Speeches

February 14, 2019

Fannie Mae Fourth Quarter and Full Year 2018 Earnings Media Call Remarks

Adapted from Comments Delivered by Hugh Frater, Interim CEO, and Celeste Brown, Executive Vice President and Chief Financial Officer, Fannie Mae, Washington, DC

Hugh Frater: Thank you and good morning. Thanks for joining us to discuss Fannie Mae's results for the fourth quarter and full year 2018.

I'm joined today by our Chief Financial Officer, Celeste Brown. In a moment, Celeste will review our 2018 performance, the economic outlook, and capital. After that, we'll be glad to address any questions you have.

First, however, I would like to review with you Fannie Mae's priorities for the year ahead and, at a high level, how we see some of the major trends in our business and the market we serve.

First, our customer focus has helped us deliver a stream of innovations that are improving the experience of being a Fannie Mae customer and helping make the mortgage process more efficient for their customers. These innovations include our Day 1 Certainty tools that are cutting costs and time out of the loan production process. They also include new servicing tools that are making it easier and less costly to service a Fannie Mae residential loan. In the Multifamily space, we have Green Financing to support cost-effective environmental improvements and reduce utility costs for residents. And we have enhanced delegations that streamline our DUS Multifamily origination process.

Second, as part of our strategy we are continuing to strengthen our business model. In 2018, for example, we continued to expand our credit risk transfer programs. Through this work, we are bringing more private capital into the housing finance system and are moving risk away from the taxpayers.

As a result of these strategic choices, Fannie Mae heads into 2019 with a strong market position and stable business model.

Our priorities for 2019 are clear.

First, we are working to ensure a smooth transition to the Uniform Mortgage Backed Security.

While there is still testing underway, we expect that Fannie Mae and Freddie Mac will begin issuing the new UMBS in June. We have been working with Freddie Mac, FHFA, our customers, investors, and many other market stakeholders to help ensure that this process is orderly and transparent.

Second, in 2019, we are going to continue to drive progress toward our vision of an all-digital mortgage process. We believe we are still in the early stages of a technological trend that will drastically improve the quality, efficiency, speed, and safety of the mortgage process. We believe the potential benefits to our customers and the housing market are enormous, and that Fannie Mae is in a unique position to help enable this digital transformation.

A third area of focus in 2019 is capital, which Celeste will address in more detail in a moment.

As you know, our regulator has put forth a proposed capital rule, and we have provided comments on the proposal. Obviously, capital is critically important to our business and our mission. A robust and sensible capital regime for the GSEs is necessary to both protect taxpayers and sustainably attract private capital to the housing finance system.

And last, but far from least, in 2019 Fannie Mae will direct more of its energy and focus to helping address the significant shortage of affordable housing in the United States. The supply of homes that are affordable to working and lower income families has been on a decade-long decline due to the combination of growing demand and inadequate supply. Fannie Mae wants to put both its intellectual capital and its real capital to work to help reverse this trend – but, do so in a way that is consistent with our charter, mindful of risk, and beneficial to the market.

This is why we are working with innovators in the housing and mortgage markets to explore new ways to build, maintain, and finance homes and multifamily properties that are fundamentally less costly to the end-user. It is also why we have committed to helping develop a secondary market for manufactured housing loans.

Our housing supply challenge is not something that Fannie Mae alone can overcome. It will require collaboration with and focus by many stakeholders, including those operating at the national and the local levels. But Fannie Mae has a role to play. We are committed to participating and, where appropriate, leading efforts to increase the supply of affordable housing in the United States. It took more than a decade for our housing scarcity problems to develop, and it may take as long to fix them.

Before I turn it over to Celeste, I want to mention that 2019 will be a year of transition and change for the industry and for Fannie Mae. It's a year of transition in the leadership team at FHFA. As our regulator and conservator, FHFA plays a very influential role in our business. We have built a strong and constructive relationship with FHFA over the years, and we will focus on maintaining that relationship in 2019.

It is also a year of transition for Fannie Mae. Consistent with its plans, our Board continues the selection process for a permanent chief executive officer. And, as Celeste will discuss, we are keeping close tabs on a number of trends in the overall economy and in the housing market this year.

Whatever changes may come, Fannie Mae's focus remains the same: We will maintain a strong book of business, prudently manage our risk, and continue to build a company that is ready to meet the changing needs of the housing finance system.

