Credit Enhancements and Loss Absorption Explained
Last Updated on February 18, 2021
An in-depth analysis of MPF Traditional's most important features
The sale of loans into MPF Traditional allows for the waiver of the LLPAs charged by other market investors. The participating member will share a small amount of the credit risk in each loan with the FHLBDM; the amount of the shared credit risk is determined on an individual loan and tracked within the pool of loans sold. The amount of the shared risk in each loan is determined using an S&P Levels model; loans risk that exceed the required risk level will not require any credit enhancement. However, loans that fall below this level, albeit because of high LTV, high DTI or any other risk factor, will require an amount of credit enhancement to achieve the desired level. It is this layer of credit enhancement (CE) that the member and the FHLBDM risk-share, not the entire loan balance. The CE is determined at the loan level and tracked at the pool level; the member knows their pool CE exposure at all times.
Should a loan go into default and proceed to foreclosure sale, there is a set structure to remediate any deficient balance. The very first step is to apply the sale proceeds towards the outstanding UPB; if this amount provides for the liquidation of the balance, no further action is required. However, should there be a deficient balance after sale proceeds have been applied, we would look towards any mortgage insurance claim to reduce or fully offset the loss. Should there still be an outstanding balance after these two actions, funds would be supplied from the FHLBDM’s First Loss Account (FLA). The FLA is a reserve account established separately for each member’s pool and is completely funded through our resources, there are no monies impacted at the time of the loan sale to fund the FLA. However, the amount in the FLA is determined by the amount of loans sold into each pool and can be depleted based on the number or the size of the claims against the Account. Once the FLA is depleted, the member’s level of obligation is next in line to complete the payoff of deficient balance(s). It is important to note that the level of each member’s CE obligation is set and capped at the pool level. The member is never expected to pay any amount that exceeds the capped amount in their respective loan pool. Should the member’s CE obligation be depleted in full, the FHLBDM is the final backstop for all additional deficient balance claims in this pool.
Following this “waterfall” of remediation steps to cure deficient foreclosure balances in a specific pool, the FLA is depleted before the member is required to contribute funds. Once the member’s obligation has been depleted, the FHLBDM backstops all future claims. However, in order to replenish the FLA for this pool, the funds generated for the pool performance are suspended payments to the member and used to bring the FLA back to full reserve amount.