Fannie Mae Third Quarter 2018 Earnings Media Call Remarks
Good morning. Thanks for joining us to discuss Fannie Mae's third quarter results.
Just over two weeks ago, I began serving as Fannie Mae's Interim CEO, so this is my first opportunity to host this call. I will serve in this role while the Board of Directors conducts a search for a permanent CEO, a process that is well underway.
While I am still new to my current role, I am not new to Fannie Mae. I have been a Board member since 2016. And I have spent almost my entire career in financial services, including federally regulated entities.
I was a Founding Partner and Managing Director of BlackRock, and a senior executive at PNC Financial Services, where I led the real estate division, including, among other areas, agency finance.
Prior to joining the Board of Fannie Mae, I was the CEO and then Chairman of Berkadia, a national commercial real estate company and a Fannie Mae customer for multifamily housing.
As a former customer, I come to Fannie Mae with a great appreciation for the central role that the company plays in our nation’s mortgage market and in our housing economy. I also have a deep appreciation for the company's very deep bench of executive talent.
In the 10 years since conservatorship began, Fannie Mae has returned to profitability and returned to the fundamentals of mortgage underwriting. The company also has tools in place to provide fast help to borrowers facing unexpected hardships, such as natural disasters. With the help of its Conservator and Regulator, the FHFA, Fannie Mae has transformed its business model, reduced its large investment portfolio, and created a new market for transferring credit risk to private investors, all while safely and soundly providing trillions of dollars of liquidity to the mortgage market.
As Interim CEO, I view my job as maintaining the positive momentum of the company, working with management to execute on our strategy, and ensuring the company maintains its strong commitment to safety, soundness, and stewardship on behalf of taxpayers.
Our strong third quarter results are a reflection of Fannie Mae's momentum.
Our CFO Celeste Brown will cover the specifics of our third quarter results in greater detail.
At a high level, what I see is that our customers are facing a lot of headwinds in the market. Rates are up, volumes are down, and margins are tight, so lender profitability is challenged. New housing supply is up but not all the supply has been created where it’s needed. While we do see income growth nationally, in many markets home price growth has outstripped income growth so affordability for home buyers remains a challenge. In the multifamily markets, rental growth has remained fairly strong so even though incomes have started to grow, the percentage of households that are rent burdened remains near all-time highs.
Against that backdrop, we are focused on trying to help customers by enabling a mortgage process that is better, faster, cheaper, and safer to help them run their businesses and serve their customers better.
As a former Fannie Mae customer, I am acutely aware that one of the best ways we can help customers is to continuously improve and innovate. In fact, it is our responsibility to innovate if we are to effectively serve our customers.
Our lender customers are seeking to deliver a mortgage experience to their homeowner customers that is far different from today’s. Today, a home mortgage typically takes approximately 60 days from application to delivery. It is not far-fetched to envision a world where this takes as few as 10 days. That’s what our customers are striving for, so they can meet the expectations of homeowners. The eventual result of this digital transformation could be a radical reduction in the cost of processing a loan with greater certainty for lender and borrower, and no diminution of safety and soundness.
Fannie Mae needs to continue innovating in order to help our customers deliver that experience to homeowners while carefully managing risk for the taxpayer.
Fannie Mae is also committed to continuing to advance a sustainable business model that reduces risk to the housing finance system and taxpayers.
One way to improve sustainability is to increase the sources of risk capital available to the mortgage market, and we are doing this through our credit risk transfer work. Let me share a few examples.
In September, we executed our sixth Connecticut Avenue Securities, or CAS, transaction and our seventh Credit Insurance Risk Transaction, or CIRT, of 2018. These transactions shift a portion of the risk on pools of single-family loans to private investors and to a panel of insurers or reinsurers, respectively.
We are also engaged in our first Connecticut Avenue Securities transaction issued by a trust that qualifies as a Real Estate Mortgage Investment Conduit, or REMIC. This new structure is designed to make CAS deals more attractive to Real Estate Investment Trusts, or REITs, and to international investors. In a moment, Celeste will offer some additional context on this new structure.
Since we began our innovative credit risk transfer program in 2013, we have transferred a portion of the credit risk on approximately $1.5 trillion of single-family loans, measured in unpaid principal balance at the time of the transaction. All told, approximately 38 percent of the loans in our single-family guaranty book of business were covered by a credit risk transfer transaction as of the end of September.
Another example of our forward-leaning work came with our second issuance of securities indexed to the Secured Overnight Financing Rate, or SOFR. Fannie Mae leads the market in the development of SOFR as a key market index in support of the Alternative Reference Rates Committee's efforts.
Fannie Mae's second transaction was designed to provide additional points on the SOFR curve and serve as a benchmark for market participants.
We are gratified that the Federal Reserve and the ARRC recognized Fannie Mae’s efforts in helping establish the use of SOFR in financial markets.
Finally, in our Multifamily business, nearly 100 percent of our new multifamily business volume has lender risk-sharing through our DUS model. But, in addition to that, in the third quarter we also transferred multifamily mortgage credit risk through a multifamily CIRT transaction, and we expect to continue with Multifamily CIRT transactions on a regular basis going forward.
