Six Quotes from Fannie Mae on the Mortgage Industry

Here are six key quotes from Fannie Mae's (FNM) conference call. Fannie Mae primarily competes with another Government-Sponsored Enterprise, Freddie Mac (FRE). The quotes are taken from the most recent Fannie Mae transcript, published a few hours after the call ended:

1. Upheavals in the market create opportunities across business lines.

As the initial shock of home price declines dissipates and markets settle down from the enormous volatility of the past nine months, we are seeing terrific opportunities in all three businesses. Strong pricing for strong credit and increasing share in single-family; the best investment spreads in over a decade for our capital markets business; and continued market leadership, strong credit performance in HCD. As the market recovers we will be a prime beneficiary.

2. Recent capital injection frees FNM to seize opportunities

We are commencing the capital raise that has been much discussed recently, a total of $6 billion raised from a combination of preferred, convertible and common, as well as dividend actions plus a continued release of regulatory capital, will put us in the position to protect the balance sheet as the housing crisis plays itself out. And as importantly it will enable us to attack the full range of market opportunities without capital restrictions. We go into the belly of this cycle with about $48 billion in core capital, which is about $17 billion above our statutory capital level. We've said before that this is the time to be long capital and this plan firmly gets us there. We've plan to harness the capital we are raising for three goals. One, to attain a position of unquestioned capital strength; two, to pursue the best business opportunities we have seen without constricting capital; and three, to step out and play a major role in helping the market recover better and sooner and to the benefit of all investors and housing, whether there will be consumers or originators or realtors or home builders; or investors in Fannie Mae.

3. Time will heal all wounds

Right now we are in the belly of the cycle. The initial period of high volatility and big shocks in the market place seems to be dissipating. The capital markets are recovering balance and spreads are returning back to normal relationships. But with that healing in the capital markets, I think we are now beginning a period of adjustment that will work its way through the consumer in the commercial fronts. The key variable for this recovery this time -- the key variable for the recovery, I think is time. That’s the part of the equation that is unknown. And that’s time not only for prices to adjust, but for the policies that have been put in place to take effect for home owners to work through the softer economy and for mortgages to migrate from the concentration of complex lower quality products that characterize the '06 and the '07 books, to a book that will be more characterized by better credit, by more fixed rate mortgages and with the higher equity component, higher down payment component for 2008 and forward. This is the time to be long capital and this plan firmly gets us there. We plan to harness the capital we are raising for three goals. One, to attain a position of unquestioned capital strength; two, to pursue the best business opportunities we have seen without constricting capital; and three, to step out and play a major role in helping the market recover better and sooner and to the benefit of all investors and housing, whether there will be consumers or originators or realtors or home builders; or investors in Fannie Mae.

4. Four Steps to kick-start recovery

Let me touch on this return to sensible standards for a moment. We are announcing today an initiative that’s called the "Keys to Recovery" that address’s for our part the needs to restore liquidity, and affordability, and stability to this marketplace. The sub-theme there is that I think we need to recommit to home ownership as a goal for this industry and for our company and not just home buying. That implies a return to standards, and it demands that companies, including ours and including other members in the industry, to step up. So to kick start the effort we are announcing four changes effective immediately that we think will have a positive impact on the recovery of the market. - First to help borrowers,who are current on their loans but trapped and unable to refinance into Fannie Mae, the better loans that are available, we will allow refinancing of Fannie Mae loans that are up to 20% underwater into safe, affordable fully amortizing loans. - Secondly we are renewing our partnership with state housing finance authorities across the country by providing $10 billion in financing for qualified first time home buyers. This will channel mortgage liquidity directly to the families and communities that need the most help. - Third, because stabilizing neighborhoods and stabilizing communities matters so much in this recovery, we are teaming up with the Self-Help Credit Union, one of our long time partners in some of the worst hit communities, in order to get families into REO foreclosed properties on a rent-to-own basis. We think this helps stabilize communities as we continue that process. We will also continue to be the nations largest investor in multi-family or a apartment financing, to ensure that there is good shelter not just for home owners, but for renters. - And finally effective immediately we will buy new jumbo conforming loans at a price which is flat to conforming or portfolio asset acquisitions through the end of the year. What this means is that though jumbos are not TBA eligible, though we think they should be, we will be pricing them as if they were TBA eligible. That should help provide critical liquidity to the market. And in order to do that we are basically eating the liquidity premium in order to jump start the portion of the jumbo market that we have been allowed to enter.

