Enterprise Capital Requirements

Federal RegisterJul 17, 2018

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FEDERAL HOUSING FINANCE AGENCY

12 CFR Parts 1206 and 1240

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

Office of Federal Housing Enterprise Oversight

12 CFR Part 1750

RIN 2590-AA95

Enterprise Capital Requirements

AGENCY:

Federal Housing Finance Agency; Office of Federal Housing Enterprise Oversight

ACTION:

Notice of proposed rulemaking.

SUMMARY:

The Federal Housing Finance Agency (FHFA or the Agency) is proposing a new regulatory capital framework for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, the Enterprises), which includes a new framework for risk-based capital requirements and two alternatives for an updated minimum leverage capital requirement. The risk-based framework would provide a granular assessment of credit risk specific to different mortgage loan categories, as well as market risk, operational risk, and going-concern buffer components. The proposed rule would maintain the statutory definitions of core capital and total capital.

FHFA has suspended the Enterprises' capital requirements since the beginning of conservatorship, and FHFA plans to continue this suspension while the Enterprises remain in conservatorship. Despite this suspension, FHFA believes it is appropriate to update the Agency's standards on Enterprise capital requirements to provide transparency to all stakeholders about FHFA's supervisory view on this topic. In addition, while the Enterprises are in conservatorship, FHFA will expect Fannie Mae and Freddie Mac to use assumptions about capital described in the rule's risk-based capital requirements in making pricing and other business decisions. Feedback on this proposed rule will also inform FHFA's views in evaluating Enterprise business decisions while the Enterprises remain in conservatorship.

DATES:

Comments must be received on or before September 17, 2018.

ADDRESSES:

You may submit your comments on the proposed rule, identified by regulatory information number (RIN) 2590-AA95, by any one of the following methods:

•

Agency Website: www.fhfa.gov/open-for-comment-or-input.

•

Federal eRulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments. If you submit your comment to the Federal eRulemaking Portal, please also send it by email to FHFA at

RegComments@fhfa.gov

to ensure timely receipt by FHFA. Include the following information in the subject line of your submission: Comments/RIN 2590-AA95.

•

Hand Delivered/Courier:

The hand delivery address is: Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA95, Federal Housing Finance Agency, Eighth Floor, 400 Seventh Street SW, Washington, DC 20219. Deliver the package at the Seventh Street entrance Guard Desk, First Floor, on business days between 9 a.m. and 5 p.m.

•

U.S. Mail, United Parcel Service, Federal Express, or Other Mail Service:

The mailing address for comments is: Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA95, Federal Housing Finance Agency, Eighth Floor, 400 Seventh Street SW, Washington, DC 20219. Please note that all mail sent to FHFA via U.S. Mail is routed through a national irradiation facility, a process that may delay delivery by approximately two weeks. For any time-sensitive correspondence, please plan accordingly.

FOR FURTHER INFORMATION CONTACT:

Naa Awaa Tagoe, Senior Associate Director, Office of Financial Analysis, Modeling & Simulations, (202) 649-3140,

NaaAwaa.Tagoe@fhfa.gov

; Andrew Varrieur, Associate Director, Office of Financial Analysis, Modeling & Simulations, (202) 649-3141,

Andrew.Varrieur@fhfa.gov

; or Miriam Smolen, Associate General Counsel, Office of General Counsel, (202) 649-3182,

Miriam.Smolen@fhfa.gov

. These are not toll-free numbers. The mailing address is: Federal Housing Finance Agency, 400 Seventh Street SW, Washington, DC 20219. The telephone number for the Telecommunications Device for the Hearing Impaired is (800) 877-8339.

SUPPLEMENTARY INFORMATION:

Comments

FHFA invites comments on all aspects of the proposed rule and will take all comments into consideration before issuing a final rule. Copies of all comments will be posted without change, and will include any personal information you provide such as your name, address, email address, and telephone number, on the FHFA website at

http://www.fhfa.gov.

In addition, copies of all comments received will be available for examination by the public through the electronic rulemaking docket for this proposed rule also located on the FHFA website.

Table of Contents

I. Introduction

A. Rationale for Proposing a Capital Rule

B. Overview of the Proposed Rule

C. Legislative Authority and History

D. The Enterprises' Pre-Conservatorship Business and the Financial Crisis

E. Enterprises' Business Model and Changes in Conservatorship

F. Comparison of Enterprises and Large Depository Institutions

G. Dodd-Frank Act Stress Test Process

H. Important Considerations for the Proposed Rule

II. The Proposed Rule

A. Components of the Proposed Rule

B. Impact of the Proposed Rule

C. Risk-Based Capital Requirements

1. Overall Approach

2. Operational Risk

3. Going-Concern Buffer

4. Single-Family Whole Loans, Guarantees, and Related Securities

a. Credit Risk

b. Credit Risk Transfer

c. Market Risk

d. Operational Risk

e. Going-Concern Buffer

f. Impact

5. Private-Label Securities

6. Multifamily Whole Loans, Guarantees, and Related Securities

a. Credit Risk

b. Credit Risk Transfer

c. Market Risk

d. Operational Risk

e. Going-Concern Buffer

f. Impact

7. Commercial Mortgage-Backed Securities

8. Other Assets and Guarantees

9. Unassigned Activities

D. Minimum Leverage Capital Requirements

E. Definition of Capital

F. Temporary Adjustments to Minimum Leverage and Risk-Based Capital Requirements

III. Paperwork Reduction Act

IV. Regulatory Flexibility Act

Table Reference for Section II

Table 1: Fannie Mae's Capital Requirement Comparison to Peak Cumulative Capital Losses

Table 2: Fannie Mae's Single-Family Credit Risk Capital Requirement Comparison to Lifetime Single-Family Credit Losses

Table 3: Freddie Mac's Capital Requirement Comparison to Peak Cumulative Capital Losses

Table 4: Freddie Mac's Single-Family Credit Risk Capital Requirement Comparison to Lifetime Single-Family Credit Losses

Table 5: Fannie Mae and Freddie Mac Estimated Risk-Based Capital Requirements as of September 30, 2017—by Risk Category

Table 6: Fannie Mae and Freddie Mac Combined Estimated Risk-Based Capital

Requirements for the Enterprises as of September 30, 2017—by Asset Category

Table 7: Fannie Mae and Freddie Mac Estimated Minimum Leverage Capital Requirement Alternatives as of September 30, 2017

Table 8: Operational Risk Capital Requirement

Table 9: Single-Family New Originations Base Credit Risk Capital (in bps)

Table 10: Single-Family Performing Seasoned Loans Base Credit Risk Capital (in bps)

Table 11: Single-Family Non-Modified Re-Performing Loans Base Credit Risk Capital (in bps)

Table 12: Single-Family Modified Re-Performing Loans Base Credit Risk Capital (in bps)

Table 13: Single-Family Non-Performing Loans Base Credit Risk Capital (in bps)

Table 14: Single-Family Risk Multipliers

Table 15: CE Multipliers for New Originations, Performing Seasoned Loans, and RPLs When MI Is Non-Cancellable

Table 16: CE Multipliers for New Originations, Performing Seasoned, and Non-Modified RPLs When MI Is Cancellable

Table 17: CE Multipliers for Modified RPLs With 30-Year Post-Mod Amortization When MI Is Cancellable

Table 18: CE Multipliers for Modified RPLs With 40-Year Post-Mod Amortization When MI Is Cancellable

Table 19: CE Multipliers for NPLs

Table 20: Counterparty Financial Strength Ratings

Table 21: Parameterization of the Single-Family Counterparty Haircut Multipliers

Table 22: Single-Family Counterparty Risk Haircut (CP Haircut) Multipliers by Rating, Mortgage Concentration Risk, Segment, and Product

Table 23: Fannie Mae and Freddie Mac Combined Estimated Total Risk-Based Capital Requirements for Single-Family Whole Loans, Guarantees, and Related Securities as of September 30, 2017

Table 24: Fannie Mae and Freddie Mac Combined Estimated Credit Risk Capital Requirements for Single-Family Whole Loans and Guarantees as of September 30, 2017—by Loan Category

Table 25: Fannie Mae and Freddie Mac Combined Estimated Risk-Based Capital Requirements for Private-Label Securities as of September 30, 2017

Table 26: Multifamily FRM Base Credit Risk Capital (in bps)

Table 27: Multifamily ARM Base Credit Risk Capital (in bps)

Table 28: Multifamily Risk Multipliers

Table 29: Multifamily Counterparty Risk Haircut Multipliers by Concentration Risk

Table 30: Fannie Mae and Freddie Mac Combined Estimated Total Risk-Based Capital Requirements for Multifamily Whole Loans, Guarantees, and Related Securities as of September 30, 2017

Table 31: Fannie Mae and Freddie Mac Combined Estimated Credit Risk Capital Requirements for Multifamily Whole Loans and Guarantees as of September 30, 2017—by Loan Category

Table 32: Fannie Mae and Freddie Mac Combined Estimated Risk-Based Capital Requirements for Commercial Mortgage-Backed Securities as of September 30, 2017

Table 33: Fannie Mae and Freddie Mac Estimated Risk-Based Capital Requirements for Deferred Tax Assets Assuming Core Capital Equal to Risk-Based Capital Requirement

Table 34: Fannie Mae and Freddie Mac Estimated Risk-Based Capital Requirements for Deferred Tax Assets Assuming Core Capital as of September 30, 2017

Table 35: Fannie Mae and Freddie Mac Combined Estimated Risk-Based Capital Requirements for Other Assets as of September 30, 2017

Table 36: Bifurcated Minimum Leverage Capital Requirement Alternative Comparison to the Proposed Risk-Based Capital Requirements

I. Introduction

A. Rationale for Proposing a Capital Rule

FHFA's predecessor agency, the Office of Federal Housing Enterprise Oversight (OFHEO), last adopted capital rules for Fannie Mae and Freddie Mac in 2001. The Housing and Economic Recovery Act of 2008 (HERA) gave FHFA greater authority to determine capital standards for the Enterprises. Each Enterprise was placed into conservatorship shortly after the enactment of HERA. FHFA suspended the statutory capital classifications and regulatory capital requirements during conservatorship, due to the Enterprises having entered the control of the conservator. Today, the Senior Preferred Stock Purchase Agreements (PSPAs) with the U.S. Department of the Treasury (Treasury Department) limit each Enterprise's ability to hold capital.

Prior to proposing this rule, FHFA has taken other steps to assess adequate capital assumptions for the Enterprises while they operate in conservatorship. Despite the Enterprises' limited ability to hold capital, FHFA identified the need to develop an aligned risk measurement framework to better evaluate each Enterprise's business decisions while they are in conservatorship. FHFA's purpose in pursuing this effort was to ensure that the Enterprises make prudent business decisions when pricing transactions and managing their books of business. The initial framework developed as a result of this effort is called the Conservatorship Capital Framework (CCF) and was put into place in 2017 under FHFA's oversight as conservator.

The CCF is the foundation for FHFA's proposed capital regulation. Although the capital requirements in the rule would need to be suspended after adoption of a final rule because the Enterprises remain in conservatorship and are supported by the Treasury Department through the PSPAs which limit their ability to retain capital, the updated rule would achieve several objectives. The proposed rule serves to transparently communicate FHFA's views as a financial regulator about capital adequacy for the Enterprises under current statutory language and authorities. The fact that FHFA has suspended the Enterprises' capital requirements does not eliminate FHFA's responsibility, as a prudential regulator, to articulate a view about Enterprise capital requirements. It also prepares the Agency to modify the capital standards for future housing finance entities, even if they are significantly different from the Enterprises, upon completion of housing finance reform by Congress and the Administration, instead of starting from the outdated OFHEO rules. In addition, publication of this proposed rule will enable the public to provide input on these important issues.

While the Enterprises currently operate under the PSPAs with the Treasury Department, the proposed rule does not take the PSPAs into account. The proposed risk-based capital requirements are designed to establish the necessary minimum capital for the Enterprises to continue operating after a stress event comparable to the recent financial crisis. In a reformed housing finance system, policymakers would need to determine whether to retain support like that provided by the PSPAs for future housing finance entities.

In proposing this rule, FHFA is not attempting to take a position on housing finance reform. Similarly, this proposed rule is not a step towards recapitalizing the Enterprises and administratively releasing them from conservatorship. FHFA's position continues to be that it is the role of Congress and the Administration to determine the future of housing finance reform and what role, if any, the Enterprises should play in that system.

Publication of this proposed rule will assist with FHFA's administration of the conservatorships of Fannie Mae and Freddie Mac by potentially refining the CCF. As with other proposed rules, the rulemaking provides the public with an opportunity to comment on the proposed capital requirements. As FHFA reviews the public comments and works to finalize the rule, the Agency expects to adopt material and appropriate changes into the existing CCF.

B. Overview of the Proposed Rule

FHFA is proposing a regulatory capital framework for the Enterprises that would implement two components: A new framework for risk-based capital requirements and a revised minimum leverage capital requirement specified as a percentage of total assets and off-balance sheet guarantees. FHFA's proposed rule is based on a capital framework that is generally consistent with the regulatory capital framework for large banks, but reflects differences in the charters, business operations, and risk profiles of the Enterprises. The proposed rule uses concepts from the Basel framework with appropriate modifications for the Enterprises. FHFA's proposed framework recognizes that the Enterprises are monoline businesses with assets and guarantees heavily concentrated in residential mortgages with risk profiles that differ from large diversified banks.

In order to fulfill their charter responsibilities of providing stability to the secondary mortgage market, the Enterprises must remain as functioning entities both during and after a period of severe financial stress. To achieve this objective, the proposed risk-based capital framework targets a risk-invariant minimum capital level after surviving a stress event, referred to as the going-concern buffer.

The Enterprises' assets and operations are exposed to different types of risks. The proposed risk-based capital framework would address the key exposures by explicitly covering credit risk, including counterparty risk, as well as market risk and operational risk. The proposed framework would define the requirements by risk factor for each key group of the Enterprises' assets and guarantees.

In establishing risk-based capital requirements and updating the minimum leverage requirement, FHFA is seeking to ensure that the two sets of requirements complement one another. For the risk-based capital requirements, FHFA is proposing a comprehensive framework that provides a detailed assessment of the Enterprises' risk of incurring unexpected losses. Instead of applying the Basel standardized approach of a 50 percent risk weight for all mortgage assets regardless of different product features or terms, FHFA's proposed risk-based capital requirements would use a series of approaches, which include base grids, risk multipliers, assessments of counterparty risk, and capital relief due to credit risk transfer transactions, to produce tailored capital requirements for mortgage loans, guarantees, and securities. These asset-specific capital requirements would then be applied across each Enterprise's book of business to produce total risk-based capital requirements.

By differentiating between the types and features of mortgage assets, guarantees, and securities purchased by the Enterprises, FHFA believes the proposed risk-based capital requirements would represent a substantial step forward in articulating the relative risk levels of mortgage loans and quantifying the associated capital requirements for the Enterprises.

In coordination with the proposed risk-based capital requirements, FHFA is also proposing two alternative minimum leverage capital requirements. Each of these alternatives would update the existing minimum leverage requirements established by statute for the Enterprises. Under the first alternative, the “2.5 percent alternative,” the Enterprises would be required to hold capital equal to 2.5 percent of total assets (as determined in accordance with generally accepted accounting principles (GAAP)) and off-balance sheet guarantees related to securitization activities, regardless of the risk characteristics of the assets and guarantees or how they are held on the Enterprises' balance sheets. Under the second alternative, the “bifurcated alternative,” the Enterprises would be required to hold capital equal to 1.5 percent of trust assets and 4 percent of non-trust assets, where trust assets are defined as Fannie Mae mortgage-backed securities or Freddie Mac participation certificates held by third parties and off-balance sheet guarantees related to securitization activities, and non-trust assets are defined as total assets as determined in accordance with GAAP plus off-balance sheet guarantees related to securitization activities minus trust assets. The Enterprises' retained portfolios would be included in non-trust assets. In proposing these two alternatives, FHFA seeks to obtain feedback about how to balance the following considerations.

