FHFA Sends Annual Report to Congress on GSEs, FHLBanks

As required under the Housing and
Economic Recovery Act (HERA), the director of The Federal Housing Finance
Agency (FHFA) submitted the agency’s annual Report to Congress on the two government
sponsored enterprises (GSEs)
for which it is responsible and for the Federal
Home Loan Banking System (FHLBanks.)  In
addition to a lengthy recounting of the performance of the regulated entities
during the course of 2011, FHFA also provided an assessment on their safety and
soundness including information on any material deficiencies in their
operations, their overall operational status, and an evaluation of their
performance in carrying out their respective missions.

FHFA reported that it had conducted an examination
of both GSEs as to their financial safety and soundness and overall risk
management practices on a framework known as GSEER which stands for Governance,
Solvency, Earnings, and Enterprise Risk which comprises credit, market, and
operational risk management.  The agency
assigned rating of critical concern to both Fannie Mae and Freddie Mac in a
number of areas and ratings of substantial concerns in others. 

In the case of Fannie Mae, the report
says that the GSE “exhibits critical financial weaknesses as evidenced by its
poor performance and condition and prospects”. 
Credit risk remains high but is somewhat mitigated by the higher quality
of the single family book of business since 2009.  Business operations are vulnerable to
disruption, especially by human capital risk, and capital is wholly dependent
on the support of the U.S. Treasury.

In the case of Freddie Mac FHFA says its
credit risk remains high, the control structure is weak, human capital risk is
elevated, and their capital is also wholly dependent on the Treasury.

The most significant
risks facing Fannie Mae are credit risk, human capital risk, dependence on a
legacy infrastructure that needs to be updated, and the need to execute the
strategic plan for the conservator ships. 
Fannie Mae’s management and its board were responsive throughout 2011 to
FHFA findings and are taking appropriate steps to resolve issues the report
says.  However Fannie Mae must continue
to identify and proactively reduce the risk and complexity of its business
activities, focus on loss mitigation and foreclosure prevention, and maintain
sound underwriting criteria for single family and multifamily portfolios.

FHFA assigns a limited concerns
rating to Fannie Mae governance, an upgrade from the last examination and is
working with the company to identify a new president and chief executive
officer.  This solvency or capital
classification for ratings remains suspended as it has been since the beginning
of conservatorship, but FHFA assigns earnings a critical concern rating.  Fannie Mae’s net losses increased in 2011 to $16.9
billion from $14 billion in 2010, driven primarily by high provisions for credit
losses.  New delinquencies along with
further declining home prices resulted in a substantial increase in loan loss
reserves.  These reserves increased $10.6
billion to $76.9 billion in 2011.  In
addition a steep decline in long-term interest rates led to mark-to-market
losses on derivatives used for hedging purposes.

Fannie Mae’s credit risk also rates
a critical concern.  Although risk is
high and the quality of risk management is adequate and the level of risk is
decreasing the principal concerns are the credit characteristics of Fannie Mae’s
legacy 2005 to 2008 vintage single-family book of business, opportunity’s to
improve multifamily risk management, and continued weakness of its mortgage
insurer counterparties.

FHFA assigns market risk a
significant concern rating, an upgrade from 2010.  Risk levels are high but the quality of risk
management is adequate.  The concerns are
largely centered around increased balance sheet illiquidity because of the
amount of distressed assets and whole loan portfolios resulting from loss
mitigation activities, the need to strengthen attendant risk management
practices, and the continued negative effects on earnings from the mark-to-market
negative effects from derivative contracts. 
However liquidity and funding risks are low and the related risk
management is adequate.

Operational
risk is a significant concern, another upgrade from 2010.  The level of risk is high and increasing but
the quality of operational risk management is adequate although Fannie Mae needs
to further strengthen project management. 
Its uncertain future, legacy information technology, manual processes that
reduce its flexibility, and the requirement to implement the strategic plan
keep operational and process risks at elevated levels.  However the company improved risk management
in 2011 by installing new operational risk leadership, implementing a risk
management framework, centralizing the reporting structure and other
innovations.

