How risk-sharing deals are renewing the Fannie Mae, Freddie Mac rivalry

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The fierce competition between Fannie Mae and Freddie Mac has largely taken a backseat to the myriad reforms enacted over the 10 years the mortgage giants have been in federal conservatorship. But the unique approach each company is taking with their credit-risk transfer products is quickly becoming a key point of differentiation with long-term implications.

The government-sponsored enterprises have both developed multiple risk-sharing products to offload their risk exposure on the mortgages they buy to different players in the private market. This approach ensures a diverse pool of investors and promotes more competitive pricing.

But now those strategies are starting to diverge. Fannie is moving ahead in the race to develop a risk-sharing product that qualifies for real estate mortgage investment conduit tax treatment. Fannie recently launched its first risk-sharing deal using the REMIC structure, which is expected to appeal to real estate investment trusts.

The REMIC structure also allows for accounting treatment of the CRT securities "that matches up better" with the recording of losses "associated with times of stress and defaults," Celeste Brown, executive vice president and chief financial officer at Fannie, said in an interview.

While Freddie intends to launch a REMIC-based risk-sharing product sometime in 2019, it's currently focused on changes to its existing CRT products to increase the amount of risk and the span of time investors are exposed to that risk.

The GSEs' risk-sharing strategies are drawing more scrutiny from the Federal Housing Finance Agency as part of the regulator's heightened oversight of Fannie and Freddie's dwindling capital reserves.

Fannie generated $4 billion in net income during the third quarter of 2018, the company announced Friday, up from $3 billion a year ago, when reserves against expected hurricane losses hurt results. But it was down from $4.5 billion in the second quarter, when income was higher due to the reclassification of certain assets.

Earlier this week, Freddie reported net income of $2.7 billion for the third quarter, down from $4.7 billion a year ago, but up slightly from the second quarter.

Many of the other developments playing into that fact that Fannie was able to improve on its year-ago numbers, but not generate income as strong as the previous quarter, while Freddie Mac did the reverse, were based on developments distinct to the different fiscal periods involved.

The consecutive-quarter decrease "was driven primarily by lower credit-related income, which was due to a reduction in the benefit associated with reperforming loans being reclassified from a held for investment designation to a held for sale designation," Brown said during the company's earnings call.

"Also contributing to the decline in credit-related income in the quarter was a smaller improvement in home prices compared to the second quarter, which is in line with seasonal expectations," she added.

When adjusted for quarter-specific events, both Fannie's and Freddie's results show fairly consistent profitability outside a steep drop related to tax reform in the fourth quarter of last year.

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