Fannie Mae 2016 Full-Year and Q4 Earnings Media Call Remarks from Timothy J. Mayopoulos
Thank you and good morning everyone. Thanks for joining us today as we share our fourth quarter and full-year financial results for 2016. We ended the year as we began it, with solid financial performance, ongoing improvement in credit fundamentals, and progress on making our company and the housing finance system stronger and more responsive to the housing market and the evolving needs of our customers.
Today I will summarize our quarterly and annual financial results. Then I will highlight some of the significant changes we have made at Fannie Mae. While some of these changes began prior to 2016, they delivered real benefits this year to the customers we serve, and to taxpayers, and to the broader mortgage market.
Summary of 2016 Q4 and Full-Year Results
First, let me review Fannie Mae's 2016 results. For the year, we reported net income of $12.3 billion and comprehensive income of $11.7 billion. Fourth quarter net income was $5 billion and comprehensive income was $4.9 billion. This is an increase in both net income and comprehensive income from 2015 and the third quarter, respectively.
The fourth quarter increase in net income was driven primarily by fair value gains, compared with fair value losses in the third quarter. These fourth quarter fair value gains were the result of increases in longer-term interest rates, which positively affected the value of derivatives that we use to manage risk and our mortgage commitment derivatives.
This increase was partially offset by a provision for credit losses in the quarter compared with a benefit for credit losses in the third quarter. The fourth quarter provision was primarily due to an increase in actual and projected interest rates during the quarter.
For the full year, our net income increase was primarily driven by a swing from credit-related expense in 2015 to credit-related income in 2016. This was driven by both a higher benefit for credit losses and lower foreclosed property expense. We also had lower fair value losses compared with 2015.
As I have said in previous quarters, we do not control some of the important drivers of our financial results, such as changes in interest rates and home prices. As today's numbers demonstrate, these factors can cause significant volatility in our financial results and they may have a positive or negative effect in any given quarter or year.
As you know, the terms of the senior preferred stock we issued to the U.S. Treasury do not permit us to retain capital. Our capital cushion has declined to $600 million, and goes to zero in 2018.
While we expect to remain profitable on an annual basis for the foreseeable future, due to our limited and declining capital reserves, and the potential for significant volatility in our financial results, we could experience a net worth deficit in a future quarter.
As described in our 10-K, which we filed today, future legislative or regulatory changes also could result in a net worth deficit in a future period. If we experience a net worth deficit in a future quarter, we will be required to draw additional funds from Treasury in order to avoid being placed in to receivership. We expect to pay Treasury a $5.5 billion dividend based on our fourth quarter results. When Fannie Mae pays this dividend in March, we will have paid a total of $159.9 billion in dividends to taxpayers since 2008.
Delivering Innovations to the Market
Our financial results are attributable to strong performance in both our single-family and multifamily businesses during the past year. They also reflect a number of significant changes that we have taken at Fannie Mae in recent years. These changes fall into two broad categories.
First, we are delivering more innovations, more simplicity, and more certainty to our customers in the mortgage market. Second, we have improved our business model in fundamental ways. Together, these changes have better prepared Fannie Mae to meet the rapidly evolving needs of the housing market and our customers.
I will start with the ways we are delivering more value to lenders, investors, and servicers. In 2016, the most tangible and visible expression of this value was our Day 1 Certainty initiative. Day 1 Certainty is a suite of innovations that represent a step forward in the digitization of the mortgage process. It offers data validation services and improved collateral underwriting services that achieved two major improvements to the mortgage process. These tools improve the speed and efficiency of the process, helping lenders serve borrowers with more speed and ease.
They also provide lenders greater certainty that when they sell a loan to Fannie Mae, it will stay sold. This is vitally important to lenders to allow them to reduce the risk that Fannie Mae will require them to repurchase loans down the line and help them confidently lend to more borrowers.
We believe that Day 1 Certainty is a major step in creating a fully digitized mortgage process. We continue to look for ways to improve and build upon Day 1 Certainty, including expanding our sources of data validation. Our ambitious innovation agenda includes working with lenders, technology companies, and others to find new ways to make the mortgage process easier, faster, more accurate, and ultimately, safer.
The other long-term change to Fannie Mae that I want to highlight is the evolution of our business model. Let me call out several of these changes. For starters, our revenue is now largely driven by our guarantee business and not from returns on mortgage investments. Historically, returns on our mortgage investments were the single biggest generator of our revenues. Today, it is our guarantee business. This represents a fundamental change in our business model and you will see it reflected in several ways in today's filing.
It is reflected in our net interest income. More than two-thirds of our net interest income in 2016 came from our guarantee business and less than one-third came from our retained mortgage portfolio. It's also reflected in the size and shape of our retained mortgage portfolio. In 2004, this portfolio contained more than $900 billion dollars of mortgage assets, nearly all of it investment assets. At the end of 2016, the portfolio had declined to $272 billion, and most of today's portfolio does not consist of investment assets. In fact, the bulk of the portfolio consists of loans that we purchased out of mortgage-backed securities trusts in order to modify those loans.
Finally, this change to our business model is reflected in our disclosures and our financial reporting. We have added new disclosures to bring more transparency to the composition of our retained mortgage portfolio. Today's 10-K includes information that shows how much of the portfolio supports the liquidity needs of our single-family and multifamily businesses, how much supports loss mitigation activities, and how much are investment assets. In total, our retained mortgage portfolio represents 9 percent of our mortgage credit book of business. The investment asset portion represents only 2 percent, and it is getting smaller.
Given this change in our business model, we have realigned our reporting. In the past, we reported the results of three business segments – single-family, multifamily, and capital markets. We now report just single-family and multifamily results, which incorporate the capital markets activities that support each business segment. These businesses have been strong performers overall since 2012, and our single-family serious delinquency rate has declined for 27 straight quarters.
As well, our credit risk management tools have also undergone significant evolution, which speaks to another way the company's business model has changed. We began entering into credit risk transfer deals in 2013. Since then, our ability to syndicate credit risk to private market participants has grown significantly.
Investors in our credit risk transfer deals appreciate our role as a trusted intermediary. They have a high degree of respect for our ability to manage credit risk, including our sophisticated risk analytics. Credit risk transfers allow us to move some of our credit risk to other investors while ensuring that our interests stay aligned with those investors. We retain a portion of the credit risk in every credit risk transfer deal.
As of December 31, 2016, year-end, nearly $650 billion of the single-family loans in our book of business were included in a reference pool for a credit risk transfer deal. This represents 23 percent of our total single-family conventional guarantee book. The market for our credit risk transfer deals continues to mature and to grow. We expect that a larger portion of our single-family guarantee book will be covered by credit risk transfer transactions over time.
Together, these two fundamental changes, along with our stronger underwriting and eligibility standards, represent a significant shift from our prior business model. We believe these changes will help make the mortgage market more resilient, more liquid, and more stable. They will make our company more responsive and adaptive to the changing needs of the market and our customers. They increase the role of private capital in the mortgage market, and they reduce the overall credit risk to Fannie Mae and, by extension, to taxpayers. By becoming a stronger company, we are in a far better position to help our partners confidently expand access to affordable homeownership and rental options for more American families.
In summary, this was another strong year and another strong quarter. Our business has evolved significantly; we continue to work to strengthen the market we serve in ways that provide value and protect taxpayers, and we will continue to drive innovations both within Fannie Mae and in the broader market.
I appreciate your time and I am happy to open it up for your questions.