Credit enhancements, such as mortgage insurance, reduce credit-risk exposure of investors in financial instruments backed by mortgages. HUD's Office of Policy Development and Research has issued a new report, Study of the Use of Credit Enhancements by Government Sponsored Enterprises, that emphasizes how credit enhancements play a critical role in government-sponsored enterprises' (GSEs') transactions. In 1999, for example, Fannie Mae sustained approximately $400 million in single-family and multifamily credit losses. Of this amount, Fannie Mae bore approximately $125 million ($118 for single-family and $7 million for multifamily), and the remaining $275 million was assumed by risk-sharing partners, primarily mortgage insurers. The General Accounting Office recently issued a report evaluating HUD regulation of the GSEs that emphasizes the need for additional research regarding seller-provided credit enhancements on multifamily mortgages acquired by the GSEs. HUD's research deepens understanding of how and why Fannie Mae and Freddie Mac use credit enhancements in their secondary mortgage market transactions for both single-family and multifamily housing. The report begins by describing the major types of credit enhancements and their relative prevalence, circumstances under which they are typically used, and the purposes they serve. Multifamily transactions receive more attention in the report because they generally involve a greater variety of credit enhancements, pose greater risk, and have less access to mortgage insurance. The report next considers the GSEs' use of credit enhancements in both multifamily and single-family markets and discusses the GSEs' purchase of loans originated to meet Community Reinvestment Act requirements. Then the report focuses on interviews and research conducted on the credit enhancements used by nonagency participants in the secondary mortgage market. The final chapter summarizes motivations for the use of credit enhancements in secondary market transactions and contrasts the use of credit enhancements by the GSEs to other market participants. Looking at future trends, the report concludes that use of credit enhancements will continue to evolve in response to increases in information about the performance of mortgages and different financial products over time, innovations in financial structures, changes in laws and regulations, and fluctuations in the economy. Appendixes provide a review of academic literature on the role of credit enhancements, a glossary of terms, and a list of acronyms used in the report. Study of the Use of Credit Enhancements by Government Sponsored Enterprises is available for $5 from HUD USER. Use the order form.
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