In conducting its examination of
Freddie Mac, FHFA focused on matters previously identified as requiring
attention and the board and management’s response to deficiencies and
weaknesses identified by internal and external audits.

Governance was considered a
significant concern in the examination of Freddie Mac.  The company’s enterprise risk management
structure continues to benefit from a recent redesign however management is
finding it difficult to maintain an adequate control structure because of
increased employee turnover and reliance on manual processes.  The quality of information the Board of
Directors receives has improved and FHFA is working with the board to identify
a new CEO.  The board should continue to
focus on the key risks and issues facing Freddie Mac including the effect
employee turnover has on its ability to manage its information technology.

Freddie Mac received a critical concerns
rating on earnings.  Total revenues
increased slightly in 2011 and credit related expenses and mark-to-market
losses on derivatives also increased.  Derivative
losses were offset partly by interest rate related gains on assets. 

Credit risk was also considered a critical
concern although it is decreasing and its risk management is considered
adequate.  As with Fannie Mae, the
principal concerns center around the GSE’s 2005 to 2008 vintage single family
loans, coupled with underwriting and controls in the multifamily business line,
weak mortgage insurer counterparties, and increased concentration of
counterparty risk.   FHFA said that the
higher quality of Freddie’s more recent single family business and management’s
success in loss mitigation is alleviating some concerns.

Market risk is considered a significant
concern.  The level is high relative to
earnings and capital for the quality of risk management is adequate.  The retained portfolio’s growing proportion
of illiquid assets is increasing risk because of the level of distressed assets
and whole loan portfolios.  These assets
are less liquid, causing prepayment modeling difficulties and less reliable
interest rate risk metrics.  Human
capital risk in the investment and capital markets group and continued negative
effects from the mark-to-market derivative contracts are also a concern. 

Operational risk is a critical concern
as it is high and increasing and the quality of risk management needs
improvement.  Human capital risk and the dependence
on legacy operational and information technology infrastructure are among the
highest risks facing the GSEs. 

Model risk is a significant
concern but while the level is high it is stable.  FHFA’s concerns include the timeliness of
model valuations and the efficacy of models in the current economic
environment.

FHFA
followed up a special review in October of 2011 with a directive requiring
Freddie Mac to phase out its retained attorney network and to work with FHFA
and Fannie Mae through the Servicing Alignment Initiative to develop and
implement consistent requirements, policies, and processes for default and foreclosure-related
legal services.

FHFA
reported that as of the end of 2011, the FHLBanks exceeded the minimum leverage
ratio by having at least 4 percent capital-to-assets.  The weighted average regulatory capital to assets
ratio for the system was 6.9 percent in 2011 compared to 6.5 percent in 2010.  All FHLBanks were profitable for the year and
the system’s advance business continues to operate with no credit losses.  However the quality of the FHLBanks’
investments in private label mortgage backed securities (MBS) remains a
significant concern.  Exposure to such
securities dropped by 20 percent during 2011 as did the credit charges
associated with the securities.

During
2011 two FHLBanks were under consent orders because of their financial
conditions.  The FHLBank of Seattle saw deterioration
in the value of its private label MBS starting in 2010 while Chicago had been
operating under a cease and desist order since October 2007.  Seattle remains under the enforcement action
but Chicago’s order was removed in early 2012.

The
overall all scale of the FHL banks advance operations continued to decline in
2011 reaching $418 billion at year end compared to $479 billion at the end of
2010.  Investments in private label MBS
have adversely affected the overall operation of some banks reducing their
ability to repurchase or redeem stock as the banks shrunk.  FHFA has taken action where needed to address
this problem.

…(read more)

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Deal Cut to Sell ResCap out of Bankruptcy Filed Today

Ally Financial, formerly known as GMAC, took its residential lending unit into bankruptcy this morning in federal court in Manhattan.  At the same time, Nationstar Mortgage Holdings has agreed to buy substantially all of the mortgage servicing and related assets from the unit known as ResCap for about $2.4 billion including debt.

