Fannie Mae First Quarter 2019 Earnings Media Call Remarks

Hugh Frater: Good morning. Thanks, Pete. And thanks for joining us to discuss Fannie Mae's results for the first quarter of 2019.

I'm joined today by our Chief Financial Officer, Celeste Brown.  In a moment, Celeste will highlight our first quarter financial results and our economic outlook, and then briefly touch on a few items that Fannie Mae is focused on right now.  After that, we'll be glad to address any questions you have.

Fannie Mae’s financial results for the quarter continue to demonstrate the strength of our business model, our risk management capabilities, and our customer focus.

Business volume, the growth of our book, and our credit performance were all solid in the first quarter.

Fannie Mae’s credit risk transfer programs continue to grow as we become more adept at attracting private capital into the mortgage market.

And our customers continue to respond positively to technology innovations to help make the mortgage market more certain, efficient, and safe.  These innovations are part of our 2019 priority to drive digital transformation in the mortgage market.

We're also moving forward on our other 2019 priorities.

We're leaning forward to address the affordable housing supply challenge.

We are working to develop a robust secondary market for manufactured housing loans so that this financing is more accessible for lenders and borrowers.

We're working with innovators across the housing industry to find new and less expensive ways to build, maintain, and finance homes for buyers and renters. 

Fannie Mae remains a leading source of financing for workforce rental housing, with more than 85% of the multifamily units we financed during the first quarter of 2019 affordable to families earning at or below 120% of area median income. And two weeks ago, our Multifamily Green Financing work earned us a third ENERGY STAR^® Partner of the Year Award for Sustained Excellence from the Environmental Protection Agency.

Ensuring a smooth transition in June to the Uniform Mortgage-Backed Security is another important priority for Fannie Mae, and this work is on track. We're working with Freddie Mac, FHFA, our customers, investors, and the many other market stakeholders so that this process is smooth, orderly, and transparent.  Forward trading of the new Single Security has been under way since mid-March.

And, as Celeste will expand upon in a moment, Fannie Mae is increasing its focus on capital in 2019 through the lens of the proposed capital framework under consideration by FHFA. As I said last quarter, we believe that a robust and sensible capital regime for the GSEs is necessary both to protect taxpayers in future housing downturns and to sustainably attract private capital to the housing finance system.

Finally, Fannie Mae welcomes our new regulator, Federal Housing Finance Agency Director Mark Calabria. We congratulate the director on his confirmation, and we look forward to working closely with him. Director Calabria has stated that he wants to work with Treasury and others to create a path out of conservatorship. As we have said since our conservatorship began, we are committed to being as helpful as possible to the Director and the FHFA as they and other policymakers consider the future of the GSEs.

I want to close my remarks with note of appreciation to both the FHFA and to the extraordinary employees of Fannie Mae. This is my first call as the non-interim CEO of Fannie Mae, and I want to express what an honor it is to be a part this great organization.

I'm excited about the opportunities ahead for housing, I'm inspired by the people who work here and what they do every day to help American families. I look forward to contributing to Fannie Mae's success in the years to come.

With that, let me turn it over to Celeste.

Celeste Brown: Thanks, Hugh, and good morning everyone.

First, I am going to review the financial highlights for the quarter. I will then turn to our outlook, and finally touch on a number of things that impact our business.

We had solid financial performance in the first quarter of 2019, earning net income and comprehensive income of $2.4 billion. Based on these results, we expect to pay a dividend of $2.4 billion to Treasury by the end of June. That will leave us with a net worth of $3 billion, which is the maximum capital buffer permitted under our agreement with the Treasury.

Overall Highlights

Consolidated Fannie Mae profitability for the first quarter declined versus the fourth quarter. This decline was driven primarily by lower credit-related income, an increase in fair value losses, and lower net interest income during the quarter.

Credit-related income in the first quarter fell primarily due to a lower volume of redesignations of loans from held-for-investment to held-for-sale, and a smaller improvement in actual and forecasted home prices. This was partially offset by a larger benefit from lower projected future interest rates compared with the fourth quarter.

Selling reperforming and nonperforming loans is an important part of our portfolio strategy and the sales will vary from period to period based on a number of factors, including the size of the available population and market appetite. While the redesignation of certain loans from held-for-investment to held-for-sale has been a significant driver of credit-related income in recent periods, we may see a reduced impact from this activity in the future to the extent the population of loans we are considering for redesignation declines.

