Recent court decisions against Fannie Mae and Freddie Mac shareholders have put to rest the notion that the two mortgage giants exist as anything but instrumentalities of the U.S. government, according to a report released Thursday by Kroll Bond Rating Agency.
Private equity investor groups recently have raised lawsuits against the Federal Housing Finance Agency, in an effort to regain control of the two entities. The failure of these legal actions points to the de facto nature of the two entities as sovereign credits, given their complete backing by the U.S. government.
The KBRA report also suggests that Fannie Mae and Freddie Mac have morphed into insurance agents rather than insurance companies, since they cannot produce the capital to bear the risk of their guarantees that the FHFA prices to begin with.
Still, the two bodies’ investors take issue with the 3rd Preferred Stock Purchase Agreement that directs all of Fannie Mae and Freddie Mac’s profits to the government, the KBRA report said.
But these investors’ suits have been unsuccessful because, in judges’ eyes, the legislation passed by Congress that saved Fannie Mae and Freddie Mac from the brink gives the U.S. Treasury and FHFA the right to manage the two companies as they see fit. But KBRA finds instead that “the 3rd PSPA simply compensates the Treasury for the capital injection made in 2008 and, more important, the open-ended support of the U.S. taxpayer.”
The report goes on to argue that these investors misinterpret the support the U.S. government lent to the two mortgage entities. Prior to the capital injection, Fannie Mae and Freddie Mac had negative net worth, meaning that Treasury’s aid only brought them to zero.
But, as the report reads, all of the profits the two make now represent therefore the return on the government’s investment, so to recapitalize Fannie Mae and Freddie Mac would essentially involve taxpayer money, which the report found “galling.”
“They are not talking about injecting any of their own cash into the companies,” KBRA writes. “If you accept the idea that the taxpayers are due a return on both the implicit and explicit capital advanced to keep the mortgage market operating, there are no earnings to be retained in the GSEs.”
The report did contend that while this may not spell out good news for the two mortgage agencies’ equity investors, it should end some of the uncertainty bond investors have faced by confirming their standing in the eyes of government.
Fannie Mae Ended 2014 on a Sour Note
Fannie Mae hit more than a few financial potholes during 2014, closing the year with significantly lower net income and comprehensive income and a stated concern that things may not get better during 2015.
The government-sponsored enterprise reported annual net income of $14.2 billion and annual comprehensive income of $14.7 billion in 2014, far below 2013’s levels of $84 billion in net income and $84.8 billion in comprehensive income.
The fourth quarter of 2014 was especially acute: Fannie Mae’s net income of $1.3 billion and comprehensive income of $1.3 billion for this period, a steep drop from the net income of $3.9 billion and comprehensive income of $4.0 billion for the third quarter. Fourth quarter net revenues were $5.5 billion, down from $6 billion for the third quarter, while fee and other income was $323 million for the fourth quarter, compared with $826 million for the third quarter. Net fair value losses were $2.5 billion in the fourth quarter, up substantially from $207 million in the third quarter.
Fannie Mae explained that its fourth quarter results were “driven by net interest income, partially offset by fair value losses on risk management derivatives due to declines in longer-term interest rates in the quarter.” Nonetheless, Fannie Mae reported a positive net worth of $3.7 billion as of Dec. 31, 2014, which resulted in a dividend obligation to the U.S. Department of the Treasury of $1.9 billion that will be paid next month.
In announcing its 2014 results, Fannie Mae offered a blunt prediction that this year will see continued disappointments.
“[Fannie Mae] expects its earnings in future years will be substantially lower than its earnings for 2014, due primarily to the company’s expectation of substantially lower income from resolution agreements, continued declines in net interest income from its retained mortgage portfolio assets, and lower credit related income,” said Fannie Mae in a press statement. “In addition, certain factors, such as changes in interest rates or home prices, could result in significant volatility in the company’s financial results from quarter to quarter or year to year. Fannie Mae’s future financial results also will be affected by a number of other factors, including: the company’s guaranty fee rates; the volume of single-family mortgage originations in the future; the size, composition, and quality of its retained mortgage portfolio and guaranty book of business; and economic and housing market conditions.”
Default Risk Index For Agency Purchase Loans Hits Series High
The default risk for mortgage loan originations rose in January, marking the fifth straight month-over-month increase, according to the composite National Mortgage Risk Index (NMRI) released by AEI’s International Center on Housing Risk.
In January, the NMRI for Agency purchase loans increased to a series high of 11.94 percent. That number represented an increase of 0.4 percentage points from the October through December average and a jump of 0.8 percentage points from January 2014.
“With the NMRI once again hitting a series high, the risks posed by the government’s 85 percent share of the home purchase market continue to rise,” said Stephen Oliner, co-director of AEI’s International Center on Housing Risk.
Default risk indices for Fannie Mae, FHA, and VA loans hit series highs within the composite, according to AEI. The firm attributes to the consistent monthly increases in risk indices to a substantial shift in market share from large banks to non-bank accounts, since the default risk tends to be greater on loans originated by non-bank lenders.
AEI’s study for January revealed that the volume of high debt-to-income (DTI) loans has not been reduced by the QM regulation. About 24 percent of loans over the past three months had a total DTI above 43 percent, compared to 22 percent for the same period a year earlier. The study also found that Fannie Mae and Freddie Mac were compensating to a limited extent for the riskiness of their high DTI loans.
Further, the NMRI for FHA loans in January experienced a year-over-year increase of 1.5 percentage points up to 24.41 percent – meaning that nearly one quarter of all recently guaranteed home purchase loans backed by FHA would be projected to default if they were to experience an economic shock similar to 2007-08. AEI estimates that if FHA were to adopt VA’s risk management practices, the composite index would fall to about 9 percent.
“Policy makers need to be mindful of the upward risk trends that are occurring with respect to both first-time and repeat buyers,” said Edward Pinto, co-director of AEI’s International Center on Housing Risk. “Recent policy moves by the FHA and FHFA will likely exacerbate this trend.”
AEI said the cause of the softness in mortgage lending is not tight lending standards, but rather reduced affordability, loan put back risk, and slow income growth among households.
More than 180,o00 home purchase loans were evaluated for the January results, bringing the total number of loans rated in the NMRI since December 2012 to nearly 5.5 million, according to AEI.