TEXT - Fitch affirms Fannie Mae and Freddie Mac's 'AAA' ratings
Nov 28 - Fitch Ratings has affirmed the long-term Issuer Default Ratings (IDRs) of Fannie Mae and Freddie Mac at 'AAA'. The Rating Outlook remains Negative. A full list of ratings follows at the end of this release. RATING ACTION RATIONALE The ratings and Rating Outlook of Fannie Mae and Freddie Mac are directly linked to the U.S. Sovereign rating, based on Fitch's view of the U.S. government's direct financial support of the two housing government sponsored enterprises (GSEs). The linkages are further articulated in Fitch's report 'Rating Linkages to the U.S. Sovereign Rating', dated July 18, 2011. Fitch revised the Rating Outlook on the U.S. Sovereign rating to Negative from Stable on Nov. 28, 2011. The housing GSEs remain regular issuers in the capital markets, benefiting from meaningful financial support from the U.S. government. A key rating driver and Fitch's rationale for aligning the GSEs' ratings to the U.S. government rating is the the U.S. Treasury's Senior Preferred Stock Purchase Agreement (PSPA). Under the PSPA, the U.S. Treasury is required to inject funds into Fannie Mae and Freddie Mac to maintain positive net worth, so that each firm can avoid being considered technically insolvent by their conservator. The third amendment to the PSPA eliminates the fixed 10% dividend starting in January 2013 and all future earnings (in excess of a net worth buffer) will be swept to the Treasury. This effectively removes any potential upside private investors could have hoped to regain from the recent improvement in performance. Since being placed into conservatorship, the GSEs have paid back approximately 27% of the aggregate capital draws back to the Treasury in the form of dividends. In Fitch's 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. Fitch views the third amendment to the PSPA as evidence that the GSEs 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. Although a fiscal cliff scenario is not Fitch's base case expectation, if such a scenario were to play out, Fitch would not expect it to have a material direct impact on the GSEs in terms of the Treasury's ability to fund any potential capital draws. Given the recent improvement in performance, it does not seem likely that either Fannie Mae or Freddie Mac will need to draw from the Treasury to fund a net worth deficit. However, in the event that either firm reports a significant loss in 4Q12, the FHFA would make a funding request to the Treasury as soon as financial results are filed with the SEC (usually around the end of February). Under the GSE Act, if either Fannie or Freddie has a net worth deficit for longer than 60 days following the deadline for their SEC filing, the FHFA must put it into receivership. Therefore, the Treasury would have approximately four months to deal with a potential net worth deficit at Fannie Mae or Freddie Mac before they must be put into receivership and wound down. Given the present importance of the GSEs to a sustained improvement in the housing market, Fitch views receivership as a very unlikely outcome. The indirect impact of a fiscal cliff scenario could be more meaningful, as a slowdown in the economy would impact unemployment rates and housing prices. This would increase the pressure on GSEs' legacy books of business and result in additional credit losses. Operating performance has shown notable improvement at both Fannie and Freddie during the first nine months of 2012. For the past two quarters, both GSEs have been able to fund dividends to the government without a need for additional cash injections. The improvement in operating results has been driven primarily by reduced loan loss provisions, on the back of sustained increases in U.S. home prices. Improvement in spreads on private-label RMBS and CMBS securities has also had a positive impact, particularly at Freddie Mac. While national home prices have been on a positive trajectory this year, there are still significant downside risks, such as sizeable foreclosure inventories across the country and an uncertain economic recovery. As the size of the legacy mortgage portfolios continues to shrink at both agencies, improving credit quality trends for loans originated since 2009 (now roughly 61% of all mortgage loans guaranteed by the GSEs) could help limit future credit losses and lead to more stable earnings trends. Recent mortgage origination trends for both GSEs have been solid, and Fannie and Freddie are on pace to report one of their largest origination years in recent history. At the same time, both GSEs have been writing some of the highest quality new business seen in recent years. The dominant market share of the GSEs in mortgage finance remains unchallenged. Fannie Mae's market share of single-family mortgage-related securities issuances has consistently remained around 50%, with Freddie Mac at approximately half that level (based on recent origination data). The GSEs, along with FHA, VA and Ginnie Mae, stand behind more than nine in 10 mortgages originated in the U.S. today. The need for such a significant government presence in the mortgage market likely means that radical reform of the GSEs is unlikely in the foreseeable future. RATING DRIVERS AND SENSITIVITIES The ratings of Fannie Mae and Freddie Mac are directly linked to the U.S. sovereign rating and will continue to move in tandem. The timing and outcome of Fitch's resolution of its Negative Outlook on the sovereign rating will depend on the outcome of negotiations regarding the fiscal cliff and debt ceiling, as discussed in a Nov. 7, 2012 comment titled 'Fitch: No Fiscal Honeymoon for President Obama'. With the most recent PSPA amendment, Fitch believes government support for the GSEs has become even stronger. If at some point in the future, Fitch views the strength of support as being reduced, the ratings of the GSEs may be delinked from the sovereign and downgraded. Fitch has affirmed Fannie Mae and Freddie Mac's preferred stock ratings at 'C/RR6', reflecting the ongoing deferral of payments and very low prospects for recovery. Typically financial institutions with hybrid capital instruments would be assigned a Viability Rating (VR) from which the hybrid capital instruments could be notched. However, the GSEs could not exist without the funding advantage provided to them by the U.S. Government's implicit guarantee. Given this unique funding/support situation, Fitch has deviated from its financial institution criteria and not assigned VR to Fannie Mae and Freddie Mac. The terms of Fannie Mae and Freddie Mac's subordinated debt require the deferral of interest payments if the firms fail to maintain specified capital levels. However, in a 2008 statement, the Director of FHFA stated that the GSEs would continue to make interest and principal payments on the subordinated debt, even if the minimum capital levels are not maintained. Fitch's 'AA-' ratings on the subordinated debt are reflective of the conservator's willingness to support these obligations and the current timeliness of interest and principal on these obligations. Fitch would likely downgrade the ratings if the FHFA changes its position on the payment of the GSEs' subordinated debt obligations or if there is any deferral of interest or principal payments. As of Sept. 30, 2012, Fannie Mae and Freddie Mac remained by far the largest players in the U.S. mortgage market, with total assets of $3.2 trillion and $2.0 trillion, respectively. Fitch has affirmed the following ratings: Fannie Mae (Federal National Mortgage Association) --Long-term IDR at 'AAA'; --Senior unsecured at 'AAA'; --Short-term IDR at 'F1+'; --Short-term debt at 'F1+'; --Subordinated debt at 'AA-'; --Preferred stock at 'C/RR6'; --Support rating at '1'; --Support floor at 'AAA'. Freddie Mac (Federal Home Loan Mortgage Corporation) --Long-term IDR at 'AAA'; --Senior unsecured at 'AAA'; --Short-term IDR at 'F1+'; --Short-term debt at 'F1+'; --Subordinated debt at 'AA-'; --Preferred stock at 'C/RR6'; --Support rating at '1'; --Support floor at 'AAA'. The Rating Outlook is Negative.