Fannie Mae Fourth Quarter and Full-Year 2019 Earnings Media Call Remarks
Hugh R. Frater: Hi everyone.
For this morning's call, Celeste Brown, our Chief Financial Officer, will summarize our results and the main drivers behind them. And, of course, Celeste and I will be happy to take any questions you have at the end.
Before I turn it over to Celeste, I want to share what we're focusing on as we move into the new year.
We believe that 2020 could be a pivotal year for Fannie Mae.
Consistent with the goals set out by FHFA, in 2020 we are focused on:
- Fostering competitive, liquid, efficient, and resilient housing finance markets;
- Ensuring safety and soundness;
- And – very importantly – doing the necessary work to prepare Fannie Mae for an eventual transition out of conservatorship.
We begin 2020 with a net worth of $14.6 billion, thanks to strong retained earnings. Based on our agreement with the Department of Treasury and FHFA, we will continue to retain quarterly earnings and grow our capital base until our net worth reaches $25 billion.
Continuing to build our capital base is one of the most important things we can do to prepare for an eventual exit. Strong capital levels paired with strong risk management are the key to safety and soundness and a sustainable business model.
That business model has always been pretty simple – we essentially buy home mortgages and sell securities backed by those mortgages, while retaining and insuring the credit risk of those mortgages for a guaranty fee. This core guaranty fee business is performing well, and the credit quality of our book remains strong.
We continued to improve our single-family and multifamily credit risk transfer programs in 2019, and investor demand for these products has remained strong. These risk-sharing tools increase our safety and soundness, bring private risk-bearing capital into the market, and give us an important capital management tool. Today, there is currently some form of credit-risk sharing on 53% of our single-family guaranty book and nearly 100% of our multifamily book.
Last year, we provided more than $650 billion in total liquidity to the mortgage market. And in turn, this helped our customers finance 3 million home purchases, refinancings, and rental units.
In 2020, we intend to build on these strengths – and develop new ones – as we prepare for a more competitive future.
We are focused on using our capital more efficiently while operating safely and soundly. We will continue building our digital capabilities to support positive innovation that will benefit the mortgage markets and the consumers who rely on them. We believe increasing our digital agility can help our lender customers advance the transformation of mortgage lending, homebuying, renting – and housing itself – with the aim of reducing cost and complexity for consumers.
The future we envision will also be one where we lead in the environmental, social, and governance responsibilities that are expected of today's leading companies.
By our Charter and by our choice, we are a purpose-driven company.
In the years to come, we will build on this essential aspect of our company both because it is the right thing to do and because it will help us attract global capital to meet America's biggest housing challenges.
As I said last quarter, we believe that whatever the future brings, the long-term success of Fannie Mae will be defined by our ability to:
- Attract and grow capital,
- Provide a reasonable and sustainable return to the investors who entrust us with capital, and to
- Operate safely and soundly through business cycles while performing our housing mission.
I believe we have both the right plan and the right people to achieve these ambitions.
I look forward to your questions. With that, let me turn it over to Celeste.
Celeste Mellet Brown: Thanks, Hugh, and good morning everyone.
First, I will review our financial highlights for the quarter and the year, and then turn to our outlook. Finally, I will touch on a number of things that impact our business.
In the fourth quarter, our comprehensive income was $4.3 billion, a quarter-over-quarter increase of approximately $300 million. For 2019, our comprehensive income was $14 billion compared to $15.6 billion in 2018.
Our net worth reached $14.6 billion at the end of December, which we have retained as capital. At the end of the first quarter, our net worth will increase by the amount of our Q1 earnings, less an estimated $1.1 billion retained earnings adjustment associated with our adoption of CECL.
The increase in profitability in the fourth quarter versus the third was primarily driven by higher net revenues, investment gains, and fair value gains, partially offset by lower credit-related income.
- Net revenues in the fourth quarter rose by approximately $500 million, or 9%, primarily due to higher amortization income from our guaranty book of business, driven by higher single-family mortgage prepayment activity, as continued low mortgage rates resulted in higher refinance activity.
- Investment gains increased by approximately $700 million in the fourth quarter, due to an increase in the number of reperforming loans sold during the period.
- Fair value gains in the fourth quarter, compared to losses in the third, were primarily driven by increases in the fair value of our risk-management derivatives, due to rising long-term swap rates in the fourth quarter.
- Lower credit-related income partially offset these increases, as the third quarter included a benefit from enhancements to the model we use to estimate cash flows for individually impaired single-family loans.
For the year, comprehensive income declined due mainly to a shift from fair value gains in 2018 to [fair value] losses in 2019 as a result of decreasing interest rates during most of the year.
For our Single-Family business, net income increased by nearly $500 million in the fourth quarter versus the third, while declining by $1.9 billion for the full-year 2019 vs. full-year 2018, driven primarily by the same factors that drove our overall results.
