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The most exciting program in the mortgage markets today is an innovative new method of financing home loans
developed by the Federal Home Loan Banks. The Mortgage Partnership Finance® Program gives Home Loan Bank member
financial institutions a competitive new alternative when funding mortgages for their home buying customers. By
adding much-needed competition and balance to the secondary mortgage market, the MPF® Program benefits FHLB member
institutions and American homebuyers.
The MPF Program began in 1997 when the Federal Home Loan Bank of Chicago funded a modest three-bedroom bungalow in
northwest Chicago, through LaSalle Bank, F.S.B. The loan fulfilled the dream of homeownership for a young immigrant
couple who were expecting the birth of their first child. The couple moved into their new home over the Fourth of
July weekend, lending an all-American quality to that first MPF loan.
Since then, the MPF Program has grown rapidly due to enthusiastic demand from mortgage lenders. Today, the Program
is available through most regional Home Loan Banks. Hundreds of FHLB member institutions - local commercial banks,
thrifts, credit unions and insurance companies - have made billions of dollars of MPF loans in all regions of the
country. As a result, hundreds of thousands of individuals and families have purchased a new home or lowered the
cost of their existing home. The MPF Program exemplifies how the Federal Home Loan Banks add value to its member
institutions by fulfilling its mission, established by Congress, of providing economical housing finance throughout
the nation.
The Evolution of Mortgage Finance
The MPF Program was created to give local mortgage lenders a better way to fund home mortgages in the rapidly
changing financial industry. Previously, lenders had only two choices when making conventional fixed-rate mortgages,
both of which include significant drawbacks:
- Hold the mortgage loans in their own portfolio; or
- Sell the mortgages to a secondary market agency.
From a lender's standpoint, 15-year and 30-year fixed-rate mortgages, which are overwhelmingly preferred by most
American homebuyers, can be tricky instruments to hold because of their long-term nature, fixed interest rate and
complex options characteristics caused by a homebuyer's freedom to prepay the loan without penalty. By holding such
loans in portfolio until they mature or are refinanced, the lender is bearing all the risks associated with them,
including the credit risk, the interest rate risk, the liquidity risk, the prepayment risk and the servicing risk.
It can be difficult for many lenders, particularly community banks and thrifts, to properly fund and hedge the
interest rate risk and prepayment risk of these loans. For many lenders, it simply is not prudent to keep these
risks. Over the past two decades, mortgage lenders have increasingly sold their fixed-rate loans to the two
government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, which have been charged by Congress to buy
and securitize home mortgage loans. These GSEs dominate the secondary mortgage market because their special status
allows them to raise funds at rates lower than any retail financial institution.
The evolution toward the sale of home mortgages into the secondary market has resulted in a dramatic loss of market
share among U.S. financial institutions. In 1980, financial institutions, such as commercial banks and thrifts, held
64% of all mortgage loans in the U.S. By 1997, that amount had decreased to 30% while the mortgage holdings of
other investors, including Fannie Mae and Freddie Mac, more than doubled from 36% to 70%. Today, almost 80% of the
mortgages which most American families want - fixed-rate, conventional, conforming loans - are purchased or
securitized by these two agencies.
Selling mortgages to Fannie Mae or Freddie Mac has a downside, however. Lenders must pay costly "guarantee fees"
which Fannie and Freddie charge to guard against credit losses on the loans. In recent years, these fees have
averaged about 20 basis points per year of the principal balance of the mortgage pools even though these loans
historically experience losses of only 3 to 5 basis points. That means lenders are being charged four to five times
the actual rate of losses. Smaller community lenders are charged even higher rates because they do not originate
enough loans to qualify for the volume discounts given to larger originators. A typical community bank may pay 25
basis points per year or more even though their mortgages typically have very high credit quality, with average
losses of 3 basis points or less. Thus, it appears to many observers that lenders who sell their loans to Fannie or
Freddie are paying a high price for the privilege of doing so.
A Superior Approach
The Federal Home Loan Banks have created a better way. Noting the lack of competition in the secondary mortgage
market, the FHLBs realized that only a government-sponsored enterprise can truly compete with another
government-sponsored enterprise when funding mortgages. As the first housing GSE chartered by Congress in 1932, the
FHLBs are able to raise funds at virtually the same interest rates as Fannie Mae or Freddie Mac. Unlike those GSEs,
however, the Federal Home Loan Banks are owned by their member financial institutions, meaning their customers are
also their shareholders. The relationship ensures that the FHLBs pass along the advantages of their
government-sponsored status to their members, as Congress intended.
The MPF Program's premise rests on the simple, yet powerful, idea that by combining the credit expertise of a local
lender with the funding and hedging advantages of a FHLB, a more competitive, economical and efficient method of
funding residential mortgages will result. The MPF Program gives mortgage lenders the best of both previous models
of mortgage lending -- lenders can retain the credit risk and customer relationship of their loans while shifting
the interest rate and prepayment risks to the FHLB. This innovative approach to mortgage risk management represents
the next step in the evolution of mortgage financing.
The MPF model recognizes that a banker's fundamental business is prudently managing the credit risks of his or her
customers. Unlike lenders which originate mortgage loans only to immediately sell them to a secondary agency, real
bankers believe in their customers and want to maintain a credit relationship throughout the life of their loans.
With the MPF Program, they can.
Participating members are able to preserve their customer credit relationships while shifting the interest rate and
prepayment risks to the FHLB. Importantly, members are paid to manage the credit risk of their own customers.
Rather than paying guarantee fees to sell their loans to a secondary market agency, members receive credit
enhancement fees from the FHLB for their credit expertise. This is a key advantage of the MPF Program and an
important reason why the program has the enthusiastic support of FHLB members across the country.
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