On the one hand, FHFA seeks to establish a minimum leverage requirement that would serve as a backstop capital requirement to guard against the potential that the risk-based capital requirements would be underestimated or would become too low in the future following periods of sustained, strong economic conditions. A meaningful minimum leverage requirement would also guard against the risk that the risk-based capital measure significantly underestimates necessary capital levels. An underestimation of capital could occur for different reasons, including the potential for model estimation error, the possibility that loans perform differently than similar loans did in the historical periods used to estimate the models, the emergence of new products that are inadequately capitalized because of a lack of historical performance data as occurred during the financial crisis, and the possibility that the proposed risk-based capital approach would overestimate the amount of capital relief attributed to CRT transactions. A leverage backstop would also protect against a reduced risk-based capital measure during times of overly aggressive house price appreciation and low unemployment, which would result in lower capital requirements and the release of capital when loan-to-value ratios fall. In the absence of a meaningful minimum leverage capital requirement, aggressively low risk-based capital requirements could result in the Enterprises facing difficulty raising capital in worsening economic conditions when capital is most needed. A leverage backstop would also mitigate the risk of rapid deleveraging for institutions that depend on short-term funding, though, as discussed herein, this rationale applies more to large depository institutions than to the Enterprises. Lastly, a leverage backstop would provide a floor beyond the proposed going-concern buffer and operational risk capital requirement for the amount of capital released as a result of credit risk transfer transactions.

On the other hand, FHFA also seeks to avoid setting a minimum leverage requirement that is too high and would regularly eclipse the risk-based capital requirements, which could have adverse consequences. Because leverage requirements generally require firms to hold the same amount of capital for any type of asset irrespective of the asset's risk profile, a binding leverage requirement could incent firms to hold riskier assets on their balance sheets. Instead of reducing risk to the Enterprises, a high leverage requirement that surpasses risk-based capital requirements could encourage the Enterprises to forgo lower-risk assets in favor of those with higher-risks because the same capital requirement would apply for either asset. In addition, a binding leverage requirement could lead an Enterprise to reduce or halt its CRT transactions. This could occur because the proposed risk-based capital requirements provide capital relief for CRT transactions, whereas the minimum leverage capital requirements in this proposed rule do not provide capital relief for CRT transactions. As a

result, a binding leverage ratio could reduce an Enterprise's economic incentive to engage in these transactions, potentially resulting in greater concentration of credit risk at the Enterprise.

Each of these proposed capital requirements are discussed in section II.

C. Legislative Authority and History

Effective July 30, 2008, HERA created FHFA as a new independent agency of the Federal Government. The part of HERA that applies to FHFA is the Federal Housing Finance Regulatory Reform Act of 2008,

which amended the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (Safety and Soundness Act or statute).

The 1992 statute created OFHEO, one of FHFA's predecessor agencies.

Public Law 110-289, Div. A, July 30, 2008, 122 Stat. 2659.

Public Law 102-550, Title XIII, October 28, 1992, 106 Stat. 3941.

HERA transferred to FHFA the supervisory and oversight responsibilities of OFHEO over Fannie Mae and Freddie Mac. HERA also transferred the oversight responsibilities of the Federal Housing Finance Board over the Federal Home Loan Banks (Banks) and the Office of Finance, which acts as the Banks' fiscal agent, and certain functions of the Department of Housing and Urban Development (HUD) with respect to the affordable housing mission of the Enterprises. In addition to transferring supervisory responsibilities to FHFA, HERA gave the Agency greater authority than OFHEO had to determine the capital standards for the Enterprises.

1992 Statute and OFHEO Risk-Based Capital Rulemaking

As originally enacted, the 1992 statute specified a minimum capital requirement in the form of a leverage ratio for the Enterprises and a highly prescriptive approach to risk-based capital requirements for the Enterprises. The statute required that OFHEO establish a risk-based capital stress test by regulation such that each Enterprise could survive a ten-year period with large credit losses and large movements in interest rates. The statute specified two interest rate scenarios, with falling and rising rates, and provided the interest rate paths for each scenario. The statute set parameters for a benchmark loss experience for default and loss severity, but provided OFHEO discretion to determine other aspects of the capital test.

To implement this statutory language, OFHEO developed a risk-based capital standard for the Enterprises, and issued a series of

Federal Register

notices to solicit public comment. Initially, the Agency issued an Advance Notice of Proposed Rulemaking (ANPR) to seek comment on a number of issues related to the rule's development. Those comments were considered when OFHEO subsequently developed two Notices of Proposed Rulemaking (NPRs). The first NPR contained the methodology for identifying the benchmark loss experience and the use of OFHEO's House Price Index (HPI). The second NPR proposed the remaining specifications of the stress test. OFHEO also issued a notice to give interested parties an opportunity to respond to comments received by the Agency from the second NPR. OFHEO's Final Rule included consideration of the comments received in the first and second NPRs, as well as the reply comments.

Suspension of Capital Requirements During Conservatorship and Existing Regulatory Capital Requirements

On September 6, 2008, the Director of FHFA appointed FHFA as the conservator for each Enterprise, pursuant to authority in the Safety and Soundness Act. Conservatorship is a statutory process intended to preserve and conserve the assets of the Enterprises and to put the companies in a sound and solvent condition. FHFA suspended the capital classifications and the regulatory capital requirements applicable at that time, and they remain suspended.

Press Release, “FHFA Announces Suspension of Capital Classifications During Conservatorship,” Oct. 9, 2008.

Although the capital requirements are suspended while the Enterprises are in conservatorship, this section reviews the Enterprise capital standards in the prior OFHEO rule, which, though suspended, has not yet been replaced.

The OFHEO regulations on the Enterprises' minimum capital (leverage ratio) and risk-based capital requirements would be superseded by this rulemaking.

12 CFR part 1750.

The Enterprises are required by statute to maintain the capital necessary to meet certain minimum leverage and risk-based capital levels. Under HERA, the Enterprises continue to operate under the regulations issued by OFHEO until those regulations are superseded by regulations issued by FHFA. The OFHEO rule's minimum leverage and risk-based capital requirements are applied simultaneously, but are not additive. The Enterprises must meet both requirements in order to be classified as adequately capitalized.

If any Enterprise is classified as other than adequately capitalized, it triggers a series of prompt corrective actions. Since the ability of the Enterprises to obtain adequate capital was fatally impaired due to the financial crisis, capital support for the Enterprises was provided by the PSPAs with the Treasury Department when the Enterprises were put into conservatorship. Accordingly, FHFA suspended the capital classifications as well as the OFHEO capital regulation.

The minimum leverage capital requirement specified in the Safety and Soundness Act is equal to 2.5 percent of on-balance sheet assets and 0.45 percent of off-balance sheet obligations. These levels are applied to the retained portfolio and guarantee business, respectively.

The statute, today as in 1992, requires the minimum leverage capital requirement to be met with core capital, which per the statute is composed of outstanding common stock (par value and paid-in capital), retained earnings, and outstanding non-cumulative perpetual preferred stock.

Due to changes in GAAP after the statute was enacted, guaranteed mortgage-backed securities held by third parties are now consolidated by each Enterprise onto its balance sheet. However, for minimum leverage capital purposes, FHFA has interpreted the statute as continuing to apply the 0.45 percent capital requirement to these loans.

See

Regulatory Interpretation 2010-RI-1, Jan. 12, 2010.

The statute, as amended by HERA, also requires the Enterprises to meet a risk-based capital standard, to be prescribed by FHFA by regulation. The OFHEO capital rule contains a stress test, which is to be applied to each Enterprise's book of business. As prescribed by the 1992 statute, the stress test is designed such that each Enterprise could survive a ten-year period with large credit losses and large movements in interest rates. There are two interest rate scenarios, with falling and rising rates, and interest rate paths for each scenario. The test has parameters for a benchmark loss experience for default and loss severity, and uses the House Price Index produced by OFHEO (which FHFA now produces).

The statute, both in 1992 and today, requires the risk-based capital requirement to be met with total capital, which is the sum of core capital and a general allowance for foreclosure losses, plus “[a]ny other amounts from sources of funds available to absorb losses incurred by the enterprise, that the Director by regulation determines are appropriate to include in determining

total capital” (a determination that OFHEO never made).

The statute, both in 1992 and today, defines a critical capital level, which is the amount of core capital below which an Enterprise is classified as critically undercapitalized. The critical capital level is 1.25 percent of on-balance sheet assets (retained portfolio) and 0.25 percent of off-balance sheet obligations (guarantee business).

Under the statute, both in 1992 and today, an Enterprise is considered adequately capitalized when core capital meets, or exceeds, the minimum capital requirement and total capital meets, or exceeds, the risk-based capital requirement. An Enterprise is considered undercapitalized if it fails the risk-based requirement, but meets the minimum capital requirement. It is significantly undercapitalized when it fails both the minimum and risk-based capital requirements, but still has enough critical capital. It becomes critically undercapitalized when it fails both the minimum and risk-based capital requirements, as well as the critical capital requirement.

If an Enterprise becomes undercapitalized or significantly undercapitalized, under the prompt corrective action framework in the statute the Enterprise is subject to heightened supervision. This includes being required to submit a capital restoration plan, and having restrictions imposed on capital distributions and asset growth. A significantly undercapitalized Enterprise must also improve management through a change in the board of directors or executive officers. If an Enterprise becomes critically undercapitalized, then the Enterprise may be placed in conservatorship or receivership.

HERA Amendments on Enterprise Capital Requirements

FHFA's broader capital regulation authority provided by the amendments made by HERA creates an opportunity for FHFA to develop a new risk-based capital standard and an increased minimum leverage requirement. FHFA's authority to establish risk-based capital requirements was amended under HERA by removing the specific stress test requirements that had been mandated for OFHEO's rulemaking and providing FHFA with the authority to establish risk-based capital requirements “to ensure that the enterprises operate in a safe and sound manner, maintaining sufficient capital and reserves to support the risks that arise in the operations and management of the enterprises.”

While HERA did not change the minimum leverage ratio levels specified in the statute, the legislation provided FHFA with authority to increase the minimum leverage requirement above those levels as necessary,

and to temporarily increase the minimum capital level for a regulated entity.

FHFA issued a final regulation to implement the temporary increase authority in 2011.

Additionally, as amended by HERA, the statute provides FHFA with the authority to establish capital or reserve requirements for specific products and activities as deemed appropriate by the Agency.

HERA also enhanced the Safety and Soundness Act's prompt-corrective-action provisions and added the agency's conservatorship and receivership authorities.

12 U.S.C. 4611(a)(1).

12 U.S.C. 4612(c).

12 U.S.C. 4612(d), implemented at 12 CFR part 1225.

76 FR 11668 (March 3, 2011).

12 U.S.C. 4612(e).

Dodd-Frank Act Stress Tests

Section 165

of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

(Dodd-Frank Act) required the capital adequacy stress testing of large financial companies with assets over $10 billion that are supervised by a federal regulator. FHFA issued regulations to implement this requirement.

However, the Dodd-Frank Act Stress Test is a reporting requirement, not a capital requirement. The purpose of the test is to assist in the evaluation of capital sufficiency, but it does not set any capital requirements for the Enterprises.

12 U.S.C. 5365(i). The stress testing requirements of the Dodd-Frank Act have been adjusted by Title IV of the Economic Growth, Regulatory Relief, and Consumer Protection Act, Public Law 115-174, May 24, 2018, 132 Stat. 1356, to, among other things, reflect new asset thresholds and to reduce from 3 to 2 the number of testing scenarios. The effect, if any, of the new requirements will be considered and accounted for in any final rule FHFA issues.

Public Law 111-203, July 21, 2010, 124 Stat. 1376.

12 CFR part 1238.

D. The Enterprises' Pre-Conservatorship Business and the Financial Crisis

Pre-Conservatorship Business

The Enterprises' business model of supporting single-family and multifamily housing consists of both a guarantee business and a portfolio business. In the portfolio business, the Enterprises issue debt and invest the proceeds in whole loans and mortgage-backed securities. The mortgage securities held in the retained portfolio were traditionally the Enterprises' own guaranteed mortgage-backed securities. In the years leading up to the crisis, however, the Enterprises became active participants in the market for private-label mortgage securities, which exposed the Enterprises to significant fair value losses.

The Enterprises earned net interest income on the difference between rates on the mortgage securities (interest income) and the debt costs (interest expense) on their retained portfolio business. The net interest income was at risk since longer-term assets were funded by shorter-term debt. The Enterprises managed this duration mismatch using interest-rate swaps and “swaptions” in the derivatives market. By holding leveraged positions in mortgage securities and funding them with shorter-term debt, the Enterprises took on substantial market risks, in addition to supporting core business functions. Sources of this market risk include the risk of loss from changes in interest rates and the basis risk associated with imperfect hedging.

The Enterprises also used the retained portfolios to hold whole loans that could not be easily securitized, such as certain affordable loans and loans being reworked through loss mitigation. In addition, the retained portfolios were used to support the cash window for smaller lenders. This use of the retained portfolio supported core business functions and helped the Enterprises to fulfill their mission. However, during the pre-conservatorship period, the purchase of mortgage securities dominated the portfolio business.

In the guarantee business, private lenders participated in the mortgage-backed security swap program and cash window program. Through these programs, private lenders originated loans according to Enterprises' standards, and either exchanged those loans for securities that were guaranteed by either Enterprise, or sold loans directly to the Enterprises for cash. When lenders in the swap program received guaranteed mortgage-backed securities, they often sold those securities to replenish funds, enabling the lenders to make more loans. When smaller lenders sold their loans to the Enterprises for cash, the price they received was the market price for the loans less an implied guarantee fee. The Enterprises were able to quickly aggregate the cash window purchases from multiple smaller lenders and issue the guaranteed securities with a larger pool size directly. In addition, loans purchased through Freddie Mac's cash window or Fannie Mae's whole loan conduit (collectively referred to

henceforth as the cash window) noted above were aggregated and later securitized. In both the swap and cash programs, the Enterprises assumed the credit risk on the loans in exchange for a guarantee fee. The lenders earned income through originating and servicing loans, and selling MBS they received from the Enterprises; and private investors assumed the market risk from price changes driven by movements in interest rates.

Growth in Subprime and Other High Risk Loans

In the years leading up to the financial crisis, competition in the primary mortgage market for revenue and market share led mortgage lenders to relax underwriting standards and originate riskier mortgages to less creditworthy borrowers. Many of these loans were packaged into subprime and “Alt-A” private-label securities that were sold without backing from the Enterprises. Investor appetite for these loans enabled lenders to lower standards for underwriting, including credit scores, which increased the potential pool of borrowers and helped to drive up house prices. Consequently, subprime mortgages were given to borrowers with lower credit scores and low down payments.

In addition, Alt-A loans were increasingly offered to borrowers considered riskier than “A” or prime paper and less risky than subprime. Alt-A mortgages were characterized by less than the full documentation by the lender of a borrower's income and assets, which markedly increased the credit risk and fueled speculation. These high-risk loans often had features that made it increasingly difficult for borrowers to repay the loans, including low teaser rates that would reset, balloon payments, prepayment penalties, interest-only periods, and negative amortization. Weak underwriting standards during this period often included inflated appraised values, which compounded the problems. In addition, many loans had “risk-layering” of more than one higher risk attribute, significantly increasing credit exposures.