With that, let me turn it over to Celeste. And we will leave time at the end for your questions.

Celeste Brown: Thank you, Hugh, and good morning everyone.

First, I am going to review our financial highlights for the quarter and the year. I will then turn to our outlook, and finally discuss capital.

We had very solid financial performance in 2018, with net income of $16 billion, and comprehensive income of $15.6 billion. For the fourth quarter, we earned $3.2 billion of net income and comprehensive income. Based on these results, we ended 2018 with a net worth of $6.2 billion and expect to pay a $3.2 billion dividend to Treasury by the end of March. That will leave us with a net worth of $3 billion, which is the maximum capital buffer specified in the Senior Preferred Stock Purchase Agreement.

Overall highlights

Consolidated Fannie Mae revenue for the fourth quarter declined versus the third quarter.

First, while g-fee revenue increased on a larger book size, revenue declines were primarily driven by lower amortization income due to lower mortgage prepayment activity, as the steady increase in interest rates during most of 2018 resulted in fewer people refinancing their homes. In fact, 30 percent of the new single-family loans we guaranteed in the fourth quarter were refinances, compared to 46 percent in the fourth quarter of 2017, when average mortgage rates were 86 basis points lower.

Second, credit-related income increased compared to the third quarter, primarily driven by lower projected future interest rates as well as higher forecasted home prices.

And finally, we had fair value losses in the fourth quarter compared to gains in the third quarter, driven by a decrease in interest rates, particularly late in the quarter.

Single-Family highlights

Turning to our Single-Family business, our pre-tax income declined by a billion dollars in the fourth quarter versus the third, primarily driven by the factors that drove our overall results. The single-family guaranty book of business continued to grow in the fourth quarter, up 23 basis points in the quarter and 155 basis points in 2018.

Average charged fees on acquisitions, net of TCCA, decreased to 48.5 basis points in the fourth quarter from 49.7 in the third, driven by increased competition and our acquisition product mix. However, fourth quarter charged fees were more than 6 basis points higher than they were in the fourth quarter of 2017. The average charged fee on the book overall increased slightly to 43 basis points in the fourth quarter.

The single-family delinquency rate was 76 basis points at the end of 2018, continuing the downward trend since the peak of the financial crisis.

Multifamily highlights

Turning to multifamily, net income increased in the fourth quarter versus the third, driven by growth in g-fee revenue due to a larger book size, with the book up 3 percent to over $300 billion in the quarter, and up 10 percent in 2018.

We continue to see downward pressure on our acquisition charged fees in our Multifamily business due to competitive market dynamics, driven by increased demand from capital markets investors for credit risk. The average charged fee on acquisitions declined by approximately 25 basis points year over year, driving the charged fee on the overall book down from approximately 79 basis points at the end of 2017 to approximately 75 basis points at the end of 2018.

The CIRT transaction we completed in the quarter was an important tool for us to reduce capital requirements and reach our return hurdles despite the competitive environment.

The multifamily serious delinquency rate was at 6 basis points at the end of 2018.

While the population of multifamily substandard loans remains low, it increased in Q4 and was the primary driver of a slight increase in the allowance. The increase is being driven by pressure in certain segments of the book in which properties backing our loans are experiencing slower or negative NOI growth.

Overall, however, the risk ratings and credit profile of the book remain very strong with near all-time lows in delinquency.

Outlook

Turning to our outlook: Economic growth is projected to slow. Some potential risks to economic and housing market expansion include:

  • First, higher interest rates have increased borrowing costs for households and businesses over the past year. Our forecast reflects one Fed rate increase in June.
  • Second, tax reform has weakened the mortgage subsidy with potential implications for regional housing price growth over time.

We expect 2019 home price growth to be approximately 4 percent, down from 5.6 percent in 2018. While the economy is slowing, home price growth continues to be supported by a shortage of supply.

We expect total single-family refinance market originations in 2019 to be down by 8 percent versus 2018, while purchase mortgage originations are expected to increase modestly, resulting in a slight drop in the refinance share of the market originations to 26 percent in 2019.

Our outlook for the multifamily sector is that rent growth will be positive this year but slightly lower than in 2018, and between 2 and 2.5 percent, due to new supply just as job growth slows, resulting in fewer household formations and lower demand.

