Fannie Mae: 6 Months Into Conservatorship
Jim Vogel, CFAExecutive Vice PresidentFixed Income Research
March, 2009
2
GSEs Upside Down but Still Spinning Clockwise
Conservatorship is working for debt holders
Underlying financials still important
The next six months
Brave New World
3
1) From Botched Creation to Lower Spreads
Treasury over sold strength of support
Clarification for market: Seeing support in action
Transition from overseas investors to domestic
Renewed spread appetite in 2009
Fannie’s term market more than recovered from fall issuance drought.
4
U.S. Investors Perk Up as Yields and Equities FallAttractive pricing brings attention
2005-2007
2009
5
Rebuilding Fannie’s Liability BaseDiscount Note Maturities Lengthen, Too
Monthly Issuance Longer than 18 Months
Term bullets outstanding now exceed summer ‘08 by more than $15bb.
Callables still lag.
6
Spreads Improve Across the Curve As a Result
LIBOR Basis of the GSE On-the-run Bullet Curve: 2-30 Years
• Fed kickstarted the process, but influence on new issues has been limited.
• Bullet spreads have done better than current coupon mortgages (adjusted for volatility).
7
Fannie’s Retained Portfolio Holds Back
Monthly Retained Portfolio
• New Cap of $900 billion awaits clarity on debt limit.
• All growth since summer of 2008 has been in mortgage loans, mostly repurchased from pools for modification.
• 5 years ago portfolio was at $925 billion.
8
GSEs in the Mortgage WorldVital to credit, not to funding
Credit Risk Share = 49% Banks Dominate Funding
GSEs
Market Share as of March 31, 2009
9
2) Fannie’s Course Found in its Financials
GSEs are free to US policy makers after equity holders demolished.
Accumulated value accrual/destruction establishes resource pool to support housing.
Cash flow from portfolio offsets credit losses.
Analyzing reserve for future cash losses.
Speed and length of housing credit losses
10
GAAP Losses Dwarf Cash Losses
Non-Cash items include
• Mark to market charges on derivatives due to lower rates.
• Additions to reserves for future losses.
• Elimination of deferred tax calculation.
Note: 2007-08, Fannie paid $2.7 billion in federal taxes.
11
Net Interest Income Soars as Curve SteepensFannie producing cash flow to absorb credit hits
• Net interest yield of .89% in 2008 vs .39% in 2007.
• Total growth of 90% in annual net interest income.
• Typical increase for large banks was 25% to 40%.
• Built-in increases (GAAP) for 2009 based on asset write-downs in 2H 08.
Quarterly Net Interest Income
12
Credit Losses Still in Infancy Stage
• Reserve for losses now at $25 billion.
• Projected cash losses for 2009 are $25 billion, but Fannie will keep adding to reserves from cash flow and Treasury injections.
Quarterly Provision for Loan Losses and Actual Losses
13
Delinquencies are Still Accelerating
Rate of Change of Quarterly Delinquencies
• Alt-A still driving the bulk of delinquencies and losses.
• Fannie’s prime delinquencies of 1.40% at year-end still compare favorably with 3.75% for national figures.
• Florida is hands down the worst single state.
• Pre-2005 vintages remain intact for now.
14
Projecting Cash Accumulation Run RateFannie has a ‘future’ when it turns positive
Critical Components
• Net interest income growth despite refinancing role.
• Slowing additions to reserves once they are ‘ample.’
• Eliminate losses on securities holdings (nearer than expected).
• Avoid new mistakes.
15
3) Looking Ahead Six Months
Funding modified loans
Creating value in portfolio away from Fed purchase profile
Staying out of headlines. Capping preferred injections.
Regaining some dignity
16
4) Beyond Conservatorship is Congress
Overseas investors on sidelines until Treasury is no longer sole authority
Preferred stock purchase agreement very hard to reverse.
Status depends on relative success
Re-formation of housing finance system.
17
5) Brave New World
Demise of the rating agencies
Counterparty contraction
Really private equity
Sovereign wealth policy initiatives