The private-label securities were divided into tranches with different terms and credit risk attributes. Prior to 2003, the Enterprises maintained relatively high underwriting standards. However, as the Enterprises faced declining market shares of the total mortgage market with the growth of the private-label market, the Enterprises sought to increase business revenue by buying significant amounts of the AAA-rated tranches of private-label subprime and Alt-A securities for their retained portfolios. In addition, the Enterprises guaranteed increasingly larger amounts of Alt-A whole mortgage loans with non-traditional credit standards from lenders through bulk sales, outside of the normal business standards for the guarantee business.

2007-2008 Financial Crisis

The financial crisis began in 2007 with stresses in the subprime and Alt-A mortgage market. The crisis grew to other financial sectors in the United States and globally. Several large financial firms failed and others had to be supported through government intervention. After the crisis, the Dodd-Frank Act was enacted in the United States, and the Basel III capital standards were adopted globally to promote financial stability.

In the build-up to the crisis, growth in subprime and Alt-A lending drove house prices increasingly higher. The overvaluation of non-traditional mortgages was based on the assumption that house prices would continue to rise. However, as the market for those loans began to weaken, house prices started to decline nationwide, further exacerbating the problems and spreading stress to markets beyond the housing sector. By September 2008 when the Enterprises entered conservatorship, the average U.S. house price had declined by over 20 percent from its mid-2006 peak. Many borrowers were faced with underwater mortgages such that the unpaid balances of the loans exceeded the value of the homes. The economic stress affected not only the subprime and Alt-A mortgages in the Enterprises' guarantee book, but also the mortgages in the guarantee book that had been approved under more traditional mortgage underwriting standards.

The financial crisis had a major impact on the value of the private-label securities held by the Enterprises in their retained portfolios. From 2002 to 2008, Fannie Mae purchased $240 billion of subprime and Alt-A private-label single-family mortgage securities. From 2006 to 2008, Freddie Mac purchased $160 billion of these securities.

When the financial crisis hit, the Enterprises suffered sharp declines in the value of these securities, due to weakening collateral and credit rating downgrades.

See

FHFA's Report to Congress for private-label security holdings, serious delinquency rate, and credit loss data.

The SFAS 157 accounting standard issued in 2006 for fair value accounting required that tradable assets such as mortgage securities that were purchased with the intent to resell in either a short time frame (trading securities) or in a longer time frame (available-for-sale securities) be valued according to their current market value rather than historic cost or some future expected value. When the market for private-label securities collapsed, the value losses had a major financial effect on the holders of these securities. Upon entering conservatorship, the Enterprises ceased buying both subprime and Alt-A securities, and began to wind down those positions.

In addition to the private-label security losses in the portfolio, the guarantee book experienced severe stress from the financial crisis. Fannie Mae's single-family serious delinquency rate rose from 0.65 percent in 2006 to 2.42 percent in 2008, peaking at 5.38 percent in 2009. Subsequently, the delinquency rate fell below 2.00 percent by 2014 and to 1.24 percent at the end of 2017. Freddie Mac's delinquency rate rose from 0.42 percent in 2006 to 1.83 percent in 2008, peaking at 3.98 percent in 2009. At the end of 2017, ten years after the start of the financial crisis, Freddie Mac's delinquency rate had fallen to 1.08 percent.

The serious delinquency rates from the financial crisis translated into high credit losses for the Enterprises and a sharp increase in real estate owned properties (REO)

—properties acquired through foreclosure. Fannie Mae's credit losses as a percent of its guarantee book increased from 0.02 percent in 2006 to a peak of 0.77 percent in 2010. REO increased from 0.09 percent in 2006 to a peak of 0.53 percent in 2010. Freddie Mac experienced a similar loss and REO experience. Its credit losses grew from 0.01 percent in 2006 to a peak of 0.72 percent in 2010, and REO grew from 0.04 percent to 0.36 percent over this period.

When a borrower is unable to repay a mortgage, and a loan goes through the foreclosure process, the lender takes possession of the property that was pledged as collateral. When the property is conveyed to an Enterprise, it becomes real estate owned (REO) on the Enterprise's book.

As asset prices fell and other large financial firms failed, it became increasingly difficult for the Enterprises to issue debt to fund their retained portfolios, to raise new capital to cover the mark-to-market losses from private-label securities, and to build reserves for projected credit losses from credit guarantees. In the financial crisis, it became apparent that the Enterprises were not adequately capitalized to absorb these types of shocks.

In response to the substantial deterioration in the housing market that

left Fannie Mae and Freddie Mac unable to fulfill their mission without government intervention, FHFA used its conservatorship authority in the newly amended Safety and Soundness Act. On September 6, 2008, the Director of FHFA appointed FHFA as the conservator for each Enterprise to preserve and conserve the assets of the Enterprises and to put the companies in a sound and solvent condition. The goals of conservatorship are to restore confidence in the Enterprises, enhance the Enterprises' abilities to fulfill their missions, and mitigate the systemic risk that contributed directly to the instability during the financial crisis.

https://www.fhfa.gov/Conservatorship.

As conservator, FHFA directs the operations of each Enterprise. The Agency has empowered the Enterprises' boards of directors and senior management to manage most day-to-day operations of the Enterprises, so that the companies can continue to support the mortgage markets without interruption. The approach that FHFA uses to exercise control and manage the conservatorships of Fannie Mae and Freddie Mac is discussed in the next section.

While the Enterprises are in conservatorship, the Treasury Department provides Fannie Mae and Freddie Mac with financial support through PSPAs. This support is unprecedented, and was necessary for the Enterprises to be able to meet their outstanding obligations and to continue to provide liquidity to the mortgage market. The initial PSPAs in September 2008 included an initial issuance to the Treasury Department of preferred stock with a liquidation preference of $1 billion each in Fannie Mae and Freddie Mac and warrants for a 79.9 percent common equity stake in each Enterprise.

Quarterly draws were designed to allow each Enterprise to maintain positive net worth. The maximum permitted amount was set at $100 billion for each Enterprise. The dividend rate on senior preferred stock purchased by the Treasury Department was set at 10 percent. In addition, the PSPAs provided for a “periodic commitment fee” to compensate the Treasury Department for its continuing commitment to purchase further senior preferred stock, up to a maximum commitment amount, as necessary to maintain the solvency of the Enterprises. (The Treasury Department regularly waived that fee, and in the August 2012 third amendment to the PSPAs, the fee was indefinitely suspended for so long as the “net worth sweep” established by that amendment remained in effect.) The PSPAs also included a requirement for each Enterprise to reduce the size of the retained portfolio by at least 10 percent each year, but allowed a $250 billion portfolio per Enterprise to support core business functions. The first amendment to the agreement in May 2009 doubled the maximum cumulative draw per Enterprise to $200 billion, and a second amendment in December 2009 replaced the maximum draw amount with a formulaic approach.

The third amendment to the agreement in August 2012 replaced the 10 percent dividend and the periodic commitment fee with a variable structure, under which the net income of each Enterprise in excess of a small capital buffer (the “Applicable Capital Reserve Amount”) is swept to the Treasury Department. In many quarters, the payment equals quarterly net profits. With this amendment, all of the Enterprises' earnings are used to benefit taxpayers. The third amendment also provided for the uniform reduction of the Applicable Capital Reserve Amount from $3 billion to $0 at the end of 2017. In addition, the third amendment increased the rate of reduction in the size of the retained portfolios. Each Enterprise must reduce its portfolio by 15 percent per year, which is a faster reduction rate than the previous 10 percent annual reduction. This reduces the maximum retained portfolios to $250 billion by the end of 2018.

In December 2017, the PSPAs were revised to restore the Applicable Capital Reserve Amount to $3 billion. FHFA considers this capital reserve amount to be sufficient to cover normal fluctuations in income in the course of each Enterprise's business.

https://www.fhfa.gov/Media/PublicAffairs/Pages/Statement-from-FHFA-Director-Melvin-L-Watt-on-Capital-Reserve-for-Fannie-Mae-and-Freddie-Mac.aspx.

E. Enterprises' Business Model and Changes in Conservatorship

FHFA uses four key approaches to manage the conservatorships of Fannie Mae and Freddie Mac. First, it establishes the overall strategic direction for the Enterprises in the Strategic Plan for the Conservatorships and an annual scorecard. Next, within the scope of the Strategic Plan and annual scorecard, FHFA authorizes the board of directors and senior management of each Enterprise to carry out the day-to-day operations of the companies. Third, for certain actions which FHFA has carved out as requiring advance approval by the Agency, it reviews and considers those requests. Finally, FHFA oversees and monitors the Enterprises' activities.

FHFA's conservatorship strategic plan has three goals: (1) To maintain foreclosure prevention activities and new credit availability in a safe and sound manner, (2) to reduce taxpayer risk through increasing the role of private capital, and (3) to build a new securitization infrastructure. The annual scorecards provide more specific direction for meeting these goals. FHFA reports to the public on its yearly activities through a number of reports, including an Annual Report to Congress, scorecard progress reports, credit risk transfer progress reports, and updates on the implementation of the common securitization platform and single security.

As discussed earlier, the Enterprises' business model before conservatorship of supporting single-family and multifamily housing traditionally consisted of both a guarantee business and a portfolio business. In the guarantee business, lenders may exchange loans for a guaranteed mortgage-backed security, which may then be sold by the lender into the secondary market to recoup funds to make more loans, or they may sell loans directly to an Enterprise through the cash window. The Enterprises purchase loans through the cash window from multiple smaller-volume lenders to aggregate and later securitize and guarantee. Loans purchased through the cash window are held in portfolio until they are securitized and become part of the guarantee business. The Enterprises charge a guarantee fee to cover the costs of providing the guarantee. In the portfolio business, the Enterprises invest in assets such as whole loans or mortgage-backed securities, and funds those purchases with debt issuances.

Consistent with the terms of the PSPAs with the Treasury Department, the portfolio business has been reduced substantially in size during conservatorship, with the guarantee business assuming a much larger role. While the portfolio business involves both credit and market risk, in the guarantee business the Enterprises assume the credit risk and the market risk is borne by private investors in the guaranteed mortgage-backed securities. In conservatorship, consistent with direction provided by FHFA in its strategic plan and annual scorecard, the Enterprises have developed programs to transfer a significant portion of the credit risk in the single-family guarantee business to the private sector.

In addition to reducing the size of the retained portfolios, the Enterprises have also strengthened underwriting and

eligibility standards, aligned certain business processes, and worked toward implementing a common securitization platform.

Guarantee Fees

The Enterprises charge fees to lenders in return for guaranteeing the credit risk on mortgage-backed securities. In response to the housing crisis and in conservatorship, the Enterprises have made a number of changes to these guarantee fees. As a result, the average single-family guarantee fee increased from 22 basis points in 2007 to 57 basis points in 2016.

In 2008, to better align fees with credit risk, the Enterprises increased ongoing guarantee fees and added two new upfront fees: A fee based on the combination of a borrower's credit score and loan-to-value ratio, and a 25 basis point adverse market charge. In late 2008 through 2011, the Enterprises gradually raised fees and further refined their upfront fee schedules. In late 2011, as mandated by the Temporary Payroll Tax Cut Continuation Act of 2011,

FHFA directed the Enterprises to increase guarantee fees by 10 basis points on average to offset the cost to the Treasury Department of a temporary payroll tax cut enacted by Congress.

Public Law 112-78, Dec. 23, 2011, 125 Stat. 1280.

In 2012, FHFA directed the Enterprises to raise fees by an additional 10 basis points on average to better compensate taxpayers for the Enterprises' credit risk. Fees were raised in a manner that helped eliminate volume-based discounts and thereby provide a level playing field for lenders of all sizes.

In 2013, FHFA announced another round of fee increases but subsequently suspended the implementation of those changes in order to perform a comprehensive review of the Enterprises' guarantee fees. After completing that review in 2015, FHFA directed the Enterprises to implement certain adjustments. These adjustments included the elimination of the adverse market charge in all markets and targeted increases for specific loan groups. The set of fee changes was approximately revenue neutral with little to no impact for most borrowers.

In 2016, in response to findings in its ongoing quarterly guarantee fee reviews, FHFA established minimum guarantee fees by product type to help ensure the continued safety and soundness of the Enterprises.

Retained Portfolio

Under the PSPAs with the Treasury Department and direction from FHFA, the unpaid balance of each Enterprise's mortgage portfolio is subject to a cap that decreases by 15 percent each year until the cap reaches $250 billion. The Enterprises have made significant progress on reducing their retained portfolios, and toward using the portfolios to support core business activities rather than as a source of investment income. The Enterprises have reduced their retained portfolios by over 60 percent since 2009, and both Enterprises are ahead of schedule in meeting the 2018 maximum portfolio limits.

Most of the portfolio reduction has resulted from prepayments and regular amortization of mortgages. The Enterprises have also sold less-liquid assets, such as private-label securities and non-performing and re-performing loans, in order to transfer risk to private investors. The Enterprises also securitized certain re-performing mortgages held on their books and sold those securities into the market. Fannie Mae's holdings of Fannie Mae-guaranteed securities fell from $229 billion at the end of 2008 to $49 billion in 2017, and holdings of other securities fell from $133 billion to $5 billion over the same period. Freddie Mac's retained portfolio experienced similar declines, as holdings of Freddie Mac-guaranteed securities fell from $425 billion in 2008 to $132 billion in 2017, and other mortgage securities fell from $269 billion to $14 billion over the same period.

The Enterprises' retained portfolios now primarily support the core business activities of aggregating loans from single-family and multifamily lenders to facilitate securitization, and holding delinquent loans in portfolio to facilitate loan modifications in order to keep borrowers in their homes and reduce Enterprise losses. The portfolios also support certain affordable products that cannot be easily securitized. In addition, the Enterprises' retained portfolios may be used to support underserved markets under Duty-to-Serve Plans that the Enterprises have begun to implement in 2018.

Credit Risk Transfer

The Enterprises have significantly expanded their practice of transferring credit risk to the private sector in recent years. Credit risk transfer (CRT) has long been a part of each Enterprise's multifamily business. In 2016, the Enterprises transferred a portion of credit risk to private investors on over 90 percent of their combined multifamily acquisition volume. In 2013, the Enterprises began to develop programs to transfer a portion of the credit risk on their single-family new-acquisition businesses. The purpose is to reduce the risk to the Enterprises and taxpayers of future borrower defaults where it is economically sensible to do so.

FHFA assesses the Enterprises' CRT programs using certain core principles. The transactions must transfer a meaningful amount of credit risk to private investors to reduce taxpayer risk, and the cost of the credit risk transfers must be economically sensible in relation to the cost of the Enterprises self-insuring the risk. In addition, the transactions may not interfere with the Enterprises' core business, including the ability of borrowers to access credit. The CRT programs are intended to attract a broad investor base, be scalable, and incorporate a regular program of issuances. In transactions where credit risk may not be not fully collateralized, the program counterparties must be financially strong and able to fulfill their commitments even in adverse market conditions.

Loans targeted for single-family CRT include fixed-rate mortgages with loan-to-value ratios greater than 60 percent and original term greater than 20 years. These loans carry the majority of the Enterprises' credit risk exposure. Loans targeted for credit risk transfer have grown from 42 percent of total Enterprise acquisitions in 2013 to 62 percent of acquisitions in the first half of 2017. The Enterprises continue to assume the full credit risk on less risky loans with lower loan-to-value ratios and shorter terms, as well as on certain higher risk legacy loans where the economics do not favor CRT transactions. The Enterprises also transfer risk on loans outside of the targeted loan population.

