loss Account (FLA). PFIs assume or retain a portion of credit risk on the loans they deliver to the FHLBank 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 FHLBank. The PFI’s Credit Enhancement obligation is calculated to equal the difference between the
amount needed for the pool of loans (a Master Commitment) to have a rating equivalent to an “AA” rated mortgage-backed security and the FHLBank’s initial FLA exposure.
Closed Loans Only
Mortgage loans that are funded and closed can be sold to the FHLBanks through the MPF Program in a similar manner to secondary market sales to other GSEs and investors. One difference with the
Credit Enhanced products is the PFI does not pay guarantee fees to the FHLBanks as it does to the other GSEs. Instead, the PFI is paid a credit enhancement fee for continuing to manage the credit risk of
the loans plus receive the standard servicing fees paid to servicers of MPF loans.
PFIs using the MPF Program also retain more underwriting control than they would through other comparable secondary market sales. They are free to manually underwrite the loans or use other GSEs’
automated underwriting systems. While MPF loans generally conform to agency criteria, each loan is purchased 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 originate and deliver under the MPF Program.
In general, risk-based capital rules for depository institutions encourage lenders to sell their loans into the secondary market. Selling into the MPF Credit Enhanced product structure, PFIs retain certain
risk-based capital requirements depending on the risk parameters of a given Master Commitment. The PFI is expected to consult with its own accountants and attorneys for advice on this matter.
By dispersing the credit risk of its Credit Enhanced loans among hundreds of community-based lenders throughout the country, the MPF Program provides a profitable alternative for participating PFIs. Do
the Credit Enhanced products sound right for your organization? Please contact your FHLBank Relationship Manager or MPF Program marketing representative for more information.