According to Reuters, the bankruptcy filing has the support of some of ResCap’s creditors.  The unit has been a drag on Ally’s attempts to recover after the financial crisis during which it accepted $17 billion in federal bailout funds, ceding 74 percent of its stock to the U.S. Treasury.  Ally says it now owes the government about $12 billion and there is speculation that it was government pressure that finally forced Ally to file the court papers.  The bankruptcy and sale will now allow Ally to return to its main auto lending business and put together a plan to pay back Treasury.

ResCap, includes among its assets the company formerly known as Ditech, famous for its TV pitchman who concluded each ad with “Lost another deal to Ditech.”

The deal will give Nationstar first bidding rights in the auction that will be held under bankruptcy court rules and Reuters reports that the deal would be ‘transformative” for the company which would gain more the $370 billion in loans to service while any liabilities would stay with the estate.  The portfolio contains $201 billion in primary residential servicing rights and $173 billion in subservicing contracts as well as $1.8 billion of related servicing advance receivables and certain other complementary assets.

Of the proposed purchase price, about $700 million is for the servicing rights and $180 million for the advances.  Nationstar, whose principal shareholder is Fortress Investment Group will be putting up half of the cash while the remainder is expected to come from Newcastle Investment Corp, a mortgage REIT managed by Fortress.  If Nationstar does not win the auction there is a $72 million break-up fee and reimbursement of up to $10 million in transaction related expenses.  Other bidders are expected, however Nationstar’s positioning and its break-up fee are expected to lead to its success in the auction.

Other banks with troubled mortgage subsidiaries are expected to be watching the ResCap bankruptcy closely as it is a rare example of this type of subsidiary filing in which the holding company has been able to continue operations.

Ally will take a $1.3 billion charge, which covers its $400 million equity investment in ResCap, a $750 million settlement with ResCap to offset any future legal claims against it, and $130 million in reserves for claims related to mortgage-backed securities.

Ally is apparently also seeking buyers for some of its car finance and insurance related assets in Canada, Mexico, Europe, and South America.  Sale of any of these, the aggregate value of which is estimated at about $30 billion, would help it more quickly repay its debt to the Treasury

…(read more)

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Fannie Mae Posts Q1 Profit; won’t Request Treasury Draw

Fannie Mae joined Freddie Mac in showing significant improvement in its financial condition during the first quarter of 2012.  The company reported today that it had a net income of $2.7 billion during the first quarter compared to a net loss of 2.4 billion in the fourth quarter of 2011 and $6.5 billion in the first quarter last year. 

As a result of these improved numbers the company, for the first time since it was placed under government conservatorship in August 2008, will not be requesting funding from the U.S. Treasury and will be paying Treasury a first-quarter dividend of $2.8 billion.

Fannie Mae said that improvement in its results were largely due to lower credit-related expenses resulting from a less significant decline in home prices, a drop in its inventory of single-family owned real estate (REO) and lower single-family delinquency rates. 

The company’s loss reserves decreased to $74.6 billion as of March 31 from 76.9 billion at the end of the fourth quarter of 2011.  The company expects that the reserves to cover credit losses on its pre-2009 legacy book of business have reached their peak.

Fannie Mae’s net worth of $268 million at the end of the quarter reflects the company’s total comprehensive income of $3.1 billion, partially offset by its $2.8 billion payment to Treasury in senior preferred stock dividends.  Since the conservatorship began Fannie has drawn $116.1 in Treasury funds and has paid Treasury $22.6 through dividends.

The financial summary shows that Fannie Mae had net interest income of $5.2 billion compared to $4.2 billion in Quarter 4 and net revenues of $5.6 billion, up from $4.5 billion.  Total credit-related expenses dropped from $5.5 billion in the previous quarter to $2.3 billion.

Susan McFarland, executive vice president of Fannie Mae and chief financial officer said “We expect our financial results for 2012 to be significantly better than 2011.  Our credit performance is headed in the right direction with significant improvement since 2009, and we expect that the reserves we have built to cover future credit losses on the pre-2009 legacy book of business have reached their peak.  As our serious delinquency rate declines and home prices stabilize, we expect to reduce our reserves, which combined with revenue from our high-quality new book of business, will drive our future results.