The single-family CRT programs, implemented since 2013, supplement the more traditional credit enhancements required by the Enterprises' charters. The charters require loans with loan-to-value ratios above 80 percent to have loan-level credit enhancement, most often obtained through private mortgage insurance. From 2013 through the first half of 2017, the Enterprises transferred a portion of the credit risk through their single-family CRT programs on $1.8 trillion of mortgages with a combined risk in force of $61 billion, or 3.4 percent of the credit risk. During the same period, primary mortgage insurers also covered a portion of credit risk on $837 billion of unpaid principal

balances (UPB) through traditional loan-level insurance.

Since 2013, the CRT programs have become a core part of the single-family business. In the second quarter of 2017, the Enterprises transferred risk on $213 billion of mortgages, with risk in force of $6 billion or nearly 3 percent of risk. Debt issuances accounted for 70 percent of the risk in force, insurance and reinsurance transactions accounted for 25 percent, and lender risk sharing accounted for the remaining 5 percent. Front-end reinsurance transactions increased from 2 percent of the risk in force in the first quarter of 2017 to 4 percent in the second quarter. In the first half of 2017, loans targeted for CRT represented 62 percent of the Enterprises' single-family loan production.

Enterprise debt issuances have been the primary risk transfer vehicle to date. Fannie Mae uses a structure called Connecticut Avenue Securities (CAS), while Freddie Mac issues Structured Agency Credit Risk (STACR) securities. CAS and STACR have been designed to track the performance of a reference pool of loans previously securitized in Enterprise guaranteed MBS. These debt transactions are fully collateralized, since investors pay for the notes in full and absorb credit losses through a reduction in the principal due on the underlying notes. The Enterprises typically retain the first 50 basis points of expected losses in most transactions because purchasing protection for this portion may not offer economic benefits. While debt transactions have been the primary CRT method, the Enterprises have worked to broaden their investor base through other structures, and to compare executions across different structures and market environments.

Insurance and reinsurance transactions are considered part of the Enterprises' CRT programs and are separate from the Enterprises' charter requirements for loans with loan-to-value ratios above 80 percent. These transactions generally involve pool-level policies that cover a specified amount of credit risk for a large pool of loans. Fannie Mae uses a structure called Credit Insurance Risk Transfer (CIRT), while Freddie Mac uses the Agency Credit Insurance Structure (ACIS). These structures are partially collateralized, and the Enterprises distribute risk among a group of highly-rated insurers and reinsurers to reduce counterparty and correlation risk.

In senior/subordinate transactions, an Enterprise sells a group of mortgages to a trust that securitizes the cash flows into different bond tranches. Prior to 2017, super conforming loans that would otherwise have backed Freddie Mac mortgage-backed securities were used as collateral in Freddie Mac's single-family senior/subordinate transactions called Whole Loan Securities (WLS). The subordinate and mezzanine tranches, which are not guaranteed, absorb the expected and unexpected credit losses. The senior bonds, which were guaranteed by the Enterprise, have historically traded at a slight discount to comparable Freddie Mac mortgage-backed securities. In order to provide a more scalable and economic solution, in 2017 Freddie Mac introduced a revised structure to its WLS, called STACR Securitized Participation Interests (SPI). This new structure allows for the issuance of mortgage-backed securities rather than guaranteed senior certificates to improve the pricing execution in the credit risk transfer. The STACR SPI trust will continue to issue unguaranteed credit certificates as subordinate and mezzanine tranches. In contrast to synthetic CRT structures, the senior/subordinate structure is eligible for purchase by real estate investment trusts (REITs).

Another form of single-family risk structure is lender front-end CRT, where the credit risk is transferred prior to or simultaneous with the Enterprise loan acquisition. Lender front-end risk transfer can be structured through the issuance of securities with the lender holding the credit risk by retaining the securities, or by selling the securities to credit risk investors. Alternatively, in traditional lender recourse transactions, the lender may forgo securities issuance and simply retain the credit risk. The lender will often, but not always, fully collateralize its obligation. While the Enterprise charter requirement for loan-level credit enhancement is typically through private mortgage insurance, the charters allow the Enterprises to accept lender recourse as an alternative, so lender retention of credit risk has been used to a lesser extent in the past. However, this lender recourse has not always been fully collateralized.

While the newest forms of single-family CRT started in 2013, risk sharing has been an integral part of the Enterprises' multifamily business for many years. Fannie Mae's primary multifamily risk-transfer program exists through its Delegated Underwriting and Servicing (DUS). In this program, lenders typically share up to one-third of the credit losses on a pro-rata basis with the Enterprises. In an effort to broaden its program offerings, Fannie Mae completed the first non-DUS CRT in 2016 when it transferred a portion of its credit risk to the reinsurance industry. Freddie Mac's multifamily risk-transfer program generally exists through its K-Deal program in which Freddie Mac purchases loans that are put into diversified pools, and placed into multiclass securities for sale to private investors. The subordinate and mezzanine bond tranches are not guaranteed by Freddie Mac. Instead, the subordinate or “B-piece” holders are in the first-loss position in the event of a mortgage default. If losses exceed the “B-piece” level, holders of the mezzanine bond tranche assume the additional losses. The subordinate and mezzanine tranches are sized such that virtually all credit risk is transferred to the investors in those securities. The senior bonds comprise the remainder of the K-Deal and are guaranteed by Freddie Mac.

Underwriting Standards and Qualified Mortgages

The Enterprises are required to emphasize sound underwriting practices in their purchase guidelines. Since entering conservatorship, the Enterprises have continued to refine automated underwriting systems to better assess risk, reduce risk layering, improve the use of compensating factors, and enable access to credit in a safe and sound manner. The Enterprises launched the Uniform Mortgage Data Program to standardize data in the mortgage industry to help improve loan quality and mortgage risk management. The Enterprises also revamped the Representation and Warranty Framework to reduce lender uncertainty around requirements to repurchase loans from the Enterprises and to support access to credit.

In the Dodd-Frank Act, Congress adopted ability-to-repay requirements for nearly all closed-end residential mortgage loans. Congress also established a presumption of compliance with these requirements for a certain category of loans called Qualified Mortgages (QM). The Consumer Financial Protection Bureau (CFPB) adopted an ability-to-repay rule to implement these provisions.

A loan is generally considered a Qualified Mortgage if: (1) The points and fees do not exceed 3 percent of the loan amount, (2) the term does not exceed 30 years, (3) the loan is fully amortizing with no negative amortization, interest-only, or balloon features, and (4) the borrower's debt-to-income (DTI) ratio does not exceed 43 percent. CFPB also defined a special transitional class of QM loans that are not subject to the 43 percent DTI limit if they are eligible for sale to either Enterprise.

Before the CFPB rule became final, the Enterprises had already improved underwriting standards and eliminated purchases of the higher risk products such as negative amortization and interest-only loans. In 2013, after the CFPB rule became final, FHFA directed each Enterprise to acquire only loans that meet the points and fees, term and amortization requirements of the CFPB's rule for Qualified Mortgages.

Loss Mitigation

FHFA has also worked with the Enterprises to develop effective loss mitigation programs to minimize losses and enable borrowers to avoid foreclosure whenever possible. The Enterprises aligned their loss mitigation standards and developed updated loan modification and streamlined refinance products. The Enterprises are also pursuing efforts to stabilize distressed neighborhoods through the Neighborhood Stabilization Initiative. Better underwriting standards, improved loss mitigation, and an improving economy have resulted in the Enterprises' serious delinquency rates falling to their lowest level since the Enterprises entered into conservatorship in 2008.

Fannie Mae's single-family serious delinquency rate fell from 2.42 percent at the end of 2008 to 1.24 percent at the end of 2017. Freddie Mac's single-family serious delinquency rate fell from 1.83 percent to 1.08 percent over the same period.

Common Securitization Platform and Single Security

During conservatorship, the Enterprises have worked to build a new single-family securitization infrastructure. This includes development of a common securitization platform (CSP) and a single Enterprise mortgage-backed security. Fannie Mae and Freddie Mac established Common Securitization Solutions, LLC (CSS) as a jointly-owned company to develop and operate the platform. The platform will replace some of the proprietary systems used by the Enterprises to securitize mortgages and perform the back office functions.

In 2015, FHFA announced a two-part process for the CSP and single security. Release 1, which was implemented in 2016, uses the CSP to issue Freddie Mac's existing single-class securities. Release 2, the implementation of which is planned for the second quarter of 2019, will enable the issuance of the single security called the Uniform Mortgage Backed Security (UMBS) through the CSP. The single security initiative will increase the liquidity of the TBA market for newly issued mortgage-backed securities and will eliminate the differences in pricing between Fannie Mae and Freddie Mac securities.

Governance and Supervision

When FHFA placed the Enterprises into conservatorship, it replaced most members of the boards of directors and many senior managers. Through conservatorship and regular supervisory oversight, the Agency required the Enterprises to improve risk management, update legacy systems, and improve data management. As part of its supervision function, FHFA issues advisory bulletins, which communicate FHFA's supervisory expectations to the Enterprises on specific supervisory matters and topics. In addition, through its supervision program, FHFA's on-site examiners conduct supervisory activities to ensure safe and sound operations of the Enterprises. These supervisory activities include the examination of the Enterprises to determine whether they comply with their own policies and procedures and regulatory and statutory requirements, and whether they comply with FHFA directives and meet the expectations set in FHFA's advisory bulletins.

F. Comparison of Enterprises and Large Depository Institutions

FHFA has reviewed and used the regulatory capital standards applicable to commercial banks as a point of comparison in developing the proposed capital requirements for the Enterprises. In conducting this evaluation, it was important for FHFA to consider both similarities and differences in the Enterprise and bank business models. This section reviews capital requirements for depository institutions and then discusses the differences in Enterprise and bank business models.

Bank Capital Requirements

Basel Accords

The Basel Accords set the international framework for bank capital requirements. The initial framework, Basel I, was replaced by Basel II, which was in place during the financial crisis. After the financial crisis, regulators adopted standards consistent with Basel III. Each country has a different way of applying the Basel standards to meet their national legal framework. The Federal Reserve Board (Board), Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation have federal regulatory and supervisory jurisdiction over banks in the United States.

The Basel Accords have evolved over time. The 1988 Basel Accord, also known as Basel I, was implemented by the Group of Ten (G-10) countries in 1992. In Basel I, credit risk was addressed by using simple ratios, there was little attention given to market risk, and no provision was made for operational risk. The Basel II update was initially published in 2004 to make the capital calculation more risk sensitive. Basel II had three pillars: Risk-based capital requirements, supervisory review, and market discipline. For the risk-based capital requirements under Basel II, credit risk, market risk, and operational risk were all quantified based on data, and credit risk could be quantified using either the standardized approach or internal ratings based (IRB) approach. Under the supervisory review pillar, Basel II provided a framework for supervisory review of systemic, concentration, and liquidity risk among others. Under the market discipline pillar, Basel II included a set of disclosure requirements to allow market participants to better understand an institution's capital adequacy.

When the U.S. banking regulators issued the final Basel II rules in late 2007 and in 2008, the regulators required each bank to follow the set of rules that was the most conservative for the bank. The largest banks were required to use the internal ratings based approach, while the smaller banks were given a choice between using the standardized approach or the internal ratings based approach.

Basel III was developed in response to the financial crisis and was agreed to by Basel members in 2010-11. Basel III strengthened the requirements in Basel II and introduced bank liquidity requirements to reduce the risk of a run on a bank. Basel III also added capital buffers as extra capital cushions on top of regulatory capital minimums, to absorb unexpected shocks. Basel III is being phased in through 2019.

U.S. Risk-Based and Leverage Capital Requirements for Banks

Under current regulations implemented by U.S. regulators to align with Basel III, U.S. banks must meet certain leverage and risk-based capital requirements to be considered adequately capitalized. These capital adequacy standards protect deposit holders and the stability of the financial system. Two types of capital are measured: Tier 1 and Tier 2. Tier 1 capital comprises common stock, retained earnings, non-cumulative perpetual preferred stock, and accumulated other comprehensive income (AOCI). Common equity Tier 1 capital excludes cumulative preferred stock. Tier 2 capital is supplementary

capital consisting of items such as, but not limited to, cumulative preferred stock, subordinated debt, and certain reserves that provide less protection.

Banks must also meet certain risk-based capital ratios and leverage ratios under existing regulations. As part of the risk-based capital standard for credit risk, the capital ratio is the ratio of capital to risk-weighted assets (RWA). Basel allows banks to choose between two methods for calculating their capital requirement for credit risk, and U.S. regulators have implemented both methods under existing regulations: The standardized approach and the internal ratings based approach. Under the standardized approach, regulators require use of prescribed risk weights for every type of exposure to determine the credit risk RWA amount. Mortgages have a risk weight of 50 percent under the standardized approach, regardless of the loan-to-value ratio, credit score, and other risk attributes. The largest banks in the U.S. are required to use the internal ratings based (IRB) approach to determine the risk weights of asset classes. In the IRB approach, the capital charge for a mortgage varies based on the risk attributes of the specific mortgage loan using the credit model and loss experience of the bank. However, when calculating minimum capital requirements, under the Dodd-Frank Act's Collins Amendment large U.S. banks must compute their risk-weighted assets using both a standardized approach and the advanced approach, and must use the higher of these two numbers when computing pre-stress risk-based capital ratios. Because the standardized approach often results in a higher ratio, the Collins Amendment effectively makes the standardized approach the binding requirement for large U.S. banks, and serves to place all banks, regardless of size, on equal footing in terms of minimum risk-based capital requirements. In contrast to the risk-based capital ratios, the leverage ratios compare capital to assets without any weighting for risk.

Prompt Corrective Action Framework

The Federal Deposit Insurance Act requires insured depository institutions and federal banking regulators to take prompt corrective action to resolve capital deficiencies as defined under the prompt corrective action framework.

To be considered well capitalized, banks must have a total risk-based capital ratio of 10 percent, Tier 1 risk-based capital ratio of 8 percent, common equity Tier 1 risk-based capital ratio of 6.5 percent, and Tier 1 leverage ratio of 5 percent. To be considered adequately capitalized, banks must have a total risk-based capital ratio of 8 percent, Tier 1 risk-based capital ratio of 6 percent, common equity Tier 1 risk-based capital ratio of 4.5 percent, and Tier 1 leverage ratio of 4 percent. Lower levels of capital result in a bank being classified as undercapitalized, significantly undercapitalized, or critically undercapitalized. At the extreme lower end, a bank would be placed into receivership.

12 CFR 324.403.

The banking regulators also mandate three capital buffers relative to the risk-based capital ratios: The capital conservation buffer, the countercyclical capital buffer, and the global systemically important bank (G-SIB) surcharge. Banks must meet applicable buffers to avoid restrictions on capital distributions.

The capital conservation buffer requires banks to maintain each of the three risk-based capital ratios (Common Equity Tier 1, Tier 1, and Total Capital) at levels in excess of 2.5 percent above the minimum required levels. The countercyclical capital buffer requires banks to maintain an additional amount of excess capital during economic periods of non-stress. The countercyclical buffer has a potential range of 0 percent to 2.5 percent, and is currently set to zero. As it is structured, the countercyclical capital buffer functions as an extension of the capital conservation buffer. The G-SIB surcharge is applied in addition to the capital conservation buffer, but only on the largest banks identified as globally systemically important. The G-SIB surcharge is based on defined criteria that determine the size of the bank's systemic footprint, which represents the risk that the bank poses to the global financial system in excess of risk posed by financial institutions not subject to the surcharge. The different buffers are being phased-in through 2019.

In addition to the risk-based capital requirement, federal banking regulators have also established a 4 percent Tier 1 leverage ratio that measures the Tier 1 capital available relative to average consolidated assets. This measure does not capitalize off-balance sheet exposures.

Bank regulatory capital rules also require calculation of a supplementary leverage ratio (Tier 1 capital/total leverage exposure) for banks that are subject to that requirement starting in January 2018.