Our market share of single-family mortgage loans securitized by the GSEs was 57% in the fourth quarter, compared to 59% in the third quarter. We continue to expect to see fluctuations in market share due to product mix, market dynamics, our mission requirements, and our focus on generating appropriate risk-adjusted returns.
Single-family acquisitions were nearly $190 billion in the fourth quarter, similar to the third, as low mortgage rates continued to drive large refinance volumes. Our average single-family conventional guaranty book of business grew by $38 billion year-over-year, while the serious delinquency rate declined further to 66 basis points at the end of the year from 76 basis points at the end of 2018 due to strong single-family housing fundamentals, acquisition volumes, and book performance.
The credit profile of our single-family acquisitions continued to improve, due both to greater refinance activity, and to updates we've made to DU®, our proprietary underwriting system. The proportion of acquisitions with debt-to-income ratios over 45% declined from 25% in 2018 to 19% in 2019, and the proportion of acquisitions with FICOs below 680 declined from 11% in 2018 to 7% in 2019. For purchase money mortgages, which best represent the impact from the DU changes, the proportion of acquisitions with debt-to income ratios over 45% declined from 24% in 2018 to 21% in 2019, and the proportion of acquisitions with FICOs below 680 declined from 8% in 2018 to 7% in 2019. The continued improvement in credit quality has reduced our capital requirement for new acquisitions under the FHFA's conservator capital [requirement], or our acquisition capital rate, by approximately 16% since the fourth quarter of 2018.
As discussed in the past, credit risk transfer, or CRT, is a tool that we use to transfer a portion of credit risk to private investors, and to provide a hedge against losses in the event of a downturn or a stressed environment, while at the same time reducing our capital requirement under the FHFA's conservator capital framework. In the third quarter, we made substantial improvements to our Connecticut Avenue Securities, or CAS, product, by extending the deal terms and reducing the attachment point so that we can transfer a greater portion of the first loss position. In the fourth quarter, we took advantage of strong market conditions and issued our first seasoned loans CRT deal, and will evaluate doing more of these deals in the future. These innovations have enabled us to further reduce our capital requirement. Single-family CRT and mortgage insurance transactions through 2019 have reduced our conservatorship capital framework requirement for credit risk on our covered 2018 single-family loan acquisitions by more than 80%.
For Multifamily, our net income decreased by approximately $90 million [in the fourth quarter of 2019] versus the third quarter, driven primarily by lower yield maintenance fees and a shift to fair value losses, both due to rising interest rates. While the company experienced fair value gains in the fourth quarter, the Multifamily segment incurred fair value losses on commitments as a result of rising interest rates during commitment periods in the fourth quarter. This was partially offset by higher guaranty fee income as the book continued to grow. For the year, net income increased by $110 million, driven largely by an increase in yield maintenance revenue due to higher prepayment volumes as a result of declining rates through much of 2019, as well as higher guaranty fee income due mainly to the larger size of the book.
The average multifamily book was up by over 2% in the quarter and over 10% year-over-year. After declining for several quarters, average book guaranty fees stabilized at approximately 72 basis points in the fourth quarter, due to an increase in the average guaranty fees on our fourth quarter acquisitions. The multifamily book remained strong from a credit perspective. The serious delinquency rate was just 4 basis points at the end of the year, while the substandard rate remained low at 2.2%.
Our 2019 share of multifamily GSE mortgage acquisitions increased slightly to 47% from 46% in 2018. We will likely hover around 50% given the FHFA's new volume cap framework. The fourth quarter was the first quarter that we operated under these new volume cap rules. Multifamily volume in Q4 was $18 billion, leaving $82 billion in capacity under the $100 billion volume cap through the end of 2020. For the year, multifamily acquisition volume grew by 7% from 2018 levels to reach $70 billion, the highest annual volume in the history of our DUS program.
In October, we expanded our multifamily back-end credit risk transfer activities with our first Multifamily Connecticut Avenue Securities® deal. In 2020, we expect these CAS deals to be programmatic for the Multifamily business, in the same ways as Multifamily's Credit Insurance Risk Transfer deals are. These credit risk transfer transactions supplement the amount of credit risk on acquisitions that we are already sharing through our Delegated Underwriting and Servicing program. All our credit risk transfer activities allow us to provide competitive execution and greater capital relief than our DUS program on its own. The multifamily CRT and other credit enhancements including DUS have reduced our conservatorship capital framework for credit risk on 2018 multifamily acquisitions by more than 70%.
Our capital requirement under FHFA's conservatorship capital framework was approximately $84 billion in the fourth quarter, down from $86 billion in the third. Continued high acquisition volumes increased the risk-based capital requirement for our Single-Family and Multifamily businesses. However, this increase was more than offset by a larger capital benefit from credit risk transfer, including the aforementioned first single-family seasoned CAS deal and the first Multifamily CAS transaction, which reduced our capital requirement by well over a billion dollars. Additionally, our capital requirement for the retained portfolio declined due to continued legacy asset dispositions. We are awaiting the FHFA's new capital rule, which will be key in shaping our business prospectively. We believe an appropriately calibrated capital rule is key to the safety and soundness of Fannie Mae and the housing finance system.
