Nov 5 - 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.