The supplementary leverage ratio is 3 percent of on-balance sheet assets and off-balance sheet exposures and applies to those banking institutions that must adhere to the advanced approach. In addition, those institutions with more than $700 billion in total consolidated assets are also subject to the enhanced supplementary leverage buffer of an additional 2 percent, totaling 5 percent when combined with the supplementary leverage ratio of 3 percent.

Banks must meet each of these minimum regulatory capital ratios, as required, after making all capital actions included in the capital plan, under both the baseline and stress scenarios over the nine-quarter planning horizon.

The supplemental leverage ratio includes off-balance sheet exposures for large banks.

The Federal Reserve Board and the Office of the Comptroller of the Currency (OCC) recently proposed a rule that included changes to the enhanced supplementary leverage ratio standards.

See https://www.gpo.gov/fdsys/pkg/FR-2018-04-19/pdf/2018-08066.pdf.

See

Table 1 at

https://www.federalreserve.gov/publications/comprehensive-capital-analysis-and-review-summary-instructions.htm.

Some banks, depending on their size and complexity, must meet additional buffers—capital conservation buffer, countercyclical buffer and globally systemically important bank surcharge—but these are not included in the stress test assessment.

Comprehensive Capital Analysis and Review (CCAR) and Capital Plan Requirements

In addition to the requirements that are tied to a prompt corrective action framework, the Federal Reserve Board's annual CCAR also assesses the capital adequacy of large bank holding companies with at least $50 billion in assets. The CCAR review is based on a going-concern structure, where the bank holding company must hold enough capital to withstand a severely adverse scenario, continue to lend, and meet creditor obligations over a nine-quarter period of time. The CCAR stress tests are tied to the Board's capital plan requiring that these bank holding companies submit a capital plan to the Federal Reserve each year. The bank holding companies are required to report the results of stress tests conducted under supervisory scenarios provided by the Board and under a baseline scenario and a stress scenario designed by the bank holding company.

The Board's qualitative assessment of each bank holding company's capital plan considers the institution's capital planning process, including the stress testing methods, internal controls, and governance. The quantitative assessment of the plan is based on the supervisory and institution-run stress tests that are conducted in part under the Dodd-Frank Act stress test rules.

The Board may object to a capital plan based on the qualitative and quantitative assessments, and, as a result, may restrict capital distributions.

However, the stress test results do not trigger prompt corrective actions as described above under the Federal Deposit Insurance Act.

The DFAST and CCAR capital analyses use the same projections of income, assets and RWA, but

use different capital action assumptions to project post-stress capital levels.

The Federal Reserve Board recently published a notice of proposed rulemaking that would create a single, integrated capital requirement by combining the quantitative assessment of the CCAR with the buffer requirements in the Board's regulatory capital rule, and eliminate the CCAR quantitative objection in the process.

See

83 FR 18160 (April 25, 2018).

Under CCAR, during anticipated stress periods defined by the stress test scenarios required by the Board, banks are expected to maintain capital levels above the minimum risk-based and leverage capital ratios for adequately capitalized institutions under the prompt corrective action framework described earlier.

The stress test uses RWA based on the standardized approach, but these large banks may use the model-based internal ratings-based approach for capital adequacy under the prompt corrective action framework.

Comparison of Enterprise and Bank Business Models

While the Enterprises are comparable in size to some of the largest depository institutions, the relative risks of banks compared to the Enterprises differ in important ways. These differences include, among others, the sources and associated risk level of income and assets, differences in funding risk, and the relative exposure to mortgage assets. Each of these differences is discussed below.

First, while banks have a more diversified source of income and assets compared to the Enterprises, the overall risk of Enterprise mortgage assets is lower than that of banks. Banks are depository institutions that attract customer deposits on which banks pay interest expense, and lend those funds through loans in diversified asset classes to other customers from whom the bank earns interest income, thereby earning net interest income. Bank lending covers a number of different asset classes, not just real estate lending, such as credit cards, car loans, and business loans. Since the repeal of the Glass-Steagall Act in 1999, banks have also been more active in earning non-interest income through brokerage fees and other business activities. However, traditional depository institutions still rely primarily on net-interest income, as compared to investment banks.

The Enterprises are monoline businesses focused on mortgage assets. For banks, mortgage assets carry a 50 percent risk weight in the Basel standardized framework. Therefore, the Enterprises' aggregate risk weight is lower than the average risk weight of banks with an abundance of assets with risk weights higher than 50 percent. To derive the risk-weighted asset density of bank assets, FHFA looked at the 31 largest bank holding companies subject to CCAR, to calculate an average risk-weighted asset density using end-of-quarter data from the first quarter of 2011 through the fourth quarter of 2014. The analysis estimated an overall risk-weighted asset density of 72 percent for the banks compared to 50 percent for residential mortgages.

Second, banks rely on more volatile funding sources compared to the Enterprises, which exposes banks to a greater degree of funding risk during times of market and economic stress. Banks use short-term customer deposits and debt as sources of funding for their business activity, both of which can leave a bank in need of new funding sources during times of economic uncertainty, such as during the recent financial crisis. In such situations, a bank could find that new sources of debt become considerably more expensive, if such sources are available at all. This type of funding risk is commonly referred to as rollover risk. By comparison, the Enterprises' core credit guarantee business of purchasing and securitizing mortgage loans provides a more stable source of funding that cannot be withdrawn during periods of market and economic stress, and is therefore not subject to rollover risk. Investors purchasing Enterprise mortgage-backed securities provide the companies with match-funding for these mortgage assets. The funding risk associated with the Enterprises' retained portfolios is more comparable to the funding risks of banks described above.

Third, even when comparing risk specifically associated with mortgage lending the Enterprises hold less risk compared to the mortgage investments of banks. Banks hold a larger portion of mortgages—both single-family and multifamily loans—as whole loans on their balance sheets. This exposes banks to interest rate, market, and credit risks associated with those loans. On the other hand, through their core guarantee business of purchasing mortgage loans and issuing mortgage-backed securities, the Enterprises transfer the interest rate and market risk of these loans to private investors. In addition, as mentioned above, the Enterprises also face substantially less funding risk compared to banks because of the match funding provided through mortgage-backed securities investors.

While the Enterprises remain responsible following securitizations for guaranteeing the credit risk of securitized loans, they have also developed ways to transfer significant parts of their credit risk to private market participants. During conservatorship, the Enterprises have developed credit risk transfer programs to transfer a portion of the credit risk for single-family mortgage purchases to private investors. In addition, the Enterprises' unique business models transfer credit risk on multifamily loans to private investors. Thus, the Enterprises have transferred a significant portion of the credit risk associated with their whole mortgage loans, whereas comparable whole mortgage loans are typically held by banks on their balance sheets.

The risk associated with the Enterprises' retained portfolios is similar in nature to risks held by banks. However, the Enterprises' retained portfolios have declined by more than a combined 60 percent while in conservatorship and are required by the PSPAs not to exceed $250 billion. While the Enterprises still have legacy assets that were purchased before conservatorship as part of their retained portfolios, their ongoing use of retained portfolios during conservatorship has focused on supporting their core credit guarantee business. The Enterprises use their cash window to purchase single-family and multifamily loans directly from lenders, often smaller lenders, and aggregate these loans for subsequent securitization. The cash window enables smaller lenders to access the secondary market at competitive rates. The Enterprises also use their retained portfolios to repurchase non-performing loans as part of loss mitigation efforts to reduce losses for the Enterprises and taxpayers, and to help homeowners stay in their homes whenever possible.

FHFA is also not including separate buffers in this proposed rule beyond the proposed risk-invariant going-concern buffer for several reasons. First, FHFA believes that the robust features it selected for the proposed risk-based capital requirements make including a separate buffer unnecessary. These features include (1) covering losses for different loan categories for a severe stress event comparable to the recent financial crisis,

with somewhat more

conservative house price recoveries than were observed following the recent financial crisis, (2) setting capital requirements without including future revenue, consistent with the Basel methodology, (3) requiring the full life-of-loan capital be put in place for each loan acquisition, and (4) the proposed risk-based capital requirements would include components for operational risk, market risk, and a risk-invariant going-concern buffer. Second, FHFA has the authority to increase capital requirements when prudent—either for risk-based capital or minimum leverage capital requirements—by order or regulation. Third, while bank capital buffers are used to decide whether to restrict distributions of income, rather than changing the level of capital that is necessary to declare a bank undercapitalized and activate the prompt-corrective-action framework if the level is not met, the primary intent of the FHFA capital rule would be to establish the level of capital that should be considered “adequate” for the prompt-corrective-action framework of the Safety and Soundness Act.

The 25 percent home price decline assumption in the severe stress event is also consistent with assumptions used in the DFAST severely adverse scenario over the past several years, although the

2017 DFAST cycle assumes a 30 percent home price decline in its severely adverse scenario.

G. Dodd-Frank Act Stress Test Process

Section 165 of the Dodd-Frank Act required the annual stress testing of certain financial companies with consolidated assets over $10 billion that are supervised by a federal regulator. Consistent with the Act, FHFA conducts stress tests of the Enterprises to determine whether each firm has the capital necessary to absorb losses during a period of adverse economic conditions. While in conservatorship, the Enterprises receive financial support through the PSPAs with the Treasury Department. Although the PSPAs restrict the ability of the Enterprises to hold equity capital beyond their approved capital buffers, FHFA expects the Enterprises to have procedures in place to support sound business decisions and the Enterprises have continued to consider capital levels and return on capital as integral parts of their business decision-making processes.

FHFA's stress testing rule establishes the basic requirements for the Enterprises on how to conduct the Dodd-Frank Act Stress Test (DFAST) each year. The Dodd-Frank Act requires financial regulators to use generally consistent and comparable stress scenarios. FHFA has generally aligned the stress scenarios for the Enterprises with the Federal Reserve Board's supervisory scenarios for annual stress testing required under the DFAST rule and CCAR. Each year, FHFA provides the Enterprises with specific instructions and guidance for conducting the stress tests, as well as for reporting and publishing results.

The annual stress testing process includes three distinct scenarios—baseline, adverse, and severely adverse—with each scenario covering a nine-quarter period. The scenarios include macroeconomic variables, interest-rate variables, and indices (

e.g.,

unemployment rates, mortgage rates, house price paths, and gross domestic product). The Enterprises use these variables and indices as model inputs to stress the retained portfolios and guarantee business.

Since the Enterprises began conducting the annual DFAST process in 2014, the severely adverse scenario has generally represented economic conditions similar to those that occurred during the 2008 financial crisis. Although the specific scenario variables differ from year to year, the conditions represented by the macroeconomic, interest rate, and asset price shocks in the severely adverse scenario are consistent with a major market disruption similar to the disruption experienced in the 2008 crisis.

The severely adverse scenario also includes a global market shock component which is tailored to include particular risks faced by the Enterprises. This shock is treated as an add-on to the macroeconomic scenario and is taken as an instantaneous loss and reduction of capital in the first quarter of the nine-quarter planning horizon. It is assumed that none of these losses are recovered over the nine quarters. The Enterprises apply the shock to portfolio assets that are subject to fair value accounting (

i.e.,

assets classified as held-for-trading, available-for-sale, and held-for-sale). In addition, the global market shock includes a default of each Enterprise's largest counterparty. The shock assumes that each Enterprise incurs losses due to the sudden and unexpected default of the counterparty to which it has the greatest financial exposure. Counterparties within the scope of the largest counterparty default component include security dealers for derivatives, private mortgage insurers, and multifamily credit enhancement providers.

The Federal Reserve Board releases DFAST supervisory scenarios in January or February of each year. FHFA provides the Enterprises with summary instructions and guidance within 30 days following the issuance of the Federal Reserve Board's final element of its supervisory scenarios. The instructions include submission templates for use in compiling and reporting the DFAST results for the three stress scenarios. The Enterprises conduct the stress tests and submit their results to FHFA on or before May 20 each year. For capital planning purposes, the Enterprises focus on the severely adverse scenario. FHFA requires the Enterprises to publicly disclose the DFAST stress test results under the severely adverse scenario between August 1 and August 15 each year.

For DFAST reporting purposes, FHFA requires the Enterprises to report two sets of financial results for the severely adverse scenario: One with and one without the establishment of a valuation allowance on deferred tax assets. In general, deferred tax assets are considered a capital component because these assets have loss absorbing capability by offsetting losses through the reduction of taxes. A valuation allowance on deferred tax assets is typically established to reduce deferred tax assets when it is more likely than not that an institution would not generate sufficient taxable income in the foreseeable future to realize all or a portion of its deferred tax assets. A valuation allowance on deferred tax assets is a non-cash charge resulting in a reduction in income and the retained earnings component of capital.

In 2008, during the financial crisis, Fannie Mae and Freddie Mac established partial valuation allowances on deferred tax assets of $30.8 billion and $22.4 billion, respectively. The reduction in capital from partial valuation allowances in 2008 contributed to the Enterprises' draws from the Treasury Department. Both Enterprises released the valuation allowances on deferred tax assets several years later, which resulted in a benefit to income at both Enterprises. For full transparency of the potential impact of deferred tax assets on the Enterprises' capital positions in a stress scenario, FHFA requires the Enterprises to disclose the severely adverse results both with and without the establishment of a valuation allowance on deferred tax assets. In the 2017 DFAST severely adverse scenario, for results that do not include establishing a valuation allowance on deferred tax assets, Fannie Mae's cumulative stress losses were $15 billion and Freddie Mac's cumulative stress losses were $20 billion. For results that include establishing a valuation allowance on deferred tax assets, Fannie Mae's cumulative stress losses were $58 billion and Freddie Mac's cumulative stress losses were $42 billion.

H. Important Considerations for the Proposed Rule

In summary, in developing the proposed rule, FHFA considered all information in this proposal and developed the proposed rule with the following factors in mind:

1. The Enterprises should operate under a robust capital framework that is similar to capital frameworks applicable to banks and other financial institutions, but appropriately differentiates from other capital requirements based on the actual risks associated with the Enterprises' businesses;

2. In proposing capital requirements, FHFA should use the substantial expertise and experience gained during the protracted conservatorships of the Enterprises to ensure that the capital requirements secure the safety and soundness of the Enterprises while also supporting their statutory missions to foster and increase liquidity of mortgage investments and promote access to mortgage credit throughout the Nation;

3. FHFA considers it prudent to have risk-based capital requirements that include components of credit risk, operational risk, market risk, and a risk-invariant going-concern buffer; that require full life-of-loan capital for each loan acquisition; that are calculated to cover losses in a severe stress event comparable to the recent financial crisis, but with house price recoveries that are somewhat more conservative than experienced following that crisis; and that do not count future Enterprise revenue toward capital;

4. FHFA's ongoing authority under the Safety and Soundness Act to increase by order or regulation capital requirements—either risk-based or minimum leverage—reduces the need to put in place at this time specific limited-purpose or countercyclical buffers; and

5. It may be necessary in the future for FHFA to revise this rule or to develop a separate capital planning rule to more fully address stress testing of the Enterprises, the timing and substance of which will depend on the status of the Enterprises after housing finance reform.

II. The Proposed Rule

A. Components of the Proposed Rule

Risk-Based Capital Requirements

The Enterprises' assets and operations are exposed to different types of risk, and the proposed risk-based capital requirements would provide a granular and comprehensive approach for assigning capital requirements to individual asset and guarantee categories. The proposed risk-based capital requirements cover credit risk, including counterparty risk, as well as market risk and operational risk capital requirements for each asset and guarantee category. The proposed risk-based capital requirements also include a going-concern buffer, which would require the Enterprises to hold additional capital beyond what is required to cover economic losses during a severe financial stress event in order to maintain market confidence.