As it relates to our earnings, let me remind you of several things as you think about 2019:

  • First, while the sale of reperforming and nonperforming loans, and the associated redesignation of these loans from held-for-investment (or HFI) to held-for-sale (or HFS), has been a significant driver of income in recent periods, we may see less benefit in 2019 to the extent the population of loans we are considering for sale declines. In the past year, redesignations and investment gains on sales of these loans from our retained portfolio were a significant driver of earnings, contributing $2.3 billion on a pre-tax basis.
  • Second, we are unlikely to experience the same fair value gains as we did in 2018. Our fair value gains and losses are dependent on a number of factors, including changes in interest rates, which are difficult to predict. If rates were to decline, fair value gains could be much lower or turn to losses. Fair value gains drove positive $1.1 billion of pre-tax income in 2018.
  • Third, lower home price growth and a smaller allowance overall will likely further reduce credit-related income in 2019, while higher rates are also a headwind. Actual and projected home price growth drove $1.2 billion of benefit to our pre-tax income in 2018.

Finally, I will turn to capital. At the end of 2018, our proposed capital requirement was $89 billion, down $5 billion from the end of 2017.  Excluding the impact of DTA, which was included in the year-end 2018 number, but not in the 2017 number, our conservator capital requirement would have been down $11 billion. The key driver of the decline of our theoretical capital requirements was the 5.6 percent increase in home prices during the year, which drove an approximate $13 billion decline in our requirements, though this was partially offset by other factors.

The capital rule is very sensitive to home prices – when home prices go up, capital requirements go down – and if home prices decline, capital requirements increase. This feature of the proposed capital framework is commonly referred to as pro-cyclicality.

We are committed to reducing the risk of the business in a prudent way, and the reduced capital number also reflects our business actions. The reduction in our retained portfolio, down $52 billion during the year due in part to aggressive sales of RPL and NPL loans, and other factors, was a meaningful contributor, and reduced our capital requirement beyond the reduction driven by pro-cyclicality.

The reduction in capital from portfolio sales and pro-cyclicality was partially offset by book growth associated with new acquisitions. To reduce the gross spot capital requirements on these new acquisitions, we continue to transfer risk across both businesses, including our highly successful DUS risk-sharing program, which transfers almost a third of our risk for Multifamily on day one, and the back-end risk transfers we executed in Single-Family and Multifamily. We are proud of the advances we made in risk transfer this year, including:

  • We transferred a portion of risk on over 90 percent of our recently acquired, eligible single-family loans using CRT transactions. This population generally consists of non-Refi Plus 30-year fixed-rate mortgages with loan-to-value ratios between 60 percent and 97 percent.  Through these programs, we transferred a small portion of our expected losses and a significant portion of the losses we expect we'd incur in a stressed credit environment, such as a severe or prolonged downturn.
  • We also introduced the new CAS REMIC structure for Single-Family, which has attracted additional investors and better aligns the benefits of the risk transfer with GAAP accounting.
  • As I mentioned, we continued to transfer approximately 30 percent of our front-end risk in the Multifamily business through our DUS program, which covers a portion of both expected and stress losses.
  • We also expanded our multifamily CIRT program while exploring additional programs for transferring multifamily credit risk.
    • In addition to the coverage we get through DUS, the two Multifamily CIRT transactions we initiated in 2018 covered over one-third of our acquisitions, or $22 billion of unpaid principal balance. This allowed us to transfer a significant portion of the losses we would expect to experience on those loans in a stress environment.

As we think about capital more broadly, we are focused on optimizing around the capital standard in place and considering the proposed rule generally.  Key inputs to our analyses are:

  1. Our mission requirement to provide liquidity in all markets
  2. The depth and availability of the risk transfer markets:
    1. We are mindful that GSE credit risk transfer markets are unproven in prolonged stress conditions. In our 2018 DFAST severely adverse stress test, we assumed that we would be unable to issue CRT.
    2. It is worth noting that our DUS model has proven to be an effective risk sharing structure even in very stressed markets, while reducing risk to the tax payer by aligning incentives.
  3. The ability of appropriately structured risk transfer to mute the impact of the allowance in stress tests and thus reduce our stress losses
  4. The cost/benefit of transferring risk more dynamically
  5. The company’s cost structure
  6. The pro-cyclicality of the proposed rule
  7. And finally, our ability to generate appropriate risk-adjusted returns

Conclusion

Hugh Frater: Thank you everyobody for your time this morning, and thank you [operator], and we'll look forward to seeing you next time.