The insurance industry is a hefty investment participant in the government-sponsored enterprise (GSE) mortgage-backed marketplace. Your organization own some of the affected securities detailed below.
Fannie Mae and Freddie Mac hold about half of the U.S. mortgage market with $5 trillion in bonds guaranteed by the two mortgage finance firms. To develop a common mortgage-backed security to be used by both entities (currently separate) and combine their separate bond markets, they will both begin issuing 55-day mortgaged-backed securities. (Previously, Freddie Mac offered 45-day securities while Fannie Mae offered 55-day securities.) Freddie Mac is offering an optional offering to exchange 45-day eligible and non-eligible securities to 55-day Freddie Mac counterparts. The security received in the exchange will exactly match the components of the security to be exchanged.
The NAIC Statutory Accounting Principles Working Group (SAPWG) has contemplated the process, and through INT 19-02, has proposed a simplified accounting approach to the exchange process via a limited-scope exception to SSAP No. 26R – Bonds.
Contrary to the typical method of statutory accounting in an exchange or conversion of a security, INT 19-02 tentatively proposes to make an exception to SSAP 26R, by not recognizing the newly exchanged security at fair value but continue to record it at the existing amortized cost basis. Why? The thought here is that the newly exchanged security is practically identical to the prior security in form, substance, and make-up. Accordingly, the effort in time working up fair values becomes more burden than practicality. This exception would only apply to the SSI program.
As part of the transition process from the 45-day to the 55-day security, investors will receive a one-time recompence intended to approximate the fair value compensation for the 10-day delay of the new bond payment. Basically, this is float reimbursement. The float adjustment will be treated as a tax-free adjustment by Freddie Mac. Accordingly, INT 19-02 will propose treatment of this float compensation as an adjustment to the cost basis of the security.
- The exchange program commenced on June 3, 2019
To read more about the exchange program and its treatment under SSAP, view our full SSAP Chat article here.