The credit risk capital requirements in the proposed rule are based on unexpected losses (stress losses minus expected losses) over the lifetime of mortgage assets. The proposed requirements were developed using historical loss data, including loss experience from the recent financial crisis. In addition, the proposed rule requires the Enterprises to hold this capital at the time of purchasing or guaranteeing an asset, and it does not, in general, count any future revenue toward the credit risk capital requirements.

For single-family and multifamily whole loans and guarantees, the proposed credit risk capital requirements use look-up tables consisting of base grids and risk multipliers to adjust capital requirements for the risk characteristics of each type of mortgage asset. Under this approach, an Enterprise's required capital will change with the composition of its book of business.

The proposed rule also includes a framework through which the Enterprises' credit risk capital requirements would be reduced to reflect the benefit of credit risk transfer transactions that protect the Enterprises and taxpayers from bearing potential credit losses. FHFA's proposed approach to calculating the capital relief provided by credit risk transfer transactions seeks to capture the credit risk protection provided while also accounting for counterparty risk for those transactions that are not fully funded up front.

The market risk component of the proposed risk-based capital framework establishes specific requirements for the market risk associated with certain Enterprise assets. The proposed approach focuses on capturing the spread risk associated with holding different assets in the retained portfolio: Single-family whole loans, multifamily whole loans, private label securities (PLS), commercial mortgage-backed securities (CMBS) and other assets with market risk exposure.

These mortgages include legacy assets acquired by the Enterprises prior to conservatorship and assets purchased as part of the Enterprises' ongoing aggregation function, including aggregating single-family loans through the cash window before securitizing the loans into MBS, and Freddie Mac's aggregation of multifamily loans before placing the loans in K-deals or other securitizations.

The Enterprises are no longer acquiring PLS and CMBS, and their holdings of these assets are currently in run-off mode.

The operational risk component of the proposed risk-based capital framework establishes an operational risk capital requirement of 8 basis points for all assets and guarantees to reflect the inherent risk in ongoing business operations.

The going-concern buffer component of the proposed risk-based capital framework establishes a 75 basis point requirement for most assets and guarantees, regardless of credit, market, or operational risk capital requirements. This buffer would ensure that the Enterprises maintain at least 75 basis points of capital on any mortgage guarantee, whole loan, or mortgage-related security held by the Enterprises. Based on the current size and composition of the Enterprises' books of business, FHFA estimates that the going-concern buffer would provide the Enterprises with sufficient capital to continue operating without external capital support for one to two years after a stress event.

FHFA sought to reduce model risk by developing the proposed risk-based requirements using a combination of the results from multiple models.

The proposed capital requirements are based on the model results from both Enterprises, and in some cases on model results from both Enterprises and from FHFA. In all cases the models were estimated to the extent possible using the Enterprises' historical loss data, including experiences from the recent housing crisis. While the proposed risk-based capital requirements reflect the Agency's view of the relative risk of Enterprise assets, which is subject to model risk, the two proposed alternative minimum leverage capital requirements are intended to provide a backstop to offset and balance this risk.

FHFA acknowledges that multiple models could increase the burden of ongoing model risk management. However, FHFA sought to increase the reliability of the estimations used in the proposed grids and multiplier framework by combining the results of multiple models, and hence decreasing overall model risk.

Minimum Leverage Capital Requirement

The proposed rule includes two alternative minimum leverage capital requirement proposals for consideration. Under the first approach, the 2.5 percent alternative, the Enterprises would be required to hold capital equal to 2.5 percent of total assets (as determined in accordance with GAAP) and off-balance sheet guarantees related to securitization activities, regardless of the risk characteristics of the assets and guarantees or how they are held on the Enterprises' balance sheets. Under the second approach, the bifurcated alternative, the Enterprises would be required to hold capital equal to 1.5 percent of trust assets and 4 percent of non-trust assets, where trust assets are defined as Fannie Mae mortgage-backed securities or Freddie Mac participation certificates held by third parties and off-balance sheet guarantees related to securitization activities, and non-trust assets are defined as total assets as determined in accordance with GAAP plus off-balance sheet guarantees related to securitization activities minus trust assets. The Enterprises' retained portfolios would be included in non-trust assets. Both the 2.5 percent alternative and the bifurcated alternative are discussed in greater detail in the Minimum Leverage Capital Requirements section.

In considering both the need for and the structure of an updated minimum leverage capital requirement, FHFA has taken into consideration several factors, including (1) how to best set the minimum leverage requirement as a backstop to the risk-based capital requirements; and (2) how to appropriately capture the funding risks of the Enterprises. The Safety and Soundness Act requires that FHFA establish, like other financial regulators, a minimum leverage requirement that can serve as a backstop in the event the risk-based capital standard becomes too low. As discussed earlier, risk-based capital requirements depend on models and, therefore are subject to the risk that the applicable model will underestimate or fail to address a developing risk. Another factor relevant in considering the leverage requirement's role as a backstop is the pro-cyclicality of a risk-based capital framework. Because the proposed risk-based requirements use mark-to-market LTVs for loans held or guaranteed by the Enterprises in determining capital requirements, as home prices appreciate the Enterprises would be allowed to release capital as LTVs fall. Should home prices continue to rise and unemployment continue to fall, as each have done over the last several years, risk-based capital requirements such as the requirements in this proposed rule, would be expected to fall. In this context, a minimum leverage capital requirement would reduce the amount of capital released as risk-based capital levels fell below an applicable leverage requirement. In addition, and as discussed further below, FHFA has authority to adjust components of the risk-based capital requirements as a means of avoiding the pro-cyclical release of capital.

In the banking regulatory context, leverage requirements serve to help mitigate the risk that short-term funding, on which many banks rely, will become unavailable during a stress event. In proposing minimum leverage requirements, FHFA has considered the unique funding risks facing the Enterprises. As discussed in more detail below, in both the single-family and multifamily guarantee business lines the Enterprises are provided a stable source of funding that is match-funded with the mortgage assets they purchase. While these mortgage assets are reflected on the balance sheets of the Enterprises and represent the vast majority of their assets, the funding for these assets has already been provided and cannot be withdrawn during times of market stress.

FHFA is seeking comment on all aspects of both the 2.5 percent alternative and the bifurcated alternative proposed minimum leverage capital requirements, including how the different approaches relate to and complement the proposed risk-based capital measure.

B. Impact of the Proposed Rule

This section provides information about the impact of the proposed rule both at the end of 2007 (December 31, 2007) and at the end of the third quarter of 2017 (September 30, 2017). FHFA is providing this information to inform commenters about the impact the proposed rule would have on the Enterprises' capital requirements both leading up to the crisis and under the Enterprises' current operations in conservatorship. The summary information through the third quarter of 2017 is intended solely to provide context for commenters about what the impact of the proposed rule would be on the Enterprises if the Enterprises were able to build capital, and is specifically not intended by FHFA as suggesting steps toward recapitalizing the Enterprises while the Enterprises are in conservatorship. The summary information also provides context about the impact of the proposed rule on Enterprise business decisions being made while the Enterprises operate in conservatorship. While they are in conservatorship, FHFA expects the Enterprises to include capital assumptions in pricing and business decisions even though the Enterprises are unable to build capital and FHFA has suspended their regulatory capital classifications.

Impact of the Proposed Rule at the End of 2007

In 2008, the entire net worth of both Enterprises was depleted by losses. The Treasury Department invested in senior preferred stock of both Enterprises in order to offset losses. To offset losses and eliminate negative capital positions, Fannie Mae drew $116 billion from the Treasury Department between 2008 and the fourth quarter of 2011, while Freddie Mac drew $71 billion between 2008 and the first quarter of 2012. Including the loss of net worth at the start of 2008, Fannie Mae lost a total of $167 billion and Freddie Mac lost a total of $98 billion in the housing and financial crisis.

Between the second quarter of 2012 and the third quarter of 2017, neither Enterprise required additional funds from the Treasury Department, and the PSPA's capital reserve had been set to decline to zero in 2018. However, in December 2017, FHFA entered into a letter agreement with the Treasury Department on behalf of the Enterprises to reinstate a $3.0 billion capital reserve amount under the PSPA for each Enterprise, beginning in the fourth quarter of 2017, against income fluctuations and future losses. Since the agreement was reached, Congress passed and the President signed the Tax Cut and Jobs Act of 2017 on December 22, 2017, that lowered the corporate tax rate from 35 percent to 21 percent. As a result, the value of Fannie Mae's net deferred tax assets declined by $9.9 billion in the fourth quarter of 2017, necessitating a $3.7 billion draw from the Treasury Department, while the value of Freddie Mac's net deferred tax assets declined by $5.4 billion, necessitating a draw from the Treasury Department of $312 million.

FHFA assessed whether the capital requirements in the proposed rule would have required the Enterprises to hold sufficient capital at the end of 2007, when combined with the Enterprises' revenues, to absorb losses sustained between 2008 and the dates at which the Enterprises no longer required draws from the Treasury Department to eliminate negative net worth—the fourth quarter of 2011 for Fannie Mae and the first quarter of 2012 for Freddie Mac.

FHFA compared each Enterprise's estimated minimum leverage capital requirement under both alternatives and the risk-based capital requirement based on the proposed rule for the entire portfolio of business at the end of 2007 to the Enterprises' peak cumulative capital losses as described above. The

peak cumulative capital losses include losses due to establishing valuation allowances on deferred tax assets (DTAs) during the crisis. To calculate the minimum leverage capital requirement at the end of 2007, FHFA made a simplifying assumption because accounting rules have changed since 2007. Credit-guaranteed loans are now reported as assets, while in 2007 most credit guarantees were not on the balance sheet as they were netted with guarantee obligations. For purposes of this analysis FHFA treated the credit guarantees in 2007 as assets.

The Enterprises continue to report their capital levels based on prior accounting rules.

See

Regulatory Interpretation 2010-RI-1, Jan. 12, 2010.

FHFA also compared each Enterprise's single-family credit risk capital requirement as of December 31, 2007 to the Enterprise's single-family lifetime credit losses, where lifetime losses are defined in this section as actual single-family credit losses through June 30, 2017 plus projected remaining lifetime single-family credit losses on the December 31, 2007 portfolio.

A significant portion of the Enterprises' credit losses since 2007 resulted from higher risk loans which the Enterprises no longer purchase or guarantee due to the Ability to Repay and Qualified Mortgage rule issued by the CFPB in 2013 and due to the Enterprises' strengthened underwriting standards. Because the Enterprises no longer purchase these loans, FHFA also assessed whether the credit risk capital requirement under the proposed rule would have been sufficient to cover projected lifetime losses on loans that meet the Enterprises' current acquisition criteria.

In sum, the amount of capital required by the Enterprises under the proposed risk-based capital requirements would have exceeded the cumulative losses, net of revenues earned, at both Enterprises between 2008 and the respective date at which each Enterprise no longer required draws from the Treasury Department. In this analysis, cumulative losses include credit losses on all loans purchased, including those no longer eligible for purchase, and losses due to establishing a valuation allowance on DTAs. In evaluating how the proposed risk-based capital requirements would have applied to the Enterprises at the end of 2007, it is important to note that the proposed rule would establish a risk-based capital requirement for DTAs that would offset the DTAs included in core capital in a manner generally consistent to the U.S. financial regulators' treatment of DTAs.

In addition, the credit risk capital component of the proposed risk-based capital requirements exceeded projected credit losses for both Enterprises for all loans acquired or guaranteed, excluding those that are not currently eligible for purchase.

See

section II.C.8 for a detailed discussion of DTAs.

Fannie Mae

Fannie Mae's statutory minimum leverage capital requirement was $42 billion as of December 31, 2007. For comparison, and as illustrated in the table below, Fannie Mae's estimated minimum leverage capital requirement as of December 31, 2007 based on the proposed rule would have been $76 billion under the 2.5 percent alternative or $68 billion under the bifurcated alternative. Fannie Mae's estimated minimum leverage capital requirement under either proposed alternative as of December 31, 2007 would have been insufficient to cover Fannie Mae's peak cumulative capital losses of $167 billion. However, Fannie Mae's estimated risk-based capital requirement of $171 billion based on the proposed rule would have exceeded Fannie Mae's peak cumulative capital losses of $167 billion. We include in Fannie Mae's peak cumulative capital losses the valuation allowance on deferred tax assets of $64 billion and revenues of $78 billion earned between 2008 and the fourth quarter of 2011.

Table 1—Fannie Mae's Capital Requirement Comparison to Peak Cumulative Capital Losses

$ in

billions

% of total

assets and

off-balance

sheet

guarantees

as of

Dec 31, 2007 *

Net Worth as of Dec 31, 2007

$44

1.4

Equity Issuance in 2008

0.2

Cumulative Draws **

116

3.8

Peak Cumulative Losses since Dec 31, 2007

167

5.5

Statutory Minimum Capital Requirement as of Dec 31, 2007

1.4

. . . Relative to Peak Capital Losses

(126)

(4.1)

2.5% Alternative as of Dec 31, 2007

2.5

. . . Relative to Peak Capital Losses

(91)

(3.0)

Bifurcated Alternative as of Dec 31, 2007

2.2

. . . Relative to Peak Capital Losses

(100)

(3.3)

Proposed Risk-based Capital Requirement as of Dec 31, 2007

171

5.6

. . . Relative to Peak Capital Losses

0.1

* Includes Fannie Mae MBS and Freddie Mac participation certificates held by third parties, and off-balance sheet guarantees related to securitization activities.

** Includes the valuation allowance on deferred tax assets of $64 billion, Treasury draws of $20 billion related to senior preferred dividends paid to the Treasury Department between 2008 and the fourth quarter of 2011, and revenues of $78 billion earned over the same period.

Next, we analyzed Fannie Mae's single-family portfolio in the fourth quarter of 2007 and stripped out the loans that would not be acquired today under Fannie Mae's current acquisition criteria. We then added projected future credit losses for the loans that remained to the already realized credit losses to determine Fannie Mae's lifetime single-family credit losses on that portfolio. In both cases, the credit risk capital requirement would have exceeded the projected lifetime credit losses. As illustrated in the table below, Fannie Mae's estimated single-family credit risk

capital requirement of $94 billion as of December 31, 2007 based on the proposed rule would have exceeded Fannie Mae's lifetime single-family credit losses of $85 billion on the December 31, 2007 guarantee portfolio for all loans purchased. In addition, excluding loans that the Enterprises no longer acquire, Fannie Mae's credit risk capital requirement per the proposed rule of $30 billion would have exceeded projected lifetime losses of $21 billion.

Table 2—Fannie Mae's Single-Family Credit Risk Capital Requirement Comparison to Lifetime Single-Family Credit Losses

$ in

billions

% of UPB

as of

Dec 31, 2007

Lifetime Single-Family Credit Losses on the Dec 31, 2007 Guarantee Portfolio

$85

3.4

Proposed SF Credit Risk Capital Requirement as of Dec 31, 2007

3.7

. . . Relative to Lifetime Credit Losses

0.4

Lifetime Single-Family Credit Losses on the Dec 31, 2007 Guarantee Portfolio using Current Acquisition Criteria *

1.5

Proposed SF Credit Risk Capital Requirement using Current Acquisition Criteria *

2.1

. . . Relative to Lifetime Credit Losses

0.7

* Excludes loans with the following characteristics: Debt-to-income ratio at origination greater than 50 percent, cash out refinances with total LTV greater than 85 percent, investor loans with total LTV greater than or equal to 90 percent, Alt-A, Negative Amortization, Interest-only, Low or No Documentation, and other legacy programs.