As Hugh mentioned, we are focused on making changes that position us as a return-oriented company. We are taking action to prepare for and/or facilitate a conservatorship exit, as well as to ensure that we are ready to operate in a post-conservatorship environment. While we cannot be certain that the company will exit FHFA conservatorship, the actions we are undertaking position us to be stronger regardless of the outcome of the exit process.
This work builds on what we've done during our conservatorship. For instance, we are working to enhance the company's core technology, systems architecture, data environment, and business processes. We are also looking at ways to strengthen the company's financial position by, among other things, implementing hedge accounting in the next year, more comprehensively managing administrative expenses, driving improvements to our underwriting and pricing engines, and building on the ESG work that we already do to support our mission.
These activities make us stronger and help to improve the company even if we do not exit conservatorship.
Finally, let me turn to our 2020 outlook.
While GDP grew by 2.3% in 2019, we expect 2020 growth to slow modestly to 2.2%, supported by continued consumption, greater business investment to meet consumer demand, and a strong housing market.
Given the already low interest rate environment, as well as positive economic developments, we anticipate that the Fed will hold interest rates steady in 2020.
As for housing, we expect home price growth to continue to be strong in 2020, though the growth rate is expected to decelerate slightly in the second half of the year to bring overall home price growth to just above 4%, down from just above 5% in 2019. Due to overall favorable economic conditions, we expect homebuilders to expand production, driving growth in housing construction. We expect new single-family housing starts to grow by about 10% in 2020 and to top one million units in 2021. This is the highest level since 2007, though still muted compared to historic levels.
We have also increased our forecast for new home sales in 2020. While we expect declining refinance origination volumes compared to 2019 due to stabilizing mortgage rates, we believe that strong economic fundamentals support continued demand, particularly among purchase mortgages. We have increased our 2020 purchase mortgage originations forecast to $1.39 trillion, over 6% higher than 2019, partially offsetting the anticipated 12% decline in refinance originations to $895 billion. We expect the refinance share of originations to decrease from 44% in 2019 to 39% in 2020.
Given our outlook, we expect our earnings to be lower in 2020 than in 2019.
- While we expect lower interest income from a declining retained portfolio to be partially offset by higher guaranty fee income from a growing guaranty book of business, we expect that lower amortization income will be a headwind to overall revenues in 2020.
- Additionally, while the sale of reperforming and nonperforming loans, as well as the associated re-designation of these loans from held-for-investment to held-for-sale, has driven substantial income in recent periods, we may see less benefit in 2020 to the extent the population of loans we are considering for sale declines. In 2019, investment gains and re-designations on sales of these loans contributed $2.7 billion in pre-tax earnings.
- Further, slower expected home price growth will likely further reduce credit-related income in 2020, while rising interest rates are a headwind. Actual and projected home price growth drove [approximately] $900 million of pre-tax income in 2019, while declining rates drove [approximately] $300 million of pre-tax income.
- Another factor affecting our financials is fair value gains and losses, which may fluctuate from period-to-period due to a number of factors including changes in interest rates. We cannot predict fluctuations in rates that could drive fair value gains or losses in 2020.
Finally, all else being equal, 2020 credit expense will likely be higher because of the adoption of CECL. Under CECL, the allowance on our existing book will be higher and the allowance on newly acquired loans may also be higher as CECL will reflect expected losses over the life of the loan rather than incurred losses over a much shorter horizon. Additionally, under expected lifetime losses, the allowance may be more sensitive to changes in actual and forecasted home prices and interest rates and may drive additional volatility in our earnings quarter-to-quarter. Since the allowance per loan under CECL's lifetime expected loss model will generally be higher, these macroeconomic forecast changes will now have a greater impact on the allowance and on credit-related expense than under the incurred loss model. CECL adoption will also drive greater volatility in the multifamily allowance, even in a benign environment.
With that, I'll turn it over to the operator and Hugh and I will take your questions.
Fannie Mae's February 13, 2020 media call includes forward-looking statements, including statements about the company's future earnings and other financial and business results, financial condition, market share, the credit quality of its book of business, and the factors that will impact them; expectations regarding the impact of the current expected credit loss standard; business plans and strategies, and their impact; credit risk sharing; capital; status; capital requirements and their impact; and economic and housing market conditions. Actual results and events, and future projections, may turn out to be very different from these statements. Factors that may lead to different results are discussed in "Risk Factors," "Forward-Looking Statements," and elsewhere in the company's Annual Report on Form 10-K for the year ended December 31, 2019. The company's forward-looking statements speak only as of the date they are made, and the company undertakes no obligation to update any forward-looking statement as a result of new information, future events or otherwise, except as required under the federal securities laws.