FHLBI introduced the Mortgage Purchase Program (MPP) in 2001 to provide members with a competitive alternative to selling loans into the secondary mortgage market while rewarding them for high-quality loan performance through the Lender Risk Account (LRA). While LRA funds are held to offset potential loan losses, all funds not used for losses will be returned to the sellers over time.
In the original MPP design, the seller remitted principal and interest payments monthly, and FHLBI stripped off a portion of each remittance to fund the LRA. In November 2010 FHLBI introduced MPP Advantage, changing the way that the LRA is funded. The LRA is now funded at the settlement date of the loan purchase.
To provide perspective on how the LRA has evolved, let’s compare the balances at the end of 2014 on a $2 million Master Commitment Contract (MCC) under three scenarios. A $2 million MCC started in 2005 under the original MPP would have an LRA balance of $409. The same MCC begun in 2006 under Pool Aggregation would have an LRA balance of $7,320. But if the MCC had begun in 2012 under MPP Advantage, the LRA balance would be fully funded at $23,984, becoming a material part of the seller’s financials.
You may want to revisit your LRA balances and valuations before year end. Auditors looking closely at LRA balances and the materiality they have on members’ year-end financials. LRA valuation considerations differ based on the MPP product. Before MPP Advantage, LRAs were funded by spread, so MPP sellers would need to consider the discount rate, expected loss ratio and prepayment speeds. In contrast the fixed LRA under MPP Advantage is fully funded at the time of loan purchase, which means the LRA balances and the seller’s valuation is no longer subject to prepayment speeds, making the LRA valuation simpler and less volatile. It is important to note that in either case the LRA can only be a positive; if the LRA is depleted, FHLBI does not require sellers to replenish the account.
To help our members further understand their LRA, Plante Moran, the nation’s 13th largest CPA firm, says that from an accounting perspective, if the LRA represents an overfunding of expected losses, then the present value of future cash flows should be considered an asset. The company recommends monitoring LRA balances, reviewing the actual versus expected losses over similar time periods and adjusting the general ledger at appropriate intervals. Plante Moran also notes that the LRA value can be impacted by swings in the discount rate, higher than expected losses, and recapture for significant underwriting issues.
Since MPP’s inception the nation has experienced a variety of refinance booms and significant increases in property values prior to 2008. Even through the ensuing property value bubble burst and lenient underwriting guidelines, FHLBI weathered the storm well. While some of the LRAs in the 2005 to 2008 vintage have been depleted, we have made the appropriate adjustments and have stress-tested the risk valuation though sophisticated modeling to protect the program and the value of each seller’s LRA.
For more information about MPP or the LRA, contact Mortgage Acquisitions Manager Cathy Garrett at 317.465.0553 or firstname.lastname@example.org.