Freddie Mac

Freddie Mac's statutory minimum capital requirement was $26 billion as of December 31, 2007. For comparison, and as illustrated in the table below, Freddie Mac's estimated minimum leverage capital requirement as of December 31, 2007 based on the proposed rule would have been $54 billion under the 2.5 percent alternative or $53 billion under the bifurcated alternative. Freddie Mac's estimated minimum leverage capital requirement under either proposed alternative as of December 31, 2007 would have been insufficient to cover Freddie Mac's peak cumulative capital losses of $98 billion. However, Freddie Mac's estimated risk-based capital requirement of $110 billion based on the proposed rule would have exceeded Freddie Mac's peak cumulative capital losses of $98 billion by $12 billion. We include in Freddie Mac's peak cumulative capital losses the valuation allowance on deferred tax assets of $34 billion and revenues of $64 billion earned between 2008 and the first quarter of 2012.

Table 3—Freddie Mac's Capital Requirement Comparison to Peak Cumulative Capital Losses

$ in

billions

% of total

assets and

off-balance

sheet

guarantees

as of

Dec 31, 2007 *

Net worth as of Dec 31, 2007

$27

1.2

Cumulative Treasury Draws **

3.3

Peak cumulative losses since Dec 31, 2007

4.5

Statutory Minimum Capital Requirement as of Dec 31, 2007

1.2

. . . Relative to Peak Capital Losses

(72)

(3.3)

2.5% Alternative as of Dec 31, 2007

2.5

. . . Relative to Peak Capital Losses

(44)

(2.0)

Bifurcated Alternative as of Dec 31, 2007

2.4

. . . Relative to Peak Capital Losses

(45)

(2.1)

Proposed Risk-based Capital Requirement as of Dec 31, 2007

110

5.0

. . . Relative to Peak Capital Losses

0.5

* Includes Fannie Mae MBS and Freddie Mac participation certificates held by third parties, and off-balance sheet guarantees related to securitization activities.

** Includes the valuation allowance on deferred tax assets of $34 billion, Treasury draws of $18 billion related to senior preferred dividends paid to the Treasury Department between 2008 and the first quarter of 2012, and revenues of $64 billion earned over the same period.

Next, we analyzed Freddie Mac's single-family portfolio in the fourth quarter of 2007 and stripped out the loans that would not be acquired today under Freddie Mac's current acquisition criteria. We then added projected future credit losses for the loans that remained to the already realized credit losses to determine Freddie Mac's lifetime single-family credit losses on that portfolio. After stripping out the loans that would not be acquired under Freddie Mac's current acquisition criteria, the credit risk capital requirement would have exceeded the projected lifetime credit losses. As illustrated in the table below, Freddie Mac's estimated single-family credit risk capital requirement of $59 billion as of December 31, 2007 based on the proposed rule would not have exceeded Freddie Mac's lifetime single-family credit losses of $64 billion on the December 31, 2007 guarantee portfolio for all loans purchased. However, excluding loans that the Enterprises no longer acquire, Freddie Mac's credit risk capital requirement per the proposed rule of $24 billion would have exceeded projected lifetime losses of $20 billion.

Table 4—Freddie Mac's Single-Family Credit Risk Capital Requirement Comparison to Lifetime Single-Family Credit Losses

$ in

billions

% of UPB

as of

Dec 31, 2007

Lifetime Single-Family Credit Losses on the Dec 31, 2007 Guarantee Portfolio

$64

3.7

Proposed SF Credit Risk Capital Requirement as of Dec 31, 2007

3.4

. . . Relative to Lifetime Credit Losses

(5)

(0.3)

Lifetime Single-Family Credit Losses on the Dec 31, 2007 Guarantee Portfolio using Current Acquisition Criteria *

1.7

Proposed SF Credit Risk Capital Requirement using Current Acquisition Criteria *

2.1

. . . Relative to Lifetime Credit Losses

0.4

Impact of the Proposed Rule as of September 30, 2017

FHFA estimated the impact of the proposed rule on the Enterprises as of September 30, 2017. Under the 2.5 percent alternative, FHFA estimates a combined minimum leverage capital requirement for both Enterprises of $139.4 billion as of September 30, 2017, while under the bifurcated alternative FHFA estimates a combined minimum leverage capital requirement for both Enterprises of $103 billion. FHFA also estimates a combined risk-based capital requirement of $180.9 billion or 3.2 percent of the Enterprises' portfolios as of September 30, 2017. Credit risk capital accounts for $112.0 billion before CRT and $90.5 billion after CRT, market risk capital accounts for $19.4 billion, operational risk capital accounts for $4.3 billion, and the going-concern buffer accounts for $39.9 billion. The capital requirement for the Enterprises' DTAs accounts for the remaining $26.8 billion. A detailed breakdown of FHFA's estimated risk-based capital requirements by risk category for the Enterprises combined, and separately for Fannie Mae and Freddie Mac, as of September 30, 2017 is presented in Table 5. A breakdown of FHFA's estimated risk-based capital requirements by asset category for the Enterprises combined, as of September 30, 2017, is presented in Table 6. A breakdown of FHFA's estimated minimum leverage capital requirement under both proposed alternatives for the Enterprises combined, and separately for Fannie Mae and Freddie Mac, as of September 30, 2017, is presented in Table 7.

Table 5—Fannie Mae and Freddie Mac Estimated Risk-Based Capital Requirements as of September 30, 2017—by Risk Category

Fannie Mae

capital requirement

$billions

bps

(%)

Freddie Mac

capital requirement

$billions

bps

(%)

Enterprises' combined

capital requirement

$billions

bps

(%)

Net Credit Risk

$70.5

$41.5

$112.0

Credit Risk Transferred

(11.5)

(10.0)

(21.5)

Post-CRT Net Credit Risk

59.0

176

31.5

142

90.5

162

Market Risk

9.5

9.9

19.4

Going-Concern Buffer

24.0

15.9

39.9

Operational Risk

2.6

1.7

4.3

Other (DTA) * **

19.9

6.8

26.8

Total Capital Requirement

115.0

343

100

65.9

296

100

180.9

324

100

Total Assets and Off-Balance Sheet Guarantees, $billions

3,353.1

2,226.0

5,579.0

* The DTA capital requirement is a function of Core Capital. Both Enterprises have negative Core Capital as of September 30, 2017. In order to calculate the DTA capital requirement, we assume Core Capital is equal to the Risk-Based Capital Requirement without consideration of the DTA capital requirement.

** Both Enterprises' DTAs were reduced in December 2017 as a result of the change in the corporate tax rate. The risk-based capital requirement for DTAs as of December 31, 2017 would be $10.0 billion or 30 bps for Fannie Mae and $1.2 billion or 5 bps for Freddie Mac. See Table 33 and Table 34 for more detail.

Table 6—Fannie Mae and Freddie Mac Combined Estimated Risk-Based Capital Requirements for the Enterprises as of September 30, 2017—by Asset Category

Capital requirement

$billions

bps *

(%)

Single-family Whole Loans, Guarantees and Related Securities

$130.5

273

Multifamily Whole Loans, Guarantees and Related Securities

13.9

278

PLS

3.4

2,336

CMBS

0.02

279

Other (DTA)

26.8

811

Other Assets

6.3

192

Total Capital Requirement

180.9

100

* Basis points (bps) are calculated based on UPB of the respective asset category.

Table 7—Fannie Mae and Freddie Mac Estimated Minimum Leverage Capital Requirement Alternatives as of September 30, 2017

$billions

Fannie Mae

Freddie Mac

Enterprises

combined

2.5% Minimum Capital Alternative

2.5% Minimum Capital Alternative Requirement

$83.8

$55.6

$139.5

% of Total Assets and off-balance sheet guarantees

2.5%

Bifurcated Minimum Capital Alternative

Bifurcated Minimum Capital Alternative Requirement

$60.4

$43.1

$103.5

% of Total Assets and off-balance sheet guarantees

1.8%

1.9%

Requirement for Non-Trust Assets

$16.1

$15.5

$31.6

% of Non-trust Assets

Requirement for Trust Assets

$44.3

$27.6

$71.8

% of Trust Assets

1.5%

Total Assets plus off-balance sheet guarantees

$3,353

$2,226

$5,579

Non-trust Assets

$403

$388

$791

Trust Assets

$2,950

$1,838

$4,788

C. Risk-Based Capital Requirements

1. Overall Approach

The proposed rule would establish risk-based capital requirements across five categories of the Enterprises' mortgage guarantees and portfolio holdings: (1) Single-family whole loans, guarantees, and related securities, (2) private-label mortgage-backed securities (PLS), (3) multifamily whole loans, guarantees, and related securities, (4) commercial mortgage-backed securities (CMBS), and (5) other assets. An additional category, “Unassigned Assets,” would provide an approach to assigning capital requirements to new products or activities that do not have an explicit treatment in this rule. Under this proposal, each of these asset and guarantee categories may include capital requirements for three kinds of risk: Credit risk, market risk, and operational risk. FHFA's proposal for the credit risk and market risk associated with the five asset and guarantee categories reflects the Agency's view about the relative risks of these assets. The proposed rule would also establish a risk-invariant capital requirement for operational risk that applies across all asset and guarantee categories. Lastly, the proposal would apply a going-concern buffer across all asset and guarantee categories.

Each of the three risk categories (credit risk, market risk, and operational risk), in addition to the going-concern buffer, is further summarized below.

Credit Risk

In evaluating the credit risk faced by the Enterprises, mortgage credit risk can be segmented into the following categories: (1) Expected loss; (2) unexpected loss; and (3) catastrophic loss. Expected losses result from the failure of some borrowers to make their payments during stable housing market conditions. Even in a stable and healthy housing market, some borrowers are likely to default on their loan as a result of certain life events such as illness, job loss, or divorce. Unexpected losses are the potentially much larger losses that could occur above expected losses should there be a stressful, yet plausible, macroeconomic event, such as a severe downturn in house price levels as might accompany a recession. For example, the credit losses that took place during the recent financial crisis and were in excess of the predicted loss amounts would be considered unexpected losses. Catastrophic losses are those losses beyond unexpected loss and would be deemed highly unlikely to occur. In general, losses beyond those experienced during the recent financial crisis would be considered catastrophic losses. However, there is not a bright line marking the transition from unexpected to catastrophic loss.

For purposes of this proposed rule, FHFA defines the risk-based credit risk capital requirement for single-family and multifamily whole loans and guarantees as unexpected loss. As described above, these stress losses are forecasted under scenarios that are

generally comparable to stress experienced during the recent financial crisis. The proposed rule would calculate unexpected loss as the difference in the present value of lifetime losses under a stressful macroeconomic event scenario and lifetime losses under an expected scenario. Losses under the expected scenario (“expected losses”) are netted out from losses under the stressful macroeconomic event scenario (“stress losses”) in order to be consistent with other regulatory regimes. In particular, the loss scenarios draw on conceptual and methodological inputs from regulatory frameworks such as DFAST, CCAR, and the Basel Accords. The Enterprises set guarantee fees at a level to cover the lifetime cost of expected losses; therefore, there is no need for the Enterprises to hold capital for expected loss.

The starting point of the proposed risk-based credit risk capital requirement for single-family and multifamily whole loans and guarantees would be implemented through a series of look-up tables (“grids and risk multipliers”) that take into account loan risk characteristics. The proposed rule would utilize look-up tables because they are simple and transparent, are easily implemented, and allow easy comparison to other capital standards by regulators and the public. As an alternative to the use of look-up tables to implement the risk-based credit risk capital requirement for single-family and multifamily whole loans, FHFA considered using collections of econometric equations (“models”), either the Enterprises' internal models or an FHFA-specified model. FHFA determined that the use of a model would produce more nuanced results than the look-up tables, but would result in greater opacity and operational complexity. Furthermore, the use of the Enterprises' internal models for credit risk was rejected because it would result in inconsistent requirements between the Enterprises for assets with the same risk characteristics.

The proposed rule would use lifetime losses, as opposed to using a shorter horizon, in calculating the credit risk capital requirement in order to fully capture any variation in losses due to differences in loan risk characteristics. For example, if a seven year horizon were used, the risk associated with the payment reset of a multifamily loan with a ten year interest-only period would not be captured in the credit risk capital requirement. Furthermore, the use of lifetime losses is more conservative than a requirement based on losses over a shorter horizon as it covers the unexpected losses over the lifetime of the loan.

FHFA considered the inclusion of revenues into the credit risk capital requirements to reflect the fact that the Enterprises would be conducting new business and that vast majority of borrowers would continue to pay their mortgage even during a stressful macroeconomic event. For example, at the lowest point during the Great Recession, approximately 92 percent of borrowers with Enterprise guaranteed mortgages were current on their mortgages.

On the other hand, FHFA believes there is greater benefit to having a risk-based capital requirement that ensures sufficient capital without considering new revenue. Inclusion of revenues could result in very low or zero risk-based capital requirements for specific portfolio segments. FHFA also considered additional reasons for excluding revenues such as that Basel capital requirements exclude revenue, and that revenue serves to build capital during stress events so that the Enterprises can continue as going concerns.

February 2010 Foreclosure Prevention and Refinance Report.

The proposed rule also would not incorporate the tax deductibility of losses in order to create a simple and transparent measure of risk and to maintain general consistency with other regulatory regimes. Inclusion of the tax deductibility of losses would add significant complexity to the proposed rule. Additionally, FHFA already has an assessment of capitalization, the annual Dodd-Frank Act Stress Test exercise which incorporates revenue, the tax deductibility of losses and accounting impacts.

Question 1:

FHFA is soliciting comments on all aspects of the proposed risk-based capital framework. What modifications to the proposed risk-based capital framework should be considered and why?

Market Risk

The Enterprises are exposed to market risk, including interest rate risk and spread risk, through their ownership of whole loans and their investments in MBS. Interest rate risk is the risk of loss from adverse changes in the value of the Enterprises' assets or liabilities due to changes in interest rates. Spread risk is the risk of a loss in value of an asset relative to a risk free or funding benchmark due to changes in perceptions of performance or liquidity. The Enterprises have historically actively managed interest rate risk but have not fully hedged spread risk.

The proposed rule would establish risk-based capital requirements for the market risk associated with single-family whole loans, multifamily whole loans, single-family mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs), Government National Mortgage Association (Ginnie Mae) single-family and multifamily MBS, PLS, commercial mortgage-backed securities (CMBS), and other assets with market risk exposure held in the Enterprises' respective retained portfolios. While the Enterprises have legacy assets acquired prior to entering conservatorship, such as certain private-label securities investments, the ongoing use of the Enterprises' retained portfolios during conservatorship is now limited to transactions that support the Enterprises' core mortgage guarantee business activities. This includes supporting acquisitions through the cash window primarily for smaller lenders and buying delinquent loans out of securities in order to facilitate loss mitigation activities that benefit both borrowers and taxpayers. Because the Enterprises' retained portfolio activities have been greatly limited through conservatorship, these portfolios now represent a small share of the Enterprises' overall risk exposure, and the proposed methodology for calculating market risk capital requirements is therefore simple and straightforward. Although FHFA will automatically suspend a final rule because the Enterprises are in conservatorship and cannot build capital, the proposed rule is only intended to address market risks for the Enterprises as they are currently established under conservatorship. In a post-conservatorship housing finance system, FHFA may consider additional methodologies for calculating market risk capital requirements, and FHFA would have the regulatory flexibility to undertake such actions outside the scope of this proposed rulemaking.

The primary target of the risk-based capital requirement for market risk would be spread risk, as the Enterprises closely hedge interest rate risk at the portfolio level through the use of callable debt and derivatives. Spread risk is a loss in value of an asset relative to a risk free or funding benchmark. Generally, spread risk is calculated by multiplying the amount of spread widening by the spread duration of the asset. Spread widening is typically based on historical spread shocks. Spread duration, or the sensitivity of the market value of an asset to changes in the spread, is determined by using

models that involve assumptions about interest rate movements and prepayment sensitivity. Prepayment sensitivity reflects the relationship between the volume and timing of cash flows and changes in the interest rate or the spread.

