Fannie Mae (OTCQB:FNMA) Q3 2018 Earnings Conference Call November 2, 2018 8:00 AM ET
Maureen Davenport - Senior VP, CCO
Hugh Frater - CEO
Celeste Brown - CFO
Bonnie Sinnock - National Mortgage News
Welcome and thank you for standing by. At this time all participants are in a listen-only mode. Operator Instructions] Today's conference is being recorded. If you have any objections, please disconnect at this time.
I will now turn it over to your host, Maureen Davenport. Fannie Mae's Senior Vice President and Chief Communications Officer.
Thank you, Operator. And thank you for joining today's media call to discuss Fannie Mae's Third Quarter 2018 Financial Results.
Please note that this call may include forward-looking statements, including statements about the company's future, dividend payments, financial and business results, actions, business plans and strategy.
Future events may turn out to be very different from these statements. The risk factors and forward-looking statements section in the company's third quarter 2018 Form 10-Q filed today and it's 2017 Form 10-K filed February 14, 2018 describe factors that may lead to different results.
As a reminder, this call is being recorded by Fannie Mae, and the recording may be posted on the company's website. We ask that you do not red this call for public broadcast and that you do not publish any full transcript.
I'd now like to tur the call over to Fannie Mae's Interim Chief Executive Officer, Hugh Frater; and Chief Financial Officer, Celeste Mellet Brown. Hugh?
Thanks, Maureen. And good morning, everyone. Thanks for joining us to discuss Fannie Mae's third quarter results. Just over two weeks ago I began serving as Fannie Mae's Interim CEO. So, this is my first opportunity to host this call.
I will serve in this role while the Board of Directors conducts a search for permanent CEO where process for is well underway. While I'm still moved to my current role, I'm not new to Fannie Mae, I've been a board member since 2016, and I've spent almost my carrier in financial services including federally regulated entities.
I was a founding partner, managing director with BlackRock, and a senior executive at PNC Financial Services, while I led the real-estate provisioning including among other areas of agency finance.
Part of joining the board of Fannie Mae, I was the CEO and Chairman of Berkadia, a national commercial real-estate company Fannie Mae customer for multi-family housing. As a former customer, I come to Fannie Mae with great appreciation for the central role of the company players foundations mortgage market and in on our housing economy.
I also have a deep appreciation for the company's very deep financial executive talent. In the 10 years since in service ship again, Fannie Mae has returned to profitability and returned to the fundamentals of mortgage underwriting. The company also has tools in place to provide fast help to borrowers, taking unexpected hardships such as natural disasters.
With the help of the conservator and regulator, the FHFA, Fannie Mae has transformed its business model reduced its large investment portfolio and created a new market for transferring credit to private investors all the while safe and soundly providing trillions of dollars of liquidity to the mortgage market.
As the interim CEO, I do my job as maintaining deposit momentum of the company working with management to execute on our strategy and ensuring the company maintain its strong commitment to safety standards in stewardship on behalf of tax payers.
As long for the full results are reflecting Fannie Mae's momentum. Our CFO Celeste Brown, will cover the specifics about third quarter results very deeply a high level what I see as that our customers are facing a lot of headwinds in the market. Rates are up, volumes are down, margins are tight, so vendor profitability is challenged.
New housing supply is up, that not only supplies and create what's needed while we do see income growth nationally in many markets home price growth is outstripping and growths are credibility for home buyers remained the challenge. And the multi-family markets' rental growth has remained fairly strong.
So, even though incomes has started to grow, the percentage of house also the rent burden remains in open high. Again, that back up your produce and trying to help our customers by enabling a mortgage process that is better faster cheaper and safer to help them run their businesses and serve their customers better.
As a former Fannie Mae customer, I'm aware that one of the best place to get customers that could -- is to continue to improve and innovate, in fact it is our responsibility to innovate if we got to have to serve our customers. Our lender customers are seeking to deliver a mortgage experience to their home owner customers that is far different from today.
Today, a home mortgage took be place approximately 60 days from application and delivery is not farfetched to envision a world where this takes a few as 10 days. That's what our customers is driving towards so that they can meet the expectations of home owners.
The eventual result of this digital transformation to be a radical reduction to constant processing loan, greater certainty for render and while enough diminish in safety and soundness.
Fannie Mae needs to continue innovating in order to help our customers deliver that experience to home owners while carefully managing risk and the tax payer. Fannie Mae is also committed to continue to advance a sustainable business model that reduces risk to the housing finance system and tax payers.
