Fitch: Fannie, Freddie Repayment Quickening Under FHFA Scenarios
The latest projections released by the Federal Housing Finance Agency (FHFA) indicate that both Fannie Mae and Freddie Mac are in a stronger position today to reduce the amount of net cash drawn from the U.S. Treasury over the next few years. Despite these improved fundamentals, the two government-sponsored enterprises (GSEs) have become more intertwined with the state than ever before as a result of the recent third amendment to the preferred stock purchase agreement (PSPA).
Under three separate housing price path scenarios, the FHFA's latest outlook shows a significant reduction in projected cumulative draws from the Treasury compared with last year's forecast. This is particularly true for Fannie Mae, which has a larger mortgage portfolio and would benefit more from a quickened pace of recovery in the housing market. The primary driver of the improvement from last year has been stronger operating results for both Fannie and Freddie between third-quarter 2011 and second-quarter 2012, which are reflected in the new FHFA projections.
In addition, the FHFA's upside and baseline recovery scenarios have converged as tentative signs of a modest U.S. housing price recovery have emerged this year. Expected credit losses in the downside scenario have been cut, further limiting the need for additional GSE cash support should the recovery falter.
As a result of the third amendment to the PSPA, the fixed 10% dividend will be eliminated starting in January 2013 and all future earnings will be swept to the Treasury. Since being placed into conservatorship, the GSEs have paid back approximately 25% of the aggregate capital draws back to the Treasury in the form of dividends. In Fitch Ratings' view, replacement of the fixed dividend alleviates potential concerns about a breach of the support cap, which kicks in next year under the funding agreement with Treasury.
We see the third amendment and the updated FHFA projections as evidence that Fannie and Freddie will remain under government control indefinitely. With $187 billion drawn, there is currently no mechanism for the GSEs to repay the principal back to the Treasury. Furthermore, having virtually all future net worth transferred to the federal government leaves almost no recovery prospects for private common equity investors.
While Fitch generally views the economic scenarios used by FHFA as reasonable, there are other factors that could drive additional losses at the GSEs. The large derivatives portfolios, which are subject to mark-to-market, respond to sudden changes in interest rates. The potential impact of a "fiscal cliff" scenario on the U.S. economy and the housing market remains uncertain. The GSEs could also experience losses resulting from operational issues, the risk of which has increased due to elevated employee turnover at both entities.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Ilya Ivashkov, CFA, +1 212-908-0769
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Bill Warlick, +1 312-368-3141
70 W. Madison
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Brian Bertsch, +1 212-908-0549