The proposed rule would establish three approaches to determining the risk-based market risk capital requirement, each tailored to the Enterprises' businesses. The first approach defines market risk capital as a single point estimate provided by the proposed rule. The second approach is a spread duration approach that defines market risk capital by multiplying a spread shock, provided by the proposed rule, by a spread duration generated from an Enterprise's internal models. The third approach defines market risk capital through the exclusive use of an Enterprise's internal models. The proposed rule would assign the Enterprises' assets to one of the three approaches based on: (i) Whether the asset belongs to a small and declining portfolio where acquisition is limited as the result of conservatorship, (ii) the relative importance of market risk to credit risk for the asset, and (iii) the complexity of the product structure or prepayment sensitivity.

In general, the proposed rule would assign the simplified single point estimate to assets that are either (i) part of a small and declining portfolio or (ii) where credit risk is the predominant risk. A single point estimate, while simple, may inadequately capture the market risk attributes for assets with complex structures or products with high prepayment sensitivity. For instance, assets with complex structures, such as CMOs, can have different prepayment risk across different tranches, and products with high prepayment sensitivity can have spread durations varying across a wide range of characteristics.

For products with complex structures or high prepayment sensitivity, market risk capital results that rely on internal model calculations (the second and third approaches) could provide more accurate market risk capital estimates when compared with a single point estimate. Therefore, the proposed rule would rely on an Enterprise's internal models only when the market risk complexity is sufficiently high that using a single point estimate would inadequately represent the product's underlying market risk.

Market risk capital requirements resulting from the Enterprises' internal models are derived under an established model risk management governance process that includes FHFA's supervisory review. In particular, FHFA issues advisory bulletins, which are public documents that communicate FHFA's supervisory expectations to FHFA supervision staff and to the Enterprises on specific supervisory matters and topics. In addition, through FHFA's supervision program, FHFA on-site examiners conduct supervisory activities to ensure safe and sound operations of the Enterprises. These supervisory activities may include the examination of the Enterprises to determine whether they meet the expectations set in the advisory bulletins. Examinations may also be conducted to determine whether the Enterprises comply with their own policies and procedures, regulatory and statutory requirements, or FHFA directives.

FHFA's 2013-07 Advisory Bulletin reflects supervisory expectations for an Enterprise's model risk management. The Advisory Bulletin sets minimum thresholds for model risk management and differentiates between large, complex entities and smaller, less complex entities. As the Enterprises are large complex entities that develop and maintain internal market risk models, the Advisory Bulletin subjects them to heightened standards for internal audit, model risk management, model control framework, and model lifecycle management.

Question 2:

FHFA is soliciting comments on alternative approaches to determining market risk including using the global market shock component of DFAST, discussed in section I.G. Should alternative approaches be considered and why?

Operational Risk

The proposed rule would establish a risk-invariant capital requirement for operational risk as discussed below. The operational risk capital requirement would be assessed as a fixed capital requirement on the unpaid principal balance of instruments with credit risk or on the market value of instruments with market risk. The Basel Basic Indicator Approach for operational risk would be used to determine the fixed capital requirement.

Going-Concern Buffer

As also discussed below, the proposed rule would also establish a going-concern buffer to ensure the Enterprises have sufficient capital to support the mortgage markets during and after a period of severe financial stress. The going-concern buffer would be assessed as a fixed capital requirement on the unpaid principal balance of instruments with credit risk or on the market value of instruments with market risk.

Question 3:

FHFA is soliciting comments on the use of updated risk characteristics, including LTV and credit score, in the proposed risk-based capital requirements, particularly as it relates to the pros and cons of having risk-based capital requirements with elements of pro-cyclicality. Risk-based capital requirements that rely on inputs like house prices and loan risk characteristics that change over time have benefits and drawbacks. On the one hand, using updated risk characteristics such as performance history to determine risk-based capital requirements would result in a more accurate assessment of the risks faced by the Enterprises at any particular point in time within credit and economic cycles. On the other hand, using updated risk characteristics would result in pro-cyclical risk-based capital requirements, which may make it more difficult for the Enterprises to raise capital during periods of deteriorating credit or economic conditions.

As discussed above, the proposed rule's approach of using mark-to-market LTVs to determine credit risk capital requirements would more accurately represent the Enterprises' current risk profile than would using original LTVs. This is because the current value of a house influences both the probability that a homeowner will default on the mortgage and the magnitude of losses if a homeowner defaults. In times of house price appreciation mark-to-market LTVs would fall and credit risk capital requirements would decrease, while in times of house price depreciation mark-to-market LTVs would rise and credit risk capital requirements would increase. Therefore, not updating LTVs during a market downturn with decreasing house prices would, all else held constant, result in lower risk-based capital requirements relative to using mark-to-market LTVs. In such a scenario, not updating risk characteristics during a stress event could result in risk-based capital requirements being too low because original LTVs would be understated relative to current LTVs that account for decreased home values during the stress event. Whether using original LTVs or mark-to-market LTVs, the proposed credit risk capital requirements in the base grids for new originations are designed to account for a decline in house prices comparable to the 2008 financial crisis.

However, using original LTVs to determine credit risk capital requirements would reduce the pro-cyclicality of the proposed risk-based

capital requirements and smooth out the Enterprises' credit risk capital requirements across economic and credit cycles, making the Enterprises' capital planning more predictable. Maintaining original LTVs for single-family loans would, for example, result in higher credit risk capital requirements during times of house price appreciation, such as the present time, relative to the proposed rule. Because the credit risk capital requirements in the proposed rule are determined using grids based on LTVs, if original LTVs were not updated over time credit risk capital requirements would not increase as a direct result of falling house prices during a market downturn.

Comparing the use of constant or mark-to-market LTVs under the U.S. regulatory implementation of Basel III requires consideration of how the standardized approach and internal ratings-based approach interact with one another. The standardized approach maintains a 50 percent risk weight for mortgages and does not update this risk weight as house prices increase or decrease. The internal ratings-based approach allows, but does not require, institutions to use updated risk factors such as mark-to-market LTVs.

Should FHFA consider reducing the pro-cyclicality of the proposed risk-based capital requirement? For example, should FHFA consider holding LTVs and/or other risk factors constant? What modifications or alternatives, if any, should FHFA consider to the proposed risk-based capital framework, and why?

The next sections discuss the components of FHFA's proposed risk-based capital requirements in more detail. This discussion begins with operational risk, which applies consistently across all of the Enterprises' mortgage loan/asset categories. The discussion continues with the proposed going-concern buffer, which would also apply consistently across all of the Enterprises' asset and guarantee categories. The following sections then discuss risk-based capital requirements for each asset and guarantee category, with subsections that address credit risk and market risk in detail along with summaries of the operational risk and going-concern buffer provisions.

2. Operational Risk

The proposed rule would include an operational risk capital requirement of 8 basis points in the risk-based capital requirement. For assets and guarantees with credit risk, the 8 basis points would be multiplied by the unpaid principal balance of the asset or guarantee. For assets with market risk, the 8 basis points would be multiplied by the market value of the asset. For assets and guarantees with both credit and market risk, the 8 basis points would be multiplied by the unpaid principal balance.

Operational risk is the risk of loss resulting from inadequate or failed internal processes, errors made by people and systems, or from external events. Operational risk is inherent in each Enterprise's business operations. Given the nature of such risks, it is challenging to quantify or estimate operational risk at the asset level. Under the Basel II framework, which requires banks to hold capital related to operational risk, there are three approaches used to measure the operational risk capital requirement: The Basic Indicator Approach, the Standardized Approach, and the Advanced Measurement Approach.

See

the Basel Committee on Banking Supervision—International Convergence of Capital Measurement and Capital Standards, June 2004.

The Basic Indicator Approach is the simplest approach of the three, and it is generally used by banks without significant international operations. The Standardized Approach and the Advanced Measurement Approach employ increasing complexity for calculating operational risk capital requirements. The Advanced Measurement Approach is the most advanced approach and is subject to supervisory approval.

In the proposed rule, FHFA uses the Basic Indicator Approach to calculate the operational risk capital requirement for the Enterprises, as it is simple and transparent, and it ensures a consistent treatment across the Enterprises.

The Basel III framework replaces the collection of Basel II approaches used to measure operational risk with a single, risk-sensitive standardized approach based on two components: (1) A measure of a bank's income, and (2) a measure of a bank's historical losses. The new standardized approach would be used by all banks.

See https://www.bis.org/bcbs/publ/d424.htm.

The Basic Indicator Approach requires banks to hold capital for operational risk equal to a fixed percentage (scalar) of the average positive gross income relative to total assets over the previous three years. The scalar of 15 percent is the fixed percentage set by the Basel Committee on Banking Supervision (BCBS), representing the prescribed relationship between operational risk loss and the aggregate level of gross income. The prescribed scalar of 15 percent is consistent with the percentage prescribed for the commercial banking business line under the Basel Standardized Approach. Gross income is defined as net interest income plus net non-interest income. The measure is gross of any provisions and operating expenses, and excludes realized profits or losses from the sale of securities and extraordinary or irregular items.

As reflected in the table below, FHFA calculated the operational risk capital requirement for each Enterprise based on a three-year average of gross income from 2014 to 2016.

Table 8—Operational Risk Capital Requirement

[Three year average (2014-2016)]

Amounts in $billions

Fannie Mae

Freddie Mac

Weighted

average

(1) Gross consolidated income

$17.9

$9.8

(2) Scalar

15%

(3) Guarantee book of business

$3,064

$1,954

Capital Requirement (bps) = (1 × 2)/3

8.7

7.5

8.2

The Basic Indicator Approach

Banks using the Basic Indicator Approach must hold capital for operational risk equal to the average over the previous three years of a fixed percentage (denoted alpha) of positive annual gross income. Figures for any year in which annual gross income is negative or zero should be excluded from both the numerator and denominator when calculating the

average. The requirement may be expressed as follows:

KBIA = [Σ(GI1 . . . n × α)]/n

Where:

KBIA = the capital requirement under the Basic Indicator Approach

GI = annual gross income, where positive, over the previous three years

n = number of the previous three years for which gross income is positive

α = 15 percent, which is set by the Committee, relating the industry wide level of required capital to the industry wide level of the indicator.

Gross income is defined as net interest income plus net non-interest income. It is intended that this measure should: (i) Be gross of any provisions (

e.g.,

for unpaid interest); (ii) be gross of operating expenses, including fees paid to outsourcing service providers; (iii) exclude realized profits/losses from the sale of securities in the banking book; and (iv) exclude extraordinary or irregular items as well as income derived from insurance.

FHFA combined the Enterprises' results to determine an operational risk capital requirement of 8 basis points.

Question 4:

FHFA is soliciting comments on the proposed operational risk capital requirements. Should FHFA consider requiring the Enterprises to calculate operational risk capital requirements using the new standardized approach for operational risk included in the Basel III framework? What additional modifications to the proposed operational risk capital requirements should be considered and why?

3. Going-Concern Buffer

The proposed rule would include a going-concern buffer of 75 basis points in the risk-based capital requirement. For assets and guarantees with credit risk, the 75 basis points would be multiplied by the unpaid principal balance of the asset or guarantee. For assets or guarantees with market risk, the 75 basis points would be multiplied by the market value of the asset or guarantee. For assets and guarantees with both credit and market risk, the 75 basis points would be multiplied by the unpaid principal balance.

The Enterprises are required by charter to provide liquidity to the mortgage markets during and after a period of severe financial stress. During a period of severe financial distress, the Enterprises would need capital to offset credit and market losses on their existing portfolios, to support the mortgage market by purchasing new loans, and more generally, to maintain market confidence in the Enterprises' securities. Losses on the Enterprises' existing portfolios would deplete capital and would incent the Enterprises to withdraw from riskier segments of the mortgage market in order to preserve capital. Raising new capital during a period of severe housing market stress, like that envisioned in this rule, would be very expensive, if not impossible; therefore, the proposed rule would require the Enterprises to hold additional capital on an on-going basis (“going-concern buffer”) in order to continue purchasing loans and to maintain market confidence during a period of severe distress.

To quantify the size of the going-concern buffer, FHFA looked to the Enterprises' DFAST results for the severely adverse scenario. The DFAST severely adverse scenario specified by FHFA incorporates an assumption that the Enterprises will originate new business during the stress period. DFAST results reflect the impact of the stress scenario on the earnings and capital of each Enterprise.

FHFA calculated the amount of capital necessary for the Enterprises to meet a 2.5 percent leverage requirement at the end of each quarter of the simulation of the severely adverse DFAST scenario (without DTA valuation allowance) and compared that amount to the aggregate risk-based capital requirement. The difference between these two measures provided an indicator for the size of the going-concern buffer. FHFA ultimately determined that the size of the going-concern buffer should be 75 basis points and that the going-concern buffer would be risk-invariant. This approach is useful because it includes a severe stress, an assumption of new business during the severe stress, and an assumption that an Enterprise has enough capital to meet its minimum leverage requirement during and at the end of the stress period, which should contribute to maintaining market confidence. As further validation of the proposed 75 basis points going-concern buffer, FHFA compared the capital obtained by applying the proposed going-concern buffer to the 2017 single-family book of business with the capital required to fund each Enterprise's 2017 new acquisitions. FHFA found the proposed going-concern buffer would provide sufficient capital for each Enterprise to fund an additional one to two years of new acquisitions comparable to their 2017 new acquisitions.

Question 5:

FHFA is soliciting comments on the proposed going-concern buffer. What modifications to the proposed going-concern buffer should be considered and why?

4. Single-Family Whole Loans, Guarantees, and Related Securities

This section corresponds to Proposed Rule §§ 1240.5 through 1240.23.

Overview

The proposed rule would establish risk-based capital requirements for the Enterprises' single-family whole loans, guarantees, and securities held for investment. The core of the Enterprises' single-family businesses is acquiring and packaging single-family loans into mortgage-backed securities (MBS) and providing credit guarantees on the issued securities. The aim of the proposed single-family capital requirements is to ensure the continued operation of these important single-family business operations throughout periods of economic uncertainty. In the context of the proposed rule, single-family whole loans are single-family mortgage loans acquired by the Enterprises and held in portfolio, including those purchased out of MBS trusts due to issues related to payment performance. Likewise, single-family guarantees are guarantees provided by the Enterprises of the timely receipt of principal and interest payments to investors in mortgage-backed securities (MBS) that have been issued by the Enterprises and are backed by single-family mortgage loans. Except in cases where they transfer the risk to private investors, the Enterprises are exposed to credit risk through their ownership of single-family whole loans and guarantees issued on MBS. In addition, the Enterprises are exposed to market risk through their ownership of single-family whole loans and mortgage-backed securities held for investment purposes.

To implement the proposed single-family capital requirements, the Enterprises would use a set of single-family grids and risk multipliers to calculate credit risk capital, as well as a collection of straightforward formulas to calculate market risk capital, operational risk capital, and a going-concern buffer.

The proposed rule would first establish a framework through which the Enterprises would calculate their gross single-family credit risk capital requirements. The proposed methodology is simple and transparent, relying on a set of look-up tables (grids and risk multipliers) that would account for many important single-family risk factors in the calculation of gross credit risk capital requirements, including loan characteristics such as age, payment performance, loan-to-value (LTV), and credit score.

The proposed grid and multiplier framework is consistent with existing financial regulatory regimes, and would therefore facilitate comparison to those regimes and promote understanding of the framework's methodology and resulting capital requirements. In particular, the proposed rule is conceptually and methodologically similar to regulatory frameworks such as D

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