One way to improve sustainability is to increase the sources of risk capital available for the mortgage market and we are doing this through our credit responsible work. Let me share a few examples. In September, we executed our sixth Connecticut Avenue Securities or CAS transaction and our seventh Credit Insurance Risk Transaction or CIRT transaction of 2018.
These transaction shift the portion of the risk and pulls with single-family loans with private investors and to a panel of insurers respectfully. We also engaged in our first Connecticut Avenue Securities Transaction issued by a trust that qualifies the real-estate mortgage investment kind of for better.
This new structure is designed to make cash deal more attractive to real-estate investment towards the REITs and the international investors and in the moment less more office and additional context on this new structure.
Since we began our innovative credit risk transfer program in 2013, we have transferred a portion of the credit risk and approximately 1.5 trillion at single-family loans measured in unpaid principle balance the time of the transaction, well told approximately 38% of loans in our single-family guarantee book of business were covered by a better risk transfer transaction as of the end of September.
Another example of our forward lending work came at our second issuance of securities index to this cured overnight financing rate whatsoever. Fannie Mae leads the market and the development of surplus and e-market and that's since supported the alternative reference rates, committee's efforts.
Fannie Mae's second transaction is designed to provide additional points and this self-recur and has served the benchmark for market participants. We are glad that the Federal Reserve may or see recognize Fannie Mae's efforts in helping establish in using self-recur in financial markets.
Finally, in our multi-family business, 100% of our new multi-family business line has rendered this sharing robust model. But in addition to that, in the third quarter we also transferred multi-family mortgage better risk with multi-family CRT transaction and we expect to continue with multi-family CRT transactions on a regular basis going forward.
As Interim CEO, I'm commit to make ensuring across all work we are abided by a set of principles. We got this customers, homeowners and renters, reflecting tax payers and event and initiations are both in our chart. Is to do our best to ensure access to mortgage better affordability of housing and sustainability of the housing finance markets.
Now, let me turn it over to Celeste and we will reach time at the end for questions. Thank you.
Thank you, and good morning everyone. In the third quarter, we reported $4 billion in the net income and comprehensive income. This compares with net income and comprehensive income of $4.5 billion in the second quarter. Our pre-tax income was $5.1 billion compared with $5.6 billion in the prior quarter.
The decrease in net income for the quarter was driven primarily by lower credit related income which was due to a reduction and the benefit associated with re-performing loans being re-classified from a help for investment designation to a help for sale designation.
This change in designation received sale of loans to other investors. Last quarter we re-designated a larger population of loans in anticipation of sale which then closed this quarter. Also contributing to the decline in credit related income in the quarter, was a smaller improvement in home prices compared with that in the second quarter which is in line with seasonal expectations and trends.
Partially offsetting this reduction was an increase in fair value gain. Fair value gains in the third quarter were driven by gains from risk management and mortgage commitment derivative due to rate increases in the quarter.
Based on these results, we expect to pay a dividend of $4 billion to treasury in the fourth quarter. And we will continue to retain a total of $3 billion in capital. Now, focus on a few highlights.
Overall, our third quarter performance reflected strong fundamentals with solid revenue streams driven by guarantee fees on our stable book of business. We provided a $140 billion of liquidity to the mortgage market in the third quarter to guarantees and loan purchases.
This reported 360,000 home purchases, 160,000 home refinancers and financing for 206,000 multi-family rental units. We also continue to focus on managing and distributing risks. In the third quarter, we further reduce the size of our retained mortgage portfolio which in turn reduce the company's risk exposure.
Our retained portfolio is now below $200 billion well below the aperture base requirement to reduce the balance to $225 billion by the end of 2018. Through sales of re-performing and non-performing loans, we've been able to successfully reduce the loss mitigation portion of our retained mortgage portfolio, which has declined by 24% since the end of the third quarter of last year and 78% since the start of conservatorship.
Also in the third quarter, we continue to distribute credit risk to the private market to our credit risk transfer programs. As Hugh mentioned, we executed new CAS and CIRT transactions in single family. And as of the end of the third quarter, 45% of the unpaid principle balance of loans in our single-family guarantee book, now has some level of credit enhancement including primary mortgage insurance CAS deals, CIRT deals and lender risk sharing up from 40% at the end of 2017.
On the multi-family side, nearly 100% of our new business volume now has lender risk sharing through our delegated underwriting and servicing program which we refer to us our "DUS" program. This quarter, in addition to the credit transfers we do through DUS, we entered into our third multi-family CIRT transaction to-date, transferring a portion of the credit risk a multi-family mortgages within unpaid principle balance of an $11.1 billion.
