Fannie Mae's risk management advances support stable earnings in 3Q

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A risk management model revision that decreased single-family loan-loss allowances and a strong mortgage lending environment contributed to consistent earnings results at Fannie Mae in the third quarter.

The revised allowances in the single-family business' cash-flow model during the third quarter added $850 million pretax to Fannie Mae's credit income. That figure was rolled up with others into the company's $4 billion in overall net and comprehensive income for the period, matching the year-ago results and representing an increase from $3.4 billion the previous quarter.

"We typically make updates to our multifamily and single-family model that flow through to the allowance about once a year and we have been working on a much bigger update which we implemented this quarter," Celeste Brown, Fannie's chief financial officer, said in an interview. The update "shows the benefit of all the loss mitigation activities we have implemented."

"Precrisis there was very little loss mitigation when you had a loan that went delinquent, and now with the loss mitigation activities that exist, the likelihood of a loan defaulting has decreased and the severity of that default has declined. But we hadn't reflected the benefit into our model. We only put it in now because we have a number of years of data that reflects reduced severity and probability of default," she said.

Fannie's serious delinquency rate for single-family loans originated between 2009 and 2019 was 0.33% in the first nine months of this year. Loans originated between 2005 and 2008 have an SDR of 4.24% and mortgages produced before 2005 have an SDR of 2.53%. Annual SDR rates in all three categories are at five-year lows.

Other recent credit-related developments Fannie executives noted in their earnings call included continuing shrinkage in the share of single-family loan purchases with riskier attributes, and the first-time use of the Connecticut Avenue Securities structure for multifamily risk sharing.

The percentage of acquired single-family mortgages with higher loan-to-value and debt-to-income ratios was mostly lower during the period as a result of earlier underwriting changes made to address concerns about layered risk.

The share of mortgages with DTIs above 45% fell to 17% in the third quarter from 20% the previous quarter and from 25% in 3Q18. The percentage of single-family loan acquisitions with an LTV above 95% was at 7%, down from 8% from a year ago and unchanged compared to 2Q19.

In addition, the year-to-date share of Fannie loan purchases with a FICO credit score below 680 was the lowest it has been in five years at 8%.

The current weighted average life of Fannie's single-family loan book also is roughly five years, down from closer to seven years at the same time in 2018, when rates were approximately 100 basis points higher.

In line with that number, trends over five-year periods are better indicators of the performance of Fannie's acquired loan book than quarterly swings in the book of business' value, Brown noted.

Among these swings during the most recent quarter were $713 million in fair value losses related to the lower interest rate environment. While low rates bolsters single-family mortgage lending volumes, they had mixed impacts on Fannie's various mortgage-related business lines. The net fair value losses were driven primarily by changes in instruments used to hedge Fannie's interest rate exposures.

Brown said similar fair-value losses tied to lower rates in both the second and third quarters would have been "substantially lower" if Fannie had hedge accounting in place, something it plans to eventually adopt to reduce quarterly volatility. Its smaller competitor, Freddie Mac, already does this, but Fannie has been more deliberate about implementation, citing a need to wait for pending accounting changes to play out.

Freddie's third-quarter net and comprehensive income figures, which were reported earlier this week, were down year-over-year but comparatively more favorable on a consecutive-quarter basis.

Both Fannie and Freddie are reorienting themselves toward new directives that allow them to accumulate higher amounts of capital than they were previously permitted during conservatorship. Fannie can now retain up to $25 billion and Freddie can retain up to $20 billion. Until recently, each could only retain $3 billion. The GSEs' conservator and regulator, the Federal Housing Finance Agency, is working on a capital rule for the GSEs.

Fannie Mae CEO Hugh Frater said during the company's earnings call that he is cautiously optimistic about government directives to rebuild capital and exit conservatorship.

"I think paying for government support and putting private capital in front of taxpayers is the right approach but we need to remember that having private capital requires delivering a return on that capital. Choices about the structure of the GSE business and what kinds of business are permitted would affect those returns but I'm encouraged by the dialogue so far and the momentum," he said.

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Earnings GSEs Risk management Loss mitigation Fannie Mae Freddie Mac FHFA