While in both quarters we recognized fair value losses on our risk management and mortgage commitment derivatives due to declining interest rates, fair value losses were higher in the first quarter resulting from a tightening of CAS (Connecticut Avenue Securities^{®) spreads, as well as losses on debt of consolidated trusts held at fair value due to larger price increases compared to the fourth quarter.}

The decrease in net interest income was due primarily to lower amortization income from our guaranty book of business driven by lower mortgage prepayment activity due to a higher prevailing interest rate environment at the end of 2018, and a decrease in interest income from our portfolios due to lower average balances.

Single-Family Highlights

Turning to our Single-Family business, our net income declined by $825 million in the first quarter vs. the fourth quarter, driven largely by the same factors that drove our overall results.

The average single-family conventional book of business remained relatively flat from the fourth quarter to the first quarter, and increased by 13 basis points year-over-year.

Average charged guaranty fees on our new single-family acquisitions, net of TCCA fees, increased by almost 2 basis points to 50.4 in the first quarter from 48.5 basis points in the fourth quarter, and were 8 basis points higher than Q1 of 2018.  The average charged guaranty fee, net of TCCA fees, on the single-family conventional guaranty book overall, increased to 43.3 basis points in the first quarter, up slightly vs. the fourth quarter.

Our market share of single-family mortgage loans securitized by the GSEs was 56% in the first quarter compared to 57% in the fourth quarter, within our historical range. Our market share has and will continue to fluctuate depending on many factors including product mix, market dynamics, our mission requirements, and returns on capital. We actively adjust our strategy to address these factors and to achieve the appropriate risk-adjusted returns.

The single-family delinquency rate was 74 basis points at the end of the first quarter, down 2 basis points from the prior quarter and 42 basis points year over year as our Q1 2018 SDQ rate was elevated due to the impact of the 2017 hurricanes.

Multifamily Highlights

Turning to Multifamily, net income remained fairly consistent with that of the fourth quarter. We continued to grow our book, which was up 3% in the quarter and more than 10% year-over-year, driving an increase in guaranty fee income. The level of charged fees on Multifamily acquisitions remained generally consistent with the second half of 2018 as competitive market pressure has persisted but not worsened.

The Multifamily book remained strong from a credit perspective as the SDQ rate was 7 basis points at the end of the quarter, while the rate of substandard loans as a percentage of the book remained relatively flat.

For Multifamily, our market share of GSE mortgage originations was 56% in the first quarter, compared with 41% in the fourth quarter.  As in the Single-Family space, we expect to see period-to-period fluctuations due to the same drivers: product mix, market dynamics, our mission requirements, and our returns on capital.

We continue to focus on our Multifamily credit risk transfer strategy to efficiently manage our capital and returns.  We issued our first Multifamily CIRT deal of 2019 in March, which transferred a portion of the credit risk on a $11.7 billion reference pool of Multifamily loans. As of the end of the first quarter, we had covered approximately 15% of the Multifamily guaranty book through a CIRT transaction, while we continue to cover nearly all Multifamily acquisitions with DUS, a lender risk sharing program that has proven itself through economic cycles and enables us to share approximately one-third of the credit risk on our multifamily loans with our lenders.

Outlook

Turning to our economic outlook. We continue to project that economic growth will slow this year, with GDP growth projected to fall to 2.2% in 2019 from 3.0% in 2018.  We believe the boost from fiscal stimulus, which pushed rapid economic expansion in 2018, will fade over this year. We expect business investment and consumer spending to slow, but we expect residential fixed investment will rebound in 2019 following a decline in 2018.

Our proprietary Home Purchase Sentiment Index^® (HPSI) jumped 5.5 points in March to reach its highest level since June of 2018, buoyed by a brighter housing outlook as consumers appear to have regained some confidence in the housing market. The index shows that perceptions of both home buying and home selling conditions are returning to prior trends, and the uptick in the HPSI is further supported by more consumers expecting interest rates to fall in the next 12 months.

We expect 2019 home price growth to be approximately 4%, down from roughly 5% in 2018. We believe home sales will stabilize this year around their 2018 levels amid slowing home price appreciation and lower mortgage rates. Absent a shock, we believe home price movement will be more limited this year, as it's constrained at the lower end by supply pressure, and at the upper end by affordability challenges.

