As the new presidential administration takes office, there is growing speculation as to whether there will be housing finance reform, including the potential privatization of government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. Exiting conservatorship could have ramifications for the creditworthiness of the GSEs, and it could impact U.S. mortgage and housing markets broadly. S&P Global Ratings is monitoring related developments and potential credit implications. While this commentary does not contemplate the likelihood of privatization, we discuss the possible impact on mortgage-backed securities (MBS) and associated single-family credit risk transfer (CRT) transactions of the GSEs and how our CRT ratings could be affected.

Impact Of GSE Privatization Depends On Whether Government Support Continues

The impact of GSE privatization would depend on whether the U.S. would provide support to the GSEs or their obligations, including the MBS and CRT transactions they issue. While privatization could take on various forms, we believe that any housing finance reform would support the existing (and possibly future) senior obligations of the GSEs, given the outsized footprint of the GSE MBS market.

During the first Trump administration, a housing finance reform plan from the U.S. Treasury envisioned Ginnie Mae providing a catastrophic guarantee on MBS that would backstop a primary guarantee from the GSEs (see "What Factors May Inform Our Ratings On Fannie Mae And Freddie Mac After The Treasury's Housing Reform Plan?" published Sept. 9, 2019). The plan aimed to eliminate any future implicit or explicit guarantee on the GSEs themselves, while also supporting stability of the housing finance and MBS markets.

We currently rate the senior unsecured debt of the GSEs at 'AA+', equivalent to that of our sovereign credit rating on the U.S., which reflects our view that the U.S. government would likely provide financial support to the GSEs given their mission as it relates to the underlying housing and mortgage market. As noted in our analyses of Freddie Mac and Fannie Mae ("Freddie Mac," published April 16, 2024, and "Fannie Mae," published April 16, 2024), we assess their stand-alone credit profiles absent governmental support at 'b-' based mainly on their weak capital positions.

An exit from conservatorship could be a complex undertaking and would likely require a recapitalization. We therefore believe it is premature to assess the potential implications on their creditworthiness. After exiting conservatorship, our view of the ultimate strength of the business and financial positions of the GSEs and the likelihood they would receive government support would determine their issuer credit ratings (ICRs).

Impact On CRT Ratings

In this commentary, we focus on the CRT transactions that have been issued by Fannie Mae and Freddie Mac under the Connecticut Avenue Securities (CAS) and Structured Agency Credit Risk (STACR) programs, respectively. This is because our view of the creditworthiness of CRTs depends on counterparties such as the protection buyer (i.e., GSE), in contrast to typical cash securitizations. While counterparty risk is generally not a rating constraint at present for the majority of CRTs, it could have a larger influence in our rating analysis if our view of the GSE's creditworthiness were to change.

CRT background

GSEs have issued single-family CRTs since 2013, and volume has averaged roughly $13 billion annually over the past several years. S&P Global Ratings currently has outstanding ratings on approximately $28 billion of CRT notes issued by the GSEs, excluding exchangeable notes that relate to this this total. Our rating distribution for outstanding CRTs issued by Fannie Mae and Freddie Mac is shown in chart 1.

Chart 1

Structure and ratings overview

CRTs make use of a credit-linked note (CLN) structure such that bond issuance proceeds are held as collateral to pay noteholders principal, or the protection buyer (GSE) eligible losses, on the reference mortgage pool. In addition to this collateral acting as the main source of principal payment, monthly interest obligations on the issued notes depend on sources such as investment earnings on the collateral, pledged guarantee fee income from associated and unassociated reference loans, and the GSEs themselves in the form of capital contribution amounts that account for any shortfalls from investment earnings and liquidations. For more on CRT and CLN structures, see "ABS Frontiers: The Credit DNA Of Synthetic Risk Transfer Securitizations," published Sept. 3, 2024.

Our ratings on CRTs are typically driven by our credit view of the reference mortgage portfolio as it relates to the amount of expected losses under various economic scenarios, compared to the available credit enhancement for each class. They also depend on the ability to pay timely interest and ultimate principal on the notes. In addition to our assessment of the losses the reference pool may experience, there are other factors embedded in our analysis that are described below. In the case of CRT issuances with high loan-to-value (LTV) ratios (i.e., LTV ratio > 80%), most loans have mortgage insurance (MI), such that contractual claim proceeds are incorporated into the determination of net liquidation proceeds allocated to the trust, regardless of the actual receipt of such amounts by the GSE from the MI provider. Therefore, the ICR on MI providers (or that of the GSEs) doesn't create credit dependencies in our loan analysis.

