Single-Family Social Bonds under the framework of environmental, social, and governance (ESG) securities may be in the works for Fannie Mae and Freddie Mac, according to a new Request for Input (RFI) issued by the Federal Housing Finance Agency (FHFA) on February 16, 2023.
Each of Fannie Mae and Freddie Mac (sometimes referred to as the “Enterprises”) has been seeking to participate in the ESG sandbox for a few years now. The Enterprises already issue multi-family social bonds. Beginning in 2021, the Enterprises also issue single-family affordable bonds, which are securities with an ESG patina based on and backed by their respective affordable housing products, Fannie Mae’s HomeReady® and Freddie Mac’s Home Possible®. However, this is the first public attempt to assign the moniker of single-family social bonds to certain of its single-family mortgage-backed securities (MBS).
The Enterprises also pursued an initiative in 2022 regarding High Social Index Pools (HISP) based on an announced “Single-Family Social Index.” Fannie Mae explains that the Single-Family Social Index is a methodology that provides insights into socially oriented lending activities on the loans that it has acquired and assigns a score to each issuance of mortgage-backed securities. It is a disclosure based on lending activity; it is not a social impact metric. The Social Index is designed to allow investors to identify pools with high concentrations of loans that meet certain social criteria.1
The RFI is intended to enable the FHFA to understand the opportunities and potential risks associated with single-family social bonds. The announcement follows on the heels of the recent announcement by the Government National Mortgage Association (Ginnie Mae) of its launch of a new low- to moderate-income (LMI) disclosure in response to investor interest in ESG investment mandates. But the Ginnie Mae proposal does not seek to create a social index; it merely provides for new pool-level LMI disclosures in its guaranteed mortgage-backed securities. These disclosures include the number of underlying loans made to LMI borrowers, the percentage of LMI loans among the total loan count, the unpaid principal balance (UPB) of LMI loans in the MBS, and the percentage of LMI UPB of total MBS UPB.
ESG investing is quite the rage these days, and the RFI provides a concise and informative summary of this development. It notes that ESG investors have diverse priorities and may invest based on one or more ESG factors, such as climate, social or faith-based investing. The RFI also references “impact investments” that provide explicit opportunities to fund activities intended to benefit a specific class of persons or the environment through financial products that focus on facilitating positive social and environmental outcomes. In other words, “social impact investing can be defined as a subset of ESG investing and is distinguished in that social impact investing seeks to create social value, rather than minimize adverse impacts.” Included in this category is social bonds, where investors “…may have a mandate to seek positive social impacts, may invest because of expected returns, or may pursue a combination of both factors.” Yet, the RFI explains, factors related to social and other ESG bonds are not defined in federal securities law, may be subjective, and may be defined in different ways by different funds or sponsors, and there is no Securities and Exchange Commission (SEC) “rating,” “score,” or qualification that can be applied to determine whether a product is “social.”
At a minimum, though, the RFI explains that any program that is designed to positively influence a stated outcome must identify the set of specific outcomes that the program is intended to achieve and then provide the metrics to enable investors to understand the impact of the investment. It identifies borrower sustainability, affordability and/or equity as the objective of a Fannie Mae or Freddie Mac social bond, highlighting that:
“Outcomes may include homeownership rates, sustainability and home retention outcomes, or improved liquidity. A social bond program may seek to positively influence these outcomes by isolating loans originated with desirable social attributes and features, and may require that eligible collateral provide down payment assistance, buydown programs, cost subsidies, liquidity funds, increased borrower education and counselling, or other borrower benefits. Subsequently, a program would provide impact metrics to enable stakeholders to understand the impact of investments. Impact metrics may include, for example, information on mortgage rate and terms (e.g., basis points above/below the Average Prime Offer Rate (APOR)), access to credit, and improved borrowing costs. Per the International Capital Market Association (ICMA) Social Bond Principles, which outline voluntary process guidelines, a social bond program should provide regular, transparent reporting to communicate to investors the expected and/or achieved impacts of the investment.”
Of course, Fannie Mae and Freddie Mac already publish single-family disclosure data to provide investors with information on (a) individual loans, generally consisting of at-issuance data about the borrower, property, and mortgage loan and monthly data about the performance of each loan and (b) pools of loans, generally consisting of summary or aggregated information about the mortgage loans in a security. And this is a difficult balancing act when borrower privacy considerations are taken into account. As noted, more recently, Fannie Mae and Freddie Mac have issued single-family affordable bonds and provided disclosures intended to increase transparency into socially oriented lending. They subsequently began publishing single-family MBS disclosures based on the previously referenced Single-Family Social Index methodology to measure the degree of socially oriented lending activity within a pool and then issued related High Social Index Pools. But the Enterprises did not designate either single-family affordable bonds or High Social Index Pools as social bonds.
The RFI is the precursor to the actual, potential development and issuance of social bonds, and FHFA is looking to the responses to the RFI to help inform its future actions. It divides the questions to which it seeks input into four categories: (1) outcomes, borrower benefit and reporting; (2) eligible loans; (3) general questions on a social bond program; and (4) disclosures and borrower re-identification. Some of the questions are:
- What program outcomes and borrower impacts should a Single-Family Social Bond program seek to achieve? Which borrower benefit impact measures should be reported?
- What attributes should be used to determine whether a loan is eligible for a social bond pool (e.g., income, geography, down payment assistance, reduction in mortgage interest rate, buydown programs)? What are the advantages and disadvantages to identifying eligibility based on mortgage product versus some other methodology (e.g., minimum Social Index scores)?
- What considerations should be made to ensure the issuance of social bonds appropriately aligns with and supports the safety and soundness of the Enterprises? Are there social bond features or program designs that would conflict or be in tension with the Enterprises’ safety and soundness requirements?
- For investors with a social investment mandate, what attributes, impact measures, and guidelines/standards would be necessary to meet that requirement? Do current Enterprise products or programs already meet these investment guidelines, or would investors prefer or need Enterprise-labelled social bonds? Are there any guidelines that would prevent investment in social issuances?
Comments are due by April 17, 2023. FHFA will host a virtual listening session on March 28, 2023 to allow for additional public input. We are available to assist in the preparation or review of comment letters, as well as to discuss the RFI in more detail.
1 Individual loans are evaluated across eight specific social criteria: low-income borrowers, minority borrowers, first-time homebuyers, low-income areas, minority tract, high-needs rural, designated disaster area, and manufactured housing. Scoring based on these loan-level social criteria are further stratified by assigning a value based on three factors: income, borrower and property. The results are converted into two different scores that are disclosed to investors: a Social Criteria Score, which discloses the pool-level share of loans meeting specific social criteria, and a Social Density Score, which discloses the pool-level average of loan-level scores, reflecting layering of social attributes.