During the first quarter of 2012 the company signed off on 46,671 loan modifications compared to 51,936 in the previous quarter.  These included both HAMP and the company’s own modifications.  There were 8,864 repayment plays or forbearance agreements put in place, up from 8,517 and 22,213 short sales and deeds-in-lieu of foreclosure, virtually unchanged from the previous quarter.

The company acquired 47,700 single family properties in the first quarter compared to 47,256 in the fourth quarter and disposed of 52,071 single-family REO.  As of the end of March the REO inventory stood at 114,157 units, down from 118,528 units at the end of the year.  The carrying value of the properties is valued at $9.7 billion, unchanged from the fourth quarter but about half the value one year earlier. 

The foreclosure rate during the quarter was 1.07 percent compared to 1.13 percent for all of 2011.

…(read more)

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HUD Secretary Makes Case for Mortgage Write-Downs

Bloomberg News
HUD Secretary Shaun Donovan at a Senate hearing in February.

The regulator for Fannie Mae and Freddie Mac could have a “legal responsibility” to approve loan modifications for certain homeowners now that the U.S. Treasury has offered to share in the cost of mortgage write-downs, said Shaun Donovan, secretary of the U.S. Department of Housing and Urban Development.

Mr. Donovan made the comments in an interview taped Friday for C-SPAN’s “Newsmakers” program. He said that he was increasingly worried that given the severity of the collapse in home prices and the slow pace of recovery in certain housing markets, that some homeowners who owe far more than their homes are worth would conclude “there is really no light at the end of the tunnel” and ultimately default on their mortgage.

In certain hard-hit markets, families struggling to make payments “will give up at some point. We think the data shows that.” The administration’s analysis of various housing markets makes a “compelling” case for principal write-downs, he added.

But at the same time, Mr. Donovan downplayed concerns that borrowers who are deeply underwater but able to pay their loans would similarly default in order to receive debt reduction. “The vast majority of homeowners don’t operate that way,” he said.

Edward DeMarco, the acting director of the Federal Housing Finance Agency, has so far resisted principal forgiveness, arguing that other means of reducing payments are just as successful with fewer costs for taxpayers that are backing the mortgage giants.

One concern for that regulator is whether debt forgiveness would encourage more borrowers who are current on their loans to stop paying. Right now, about three in four loans backed by Fannie and Freddie that are heavily underwater are still making regular payments. “These borrowers are demonstrating a continued willingness to meet their mortgage obligations. This should be recognized and encouraged, not dampened with incentives for people to not continue paying,” said Mr. DeMarco in a speech this past week.

Mr. Donovan said for those cases where borrowers might strategically default, there are ways to carefully design a program “to ensure that it doesn’t become a real issue.”

The Obama administration in January offered to subsidize the write-downs, undercutting the position of Mr. DeMarco, who has promised to give an answer to the administration later this month.

Mr. Donovan said that his experience with Mr. DeMarco suggested that the regulator would make an impartial decision. “What he is focused on, independent of whatever his personal views may be, is what is his legal responsibility and what does the analysis say.”

Mr. Donovan also said he wouldn’t “prejudge” what the administration would do if Mr. DeMarco chose not to allow the firms to participate. If that happens, “we’re going to have to look at that analysis and understand what his concerns are,” he said.

Several Democratic lawmakers and political groups have called on the Obama administration to fire Mr. DeMarco over his resistance to debt forgiveness, but Republicans say that write-downs amount to transfers of taxpayer wealth. Economists on both sides of the issue have offered research highlighting the benefits and drawbacks of debt forgiveness.

In the interview, Mr. Donovan said that the ultimate success of the Obama administration’s housing policies would be determined by the future path of home prices and “whether the average American once again has faith that buying a home is something that is a safe investment in the long term.”

The housing secretary pointed to recent signs of improved home sales during the winter months, but home prices have been falling during the winter months. “Ultimately, the final measure of whether we’ve broken through and we’re in full recovery is when housing prices across the board start rising in a consistent way,” he said.

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