GSEs Relying More on G-Fee Revenue as Investment Portfolios Shrink
Fannie Mae and Freddie Mac are relying more and more on their income from loan guarantee fees just at a time when their regulator is considering a proposal to reduce those fees.
Fannie's mortgage investment portfolio is shrinking and an increasing share of its revenue came from guarantee fees rather than interest earned on its investments, the secondary market agency's second-quarter 2014 earnings report showed.
Fannie reported Thursday that it had net income of $3.7 billion for 2Q14, while g-fee income for the second quarter totaled $2.9 billion. That compares to net income of $10.1 billion during the same period one year ago and net income of $5.3 billion in 1Q14. The first-quarter's earnings were boosted by settlements involving securities firms that sold Fannie private-label MBS turned out to have high default rates.
Freddie posted net income of $1.4 billion for 2Q14, compared to net income of $5 billion a year ago and $4 billion in 1Q14.
Fannie and Freddie are charging the highest guarantees fees in their history. The government-sponsored enterprises suffered major losses during the housing bust and were bailed out by the U.S. Treasury. Their regulator hiked the fees to cover losses and reimburse Treasury.
Fannie Mae expects to pay the U.S. Treasury $3.7 billion in dividends in September, bringing the total dividend payments paid to the federal government to $130.5 billion, compared to $116.1 billion in draw requests since 2008, Fannie Mae said. Freddie Mac will pay the Treasury $1.9 billion in September, bringing its total dividend payments to $86.3 billion, compared to $71.3 billion in draw requests. Dividend payments do not offset prior Treasury draws.
But now, the Federal Housing Finance Agency is considering reducing the guarantee fees and is accepting public comments until Sept. 8.
G-fees have has been fairly stable source of noninterest income for Fannie and Freddie's over the past year. Fannie reported g-fee income of $2.9 billion in the second quarter, up from $2.5 billion in 2Q of 2013. Freddie reported g-fee income of $1.25 billion in 2Q14, compared to $1.3 billion a year ago.
The GSEs are also under orders to reduce their giant mortgage investment portfolios, which is impacting interest income.
Fannie and Freddie built huge mortgage investment portfolios before they were placed in conservatorships in September 2008. Fannie still had a $731.8 billion portfolio in June 2011 and Freddie had a $685 billion portfolio.
Over the years, the GSEs have slowly reduced their holdings. But that accelerated during the last 12 months ending June 30. Both reduced their portfolios by more than $100 billion and the latest reports show Fannie with a $452.8 billion portfolio of mortgages and mortgage-backed securities and Freddie with a $419.9 billion portfolio.
Further portfolio reductions are expected from both Fannie and Freddie, and it is impacting the GSEs' bottom line. Fannie reported $4.9 billion in net interest income in the second quarter of 2014, down from $5.7 billion a year ago. Freddie reported $3.5 billion in net interest income in 2Q14, down from $4.1 billion year ago.
Going forward, Fannie and Freddie's earnings are going to be determined by loan volume and guarantee fees, according to Federal Financial Analytics managing director Karen Petrou. The GSE expert also agreed with the outlook Fannie chief executive Timothy Mayopoulos presented Thursday in discussing the company's earnings.
"This is the first quarter in a long time in which we did not have any one-time events such as a large private-label securities settlement or a repurchase resolution," the Fannie CEO said. "This quarter gives you a good sense of a normalized environment for Fannie Mae."
But Fannie and Freddie could get their wings clipped if FHFA Director Mel Watt decides to reduce the g-fees to bring them down to normalized levels to make GSE loans more affordable for borrowers.
Fannie currently charges a 62.6-basis-point guarantee on new loans and Freddie charges 57.7 basis points. (Freddie's g-fee is lower because investors preferred Fannie MBS to Freddie Participation Certificates.)
Due to an act of Congress, 10 basis points of the guarantee fee are paid to the U.S. Treasury to cover the cost of a temporary payroll tax cut.
Freddie paid $187 million in 2Q and $1 billion since 2012 to cover a 10 basis point fee that Congress levied on the GSEs. Fannie paid $335 million in guarantee money to Treasury in 2Q.
Despite the reductions in the investment portfolios, the GSEs still have to hedge the assets against interest rate risk. The most efficient hedging instruments are derivatives, according to Freddie CEO Donald Layton.
"We had derivative losses of $1.9 billion" in the second quarter and a loss of $2.4 billion in the prior quarter," he said, adding "this is extreme volatility." However, he noted the losses should flatten out and turn to gains if interest rate start to rise and the yield curve steepens.