We view CIRT transactions as added in to the risk transfer activities that are as far of our core DUS program. We are continuously innovating and improving our credit risk transfer program as part of this ongoing effort and as Hugh mentioned in the single-family space we recently introduced our new CAS enhancement and enables us to issue CAS investor qualify with REMIC securities.
This week, we priced our first CAS REMIC deal. This offered with strong investor demand, attracting new investor. In addition to attracting new investors, our new CAS REMIC structure improved from the traditional CAS structure. Our previous CAS offerings were structured as Fannie Mae corporate debt, where there can be a significant lag time between when we recognize the provision for credit losses and when we recognize the related recovery from a CAS transaction.
The new REMIC structure provides the same level of risk covers that is provided by our traditional CAS products eliminates the timing mismatch and allows us to recognize the credit loss protection provided to us by these transactions. At the same time the related credit loss is recognized in our financial statement.
This is a significant benefit for the company particularly as we think about resources we may require in a stress situation. Our single-family business continue to have a strong presence in the secondary market in the third quarter. Fannie Mae remain the largest issuer of single-family mortgage related securities representing 40% of new single-family mortgage related securities issuances.
Overall, single-family results in the third quarter was solid with net income of $3.5 billion compared with $4 billion in the second quarter as with total company results the decrease was mainly driven by a reduction in credit related income primarily due to a lower benefit associated with loans in reclassified from helper to helper sale.
Additionally, while there was constant home price growth in the third quarter, the growth was smaller than in the second. The single-family business earned $4.7 billion of net interest income primarily driven by the guarantee fee income earned on our $3 trillion guarantee book business.
The performance in underwriting of loans in our single-family guarantee book remains strong, with our SDQ rate of 82 basis points as of the end of the third quarter; which is lower than the level observed before last year's hurricane. However, is possible that SDQ rates may increase in the near term as a result of hurricanes occurring in the past few months.
We are currently assessing the damage from the recent storms and the potential impacts to loans on our guarantee book. However, we do not believe that the hurricane so far in 2018 individually or an aggregate will have a material impact on our credit losses or credit reserves.
Finally, our multi-family business posted net income of $549 million in the third quarter up from $504 million last quarter. This increase was driven by a higher guarantee fee revenue due to growth in the multi-family book of business. In addition, fee and other income of a $192 million increased in the third quarter primarily driven by higher yield maintenance as a result of prepayment activity.
Our multi-family credit related expense remains low because of strong fundamentals with our SDQ rate remaining below 10 basis points in the third quarter. Multi-family business volume in the first nine months of the year was $44 billion and we continue to be a leader in affordable workplace rental housing.
More than 90% of the multi-family units we supported in the third quarter were affordable to families earning at or below a 120% of area medium income. You can find more information on the drivers of our third quarter results in our press release, our financial supplement in our Form 10-Q which we filed today.
I'd like to thank you all for joining today's call. And we will be glad to answer any questions you may have.
[Operator Instructions] And we do have a question or comment from Bonnie Sinnock from National Mortgage News. Your line is open.
Hi. Thank you, for taking my question. I wondered if you could explain a little bit more, you talked about. It sounds like the new risk sharing REMIC structure, it addresses a timing mismatch there was with previous structures. I wonder if you could walk me through that.
Yes. So, this is something we've been working on for several years. Where the CAS REMIC provides significant benefits to the company in terms of recouping losses associated with mortgage delinquencies and loans potentially going into bankruptcy.
The challenge with the prior structures was that there was while we would recognize the losses as they occurred or as our model suggested they would occur, and those with both of the income statement, the benefit from the CAS structure which we haven’t seen yet because that housing market is going quite strong would be realized much later because of the change in particular.
Because the debt is no long a debt of Fannie Mae, we will now recognize the losses and the benefits at the same time.
What does it become debt or if it's not debt of Fannie Mae?
The debt is now associated directly with the CAS REMIC. So, it is the counter party is no longer -- yes.
I got it. Okay, thanks. Thank you for explaining that.
Thank you. [Operator Instructions] At this time, I see no further questions in the queue. I will now turn it back over to Fannie May Interim Chief Executive Officer, Hugh Frater.
Thank you. And thanks to all of you for listening to the call. And we'll report until next time we are together. Maureen, anything else from you?
I think, that's it. Thank you everyone and have a great day. Operator you can disconnect the call.
That concludes today's conference call. Thank you for your participation. You may disconnect at this time.