Collateral account and eligible investments

For typical CLN structures, we consider the counterparty strength of the institution (typically a bank) holding collateral. This is because the ratings assigned to the notes depend on the likelihood that the eligible institution will be positioned to safeguard the collateral in various economic scenarios. In most cases, the collateral is invested rather than allowed to remain in cash, and in these cases, the quality of the eligible investments would be a factor when considering the sufficiency of the ratings on the notes. The counterparty requirements of the eligible account and institution would be assessed under our applicable criteria when determining the maximum potential rating for an issued note. Because the investment of cash between note remittance periods is also common, eligible investment protocols typically exist to ensure that collateral for the issued notes is invested in low credit-risk investments.

For GSE CRT issuances, the GSEs guarantee against losses on the amounts held to collateralize the issued notes. As a result, the conditions related to the collateral account provider and investment quality are not a factor at rating levels of 'AA+' and below. As mentioned above, our 'AA+' rating reflects the fact that we look to the ratings on their senior unsecured debt as an indication of their ability to meet those obligations because we do not currently have issuer credit ratings on the GSEs (as they are in conservatorship). Should the ICRs on the GSEs post-conservatorship be less than 'AA+', then the note rating may be constrained by those ratings or the ratings on the account provider, incorporating our assessment of the strength of the permitted investments, unless other mitigants could be relied upon. While other cash flow may be available in GSE CRTs, such as guarantee fees from certain loans, our assessment of how much this cash flow could be relied on would be conditioned on various factors. These include the expected lives of the associated loans generating the guarantee fees, and the extent to which such pledged fees are segregated from the potential estate of the GSE. Subject to certain conditions, the GSE may also assign its obligations to a successor. Upon any such assignment, noteholders would be exposed to the credit risk of such a successor. If a successor were to be named, we would assess its financial capacity and ability to perform the obligations under the transaction agreements.

Obligations under the capital contribution and collateral administration agreements

Interest obligations on the CLNs are supported by several sources of funds, including the premium obligations by the GSE under the capital contribution agreement and the collateral administration agreement, investment earnings from the collateral account, and pledged guarantee fee income. Given that investment earnings are likely insufficient to satisfy all note interest obligations, there are dependencies on the other sources of funds to satisfy interest payments. Circumstances such as lack of payment under the agreements, insufficient guarantee fee income, and/or the inability of the guarantee fee income to be passed on to the trust could result in interest shortfalls for some or all of the classes. An actual shortfall depends on whether other sources could be used to satisfy interest obligations (such as amounts in the collateral account).

A missed payment (when due and payable) of interest due on any note could result in an event of default. If under this scenario the event of default was not remedied and enforcement were pursued, an acceleration would take place to satisfy the note obligations via liquidation of investments in the collateral account. This would allow for payment on the unpaid and accrued interest and principal, sequentially, of outstanding notes. If such a scenario were to occur, the hierarchy of note position and amount of available funds would determine the extent that obligations were satisfied in whole. Even if principal payments were ultimately satisfied for a given note, short-term disruptions in interest payments could subject the notes to ratings downgrades based on temporary missed interest payments.

If Privatization Occurs, GSE Counterparty Risk Could Become A Constraining Factor

We believe it is premature to assess the potential impact to ICRs on the GSEs post-privatization given substantial uncertainty as to when and how they would be privatized. Hypothetically, if their privatization were to result in ICRs below 'AA+', ratings on the CRT notes could be constrained depending on the notes' potential exposure to untimely interest payments or principal loss when considering an event for which the GSE failed to fulfill its obligations related to the CRT transactions. We would also consider the sufficiency of the requirements of the eligible account and institution, and investments of the collateral backing the notes when determining whether the note ratings would be constrained directly by the GSE rating (or something higher). Furthermore, if a privatization were to occur with a government guarantee of obligations, we would need to understand whether contractual obligations under the GSE CRT transaction documents and agreements fall under purview of such a "government guarantee". In particular, obligations under the capital contribution agreement and the collateral administration agreement are "unsecured contractual obligations", while the MBS issued by GSEs represent "general unsecured obligations." If they did fall under purview of such a guarantee, then our analysis of CRTs would continue such that we look to the guarantor rating when considering the GSE obligations when providing CRT note ratings.