5. OFHEO Eases Up the Pressure

Importantly as I noted, our regulator OFHEO, as I said that it lifted our May 2006 consent order, based on the remediation we have completed. And OFHEO also said it would indicated that it would reduce the capital surplus requirement to about half of what it was at year end when we complete this capital raise. So taken together, all of those factors mean that we will have more capital to protect the balance sheet, to grow the business and to serve the market. So all told, including this perspective capital raise that we are undertaking started today will go into the belly of this cycle with about $48 billion in core capital, which is about $17 billion above our statutory capital level. We've said before that this is the time to be long capital and this plan firmly gets us there. We've plan to harness the capital we are raising for three goals. One, to attain a position of unquestioned capital strength; two, to pursue the best business opportunities we have seen without constricting capital; and three, to step out and play a major role in helping the market recover better and sooner and to the benefit of all investors and housing, whether there will be consumers or originators or realtors or home builders; or investors in Fannie Mae.

6. Still (primarily) a Traditional Portfolio

Let me make just a few comments on the credit book characteristics and our key areas of focus. I‘d encourage you to review the credit information in investor summary including a great deal of additional data on Alt-A book. The first point is our overall book is still largely a traditional conforming fixed rate book with low LTV's, moderate loan sizes, and high FICO scores, and a very low level of investor properties. The second point is our Alt-A book is a very key area of focus for the company. Slide 24 shows that 43% our credit losses in Q1 came for Alt-A book. We expect our Alt-A book will continue to drive an out-sized portion of our overall credit losses. But there are a few important distinguishments between our Alt-A book and the PLS Alt-A securities in the market. For example, slide 32 shows that for the 2005 through 2007 vintages, cumulative default rates at our Alt-A book were approximately one-half the default rates in the overall PLS Alt-A market. Moving onto point three, geography is an important part of the credit story. Part of this is because a high proportion of our Alt-A exposure is in states that saw the most severe price run-ups in recent years. Florida and California represent over 32% of our Alt-A book. The other geographic issue is, is that struggling economies in the upper Midwest, especially Michigan, Ohio, and Indiana have lead to high incidence of default and foreclosures. Michigan alone represented about 3% of our single-family book at the end of the Q1, but accounted for 23% of credit losses during the quarter.

Full disclosure: The author has previously served FNM as an outside consultant on non-financial matters; he has no holdings in FNM.

Comments

[phil from E...:]

It's worse than I thought.

2008 Jun 20 06:25 PM

[Nate C:]

Consider these facts.

1. Fannie Mae currently has $40 billion in available capital

2. Fannie Mae currently holds $74 billion in loans with FICO scores of less than 620 (subprime).

3. Fannie Mae also owns $196 billion in ALT-A loans (basically loans with no documentation where people lied about how much money they make)

4. According to Michael Mayo at Deutsche Bank (a very credible analyst) the default rate on subprime mortgages is estimated at 30-40% and a loss rate of 40-50% on subprime mortgages. This would mean losses for Fannie Mae of between $29.6 - 37 billion.

5. Fannie Mae’s AlT-A porfolio could see losses of between $19.6- 39.2 billion assuming a 10-20% loss rate (which is conservative) The real number is closer to 33%.. Many of these loans were given to subprime individuals who lied about their wages to justify the loan.

6. Fannie Mae faces losses of between $49.2-76.2 billion even though they only have $40 billion in capital. This means at the very least, Fannie Mae would have to raise $9 billion in outside capital to remain solvent. At the worst Fannie Mae would have to raise upwards of $36 billion. It is becoming more difficult for companies to raise new capital. Previous capital injections from foreign governments and private equity have all lost money, making many investors hesitant of investing in financial companies (just ask Warburg Pincus about their Mbia investment).

7. But doesn’t Fannie Mae hedge portions of their mortgage portfolio. Short answer is yes, but to do this Fannie enters into various swap agreements with bond insures like MGIC, PMI, etc. which exposes them to enormous counter-party risk. Many of these companies are themselves on the verge of bankruptcy (PMI trading at $1 a share) and face impending credit downgrades from Moody’s and S&P. Fannie Mae could be in the unenviable position of making money on their hedges but unable to collect the money from their counter-parties.

8. But won't the government save Fannie Mae and Freddie Mac from bankruptcy? The short answer is yes, but that does not mean that shareholders will be pleased with the outcome. When Fannie and Freddie get near bankruptcy, the US government is more likely to nationalize the firms then simply giving them more capital. This scenario is more likely if Senator Obama is President. When the government nationalizes a company, shareholders often receive next to nothing (think JP Morgan buying Bear Stearns for $2).

2008 Jul 01 08:40 PM