The Federal Home Loan Bank of New York won approval Thursday for a pilot program that will split the credit and interest rate risk between private-sector mortgage lenders and the government-sponsored entity.
The Home Loan bank will package into pools single-family mortgages bought at market value from member banks and thrifts. For the first seven years members will receive 97% of the principal payments and 48.5% of the interest payments. After seven years the Home Loan bank will take on 97% of the risk as well as collect that much of the cash flow. Member banks and thrifts will collect just 3%, but will only be liable for 3% of any losses.
The pilot, dubbed Community Mortgage Asset, would qualify as an acceptable investment by Home Loan banks under a July 28 proposal by their regulator, the Federal Housing Finance Board. That plan would limit Home Loan banks' investments and curtail purchases of mortgage-backed securities by 2005.
Long before the Finance Board's proposal, Home Loan banks began expanding beyond their traditional advances to member banks and thrifts. The best-known alternative is the Mortgage Partnership Finance, which the Federal Home Loan Bank of Chicago started three years ago. The Chicago Home Loan bank has generated $1.4 billion of loans under the program.
The Chicago pilot was expanded in September 1998 when the Finance Board raised the cap on the program to $9 billion from $750 million. The Chicago Home Loan Bank pays origination and servicing fees to a member bank or thrift for creating the pools, but retains ownership. The member banks and thrifts guarantee that they will cover some losses in pools, but usually no more than 2% of unpaid balance.
George E. Scharpf, president of Amboy National Bank, a $1.4 billion-asset bank in Old Bridge, N.J., said the New York Home Loan Bank's pilot is better.
Chicago's program is a "substitute for a Fannie Mae or Freddie Mac transaction - sell the whole loan," he said. But with the New York pilot, "I'm going to get half of the (principal and) interest."
Alfred A. DelliBovi, president of the Federal Home Loan Bank of New York, said the program was designed to satisfy the Finance Board's proposal. The intent, according to agency chairman Bruce A. Morrison, is to get the Home Loan banks focused on their mission of financing affordable housing.
"Aside from serving our customers, it also will meet the regulatory needs that Bruce Morrison is promoting,'' Mr. DelliBovi said. "The biggest challenge of that is finding mission-related assets -- you're not going to find them on the side of the road, you have to create them. This is one example."
He said he expects to see many alternatives proposed that provide a middle ground between traditional advances and selling loans immediately into the secondary market. These alternatives will all help the Home Loan banks meet the proposed regulatory definition of "mission mortgage asset."
Mr. Morrison said returns on direct investments in member bank and thrift mortgages could generate returns comparable to mortgage-backed securities. However, he acknowledged that start-up costs are likely cut into yields in the short run.
Yet, there is some skepticism that alternatives can replace the amount and the return of investments in mortgage-backed securities, which currently is about $60 billion.
"You need the broad mix," said John von Seggern, executive vice president of the Council of Federal Home Loan Banks, which includes 10 of the 12 banks.
Last month the Cincinnati, Indianapolis, and Seattle Home Loan banks proposed another possibility. The three institutions would buy fixed-rate, single-family mortgages from member banks and thrifts and then create an account that would assign part of the credit risk to members. Members would cover additional credit risk carried by the Home Loan banks with mortgage insurance.