Whereas interest rates increased through most of 2018, they declined in the first quarter of 2019. The 30-year fixed mortgage rate at the end of March was 49 basis points lower than at the end of December. We believe that mortgage rates have likely found an equilibrium and will now stabilize around 4.1 percent to 4.2 percent this year. Our forecast reflects our expectation of one Fed rate increase in December.

We expect total single-family mortgage originations in 2019 to be slightly above 2018 levels. Given the recent decline in mortgage rates, we now forecast slight year-over-year gains in refinancing activity for each of the remaining quarters of this year.

Our outlook for the Multifamily sector is that rent growth will be positive this year but slightly lower than in 2018 at 2.0 to 2.5 percent.

Additional Topics

I wanted to give you an update on a few items that are top of mind for Fannie Mae right now.

First, as Hugh noted, we are preparing for UMBS (Uniform Mortgage-Backed Security) to go live in June. We have put a lot of resources into ensuring that we are ready, including performing necessary testing to make sure that the platform is ready, and working with the industry to ensure that it is prepared for UMBS.

Forward trading of UMBS has been going smoothly. Since the start of trading on March 12^th, through April 25^th, $755 billion of UMBS has been traded in the TBA (to-be-announced) market. At Fannie Mae, we are forward trading UMBS for both June and July settlement dates. The next milestone is the June 3^rd "Go live" date, at which point:

• The Enterprises will have the ability to issue the new UMBS and Supers, including commingled re-securitizations, through the platform; and
• Common Securitization Solutions, or CSS, will be acting as Fannie Mae’s and Freddie Mac’s agent for issuance, bond administration and disclosures for all newly issued UMBS and Supers.

We are prepared to compete and will continue to focus on generating appropriate risk-adjusted returns.

Second, I'd like to touch on the Current Expected Credit Loss standard, or CECL. CECL is a new standard, issued by FASB, which we are required to implement by January 1, 2020. Upon implementation, we expect to recognize a cumulative adjustment to our retained earnings, which could have a significant financial impact and possibly result in a draw from Treasury in the first quarter of 2020, depending on many factors, including our first quarter 2020 earnings, the composition of our book, and economic conditions and forecasts at the time.

Under CECL, we will need to reserve for the lifetime expected credit loss of our entire book of loans. Therefore, once implemented, CECL will likely introduce more volatility to our financial results due to its procyclicality. During times of economic stress, our allowance for losses will build faster than under the current accounting standard, but our earnings should also recover faster as conditions improve.

We are evaluating selling additional risk via our various credit risk transfer programs that may enable us not only to reduce earnings volatility associated with CECL, but also to optimize returns and capital levels in normal and stress scenarios. On the Single-Family side, we are exploring options to increase the risk sold, including reviewing attachment levels and term of coverage. On the Multifamily side, we are evaluating new forms of credit risk transfer, including potentially issuing a Multifamily security similar to our Single-Family CAS securities.

We have also begun to work on developing our hedge accounting capability as it is a way to reduce earnings volatility more broadly, particularly as it relates to fair value and interest rate movements.

Finally, I will turn to our continued focus on managing capital. While we are currently not permitted to retain more than $3 billion in capital, we continually evaluate pricing and other aspects of the business to align with the FHFA's proposed capital rule.  In the first quarter, our capital requirement under the proposed capital rule declined by 2% from $89 billion at the end of 2018 to approximately $87 billion.  The decline in capital is primarily attributable to an increase in home prices and additional capital relief from credit-risk transfers, partially offset by growth of our book of business.

We use credit risk transfers to reduce the amount of capital we would be required to hold under FHFA's proposed rule. For Single-Family, we have reduced our capital requirement for credit risk on recently purchased eligible loans by more than 75% through credit risk transfers. Our Multifamily business has been transferring a substantial and growing amount of the credit risk on acquisitions through both its highly successful DUS^® (Delegated Underwriting and Servicing) risk-sharing program and back-end credit risk transfers.

With that, I will turn it over to the operator, and Hugh and I will answer your questions.

Conclusion

Hugh Frater: Thank you everyone for joining us. We look forward to seeing you again next time.