Private sector institutions, such as banks and other lenders, issue and service the mortgage-backed securities that Ginnie Mae guarantees. Our guarantee ensures that investors who own the securities are paid their principal and interest. If borrowers fail to make payments, Issuers are still required to remit scheduled payments to investors.
If a servicer fails to remit scheduled payments, though, the federal government, through Ginnie Mae, could be forced to intervene and make the payments. That’s known as “counterparty risk,” and there has been a paradigm shift over the past decade in the way that Ginnie Mae handles it.
At the recent Ginnie Mae Summit, I laid out our approach to limiting counterparty risk. We’re emphasizing engagement with Issuers, giving them tools to self-monitor their position against their peer group and utilizing various vehicles — on-site reviews, regular “spotlight Issuer” calls, periodic Issuer liquidity meetings — to make sure we have a strong understanding of Issuer business activities, and they have an understanding of how we are looking at things.
We know that working together is the best way to mitigate risk. We also know that a purely one-size-fits-all approach won’t best serve Issuers or Ginnie Mae. Because of the diversity of business models among our Issuers, we need to employ a tailored approach to ensure that potential risks, big or small, don’t fall through the cracks.
We’re now using advanced analytics to apply individual oversight to each Issuer. We are refining a newly-developed Issuer Stress Test model. The model uses a variety of data points to forecast an Issuer’s financial performance over the short- and medium-term under different economic scenarios. It provides a number of outputs, all of which give Ginnie Mae and our Issuers a view of where risk may emerge or grow. We use this forecasting to inform our work with Issuers.
For example, simpler ways of assessing counterparty risk look solely at the net worth of counterparties, using that measure as an indicator of how well an Issuer could weather a financial storm. In figure 1, both Issuers appear identical, equal to the task of withstanding an unexpected financial shock. However, when probed more deeply, another picture appears.
Given the size of their servicing portfolios, each Issuer is required to have a net worth of at least $6 million. However, meeting that threshold and having room to spare are two different things, as shown in figure 2.
One Issuer is clearly more leveraged than the other with significantly less overall equity available to manage unforeseen stresses. It would not be prudent for Ginnie Mae to assess these Issuers equally because one clearly is more of a risk to the agency than the other. Our customized counterparty risk tools dig deeper to reveal these potential exposures.
Broad-based capital and liquidity minimum standards are important, but the ability to take a more situational approach as well makes for a stronger risk management program. As always, our goal is to address risk appropriately before it adversely affects the ability of the Issuer to manage its Ginnie Mae business or has an impact on the system overall.
As we continue through 2019, our Issuers, servicers and other stakeholders can expect to hear more about our approach to measuring and managing counterparty risk, including steps we are taking to increase the flexibility of how holders of Ginnie Mae mortgage servicing rights (MSRs) can use the asset to enhance their liquidity and overall risk profile.