As Interim CEO, I am committed to making sure that across all our work, we are guided by a few simple principles:
- Doing what is best for customers, homeowners, and renters;
- Protecting taxpayers; and,
- Advancing the mission set forth in our charter: to do our best to ensure access to mortgage credit, affordability of housing, and sustainability of the housing finance markets.
Now let me turn it over to Celeste.
Thanks, Hugh, and good morning everyone. In the third quarter, we reported $4.0 billion in both net income and comprehensive income. This compares with net income and comprehensive income of $4.5 billion in the second quarter. Our pre-tax income was $5.1 billion, compared with $5.6 billion for the prior quarter.
The decrease in net income for the quarter was driven primarily by lower credit-related income, which was due to a reduction in the benefit associated with reperforming loans being reclassified from a held-for-investment designation to a held-for-sale designation. This change in designation precedes the sale of the loans to other investors. Last quarter, we redesignated a larger population of loans in anticipation of sales which then closed this quarter. Also contributing to the decline in credit-related income in the third quarter was a smaller improvement in home prices compared with that in the second quarter, which is in line with seasonal expectations and trends.
Partially offsetting this reduction was an increase in fair value gains. Fair value gains in the third quarter were driven by gains on risk management and mortgage commitment derivatives due to rate increases in the quarter.
Based on these results, we expect to pay a dividend of $4.0 billion to Treasury in the fourth quarter. And we will continue to retain a total of $3 billion in capital.
Now I'll focus on a few highlights.
Overall, our third quarter performance reflected strong fundamentals, with solid revenue streams driven by guaranty fees on our stable book of business.
We provided $140 billion of liquidity to the mortgage market in the third quarter through guarantees and loan purchases. This supported 360,000 home purchases, 160,000 home refinances, and financing for 206,000 multifamily rental units.
We also continue to focus on managing and distributing risk.
In the third quarter, we further reduced the size of our retained mortgage portfolio, which in turn reduced the company's risk exposure. Our retained portfolio is now below $200 billion, well below the FHFA's requirement to reduce the balance to $225 billion by the end of 2018. Through sales of reperforming and nonperforming loans, we've been able to successfully reduce our retained mortgage portfolio, which has declined by 19% since the end of the third quarter last year, and by 74% since the start of conservatorship.
Also in the third quarter, we continued to distribute credit risk to the private market through our credit risk transfer programs. As Hugh mentioned, we executed new CAS and CIRT transactions in single-family, and as of the end of the third quarter, 45% of the unpaid principal balance of loans in our single-family guaranty book now has some level of credit enhancement – including primary mortgage insurance, CAS deals, CIRT deals, and lender risk-sharing – up from 40% at the end of 2017.
On the Multifamily side, nearly 100% of new business volume now has lender risk-sharing through our Delegated Underwriting and Servicing program, which we refer to as our DUS program. This quarter, in addition to the credit transfers we do through DUS, we entered into our third multifamily CIRT transaction to date, transferring a portion of the credit risk on multifamily mortgages with an unpaid principal balance of $11.1 billion. We view CIRT transactions as additive to the risk transfer activities that are part of our core DUS program.
We are continuously innovating and improving our credit risk transfer programs. As part of this ongoing effort, and as Hugh mentioned, in the single-family space, we recently introduced our new CAS enhancement that enables us to issue CAS notes that qualify as REMIC securities. This week, we priced our first CAS REMIC deal; this first offering was met with strong investor demand, attracting new investors.
In addition to attracting new customers, our new CAS REMIC structure improves on the traditional CAS structure. Our previous CAS offerings were structured as Fannie Mae corporate debt, and under that structure, there can be a significant lag between the time when we recognize a provision for credit losses and when we recognize the related recovery from a CAS transaction. The new CAS REMIC structure provides the same level of risk coverage that is provided by our traditional CAS products, but eliminates the timing mismatch and allows us to recognize the credit loss protection provided to us by these transactions at the same time the related credit loss is recognized in our financial statements. This is a significant benefit for the company, particularly as we think about resources we may require in a stress situation.
Our single-family business continued to have a strong presence in the secondary market in the third quarter. Fannie Mae remained the largest issuer of single-family mortgage-related securities in the secondary mortgage market, representing 40% of new single-family mortgage-related securities issuances.
Overall, single-family results in the third quarter were solid, with net income of $3.5 billion, compared with $4.0 billion in the second quarter. As with total company results, the decrease was mainly driven by a reduction in credit-related income, primarily due to a lower benefit associated with loans being reclassified from held-for-investment to held-for-sale in the third quarter versus in the second quarter.
Additionally, while there was positive home price growth in the third quarter, the growth was smaller than in the second.
The single-family business earned $4.7 billion of net interest income, primarily driven by the guaranty fee income earned on our $3 trillion guaranty book of business.
The performance and underwriting of loans in our single-family guaranty book remained strong, with our SDQ rate of 82 basis points as of the end of the third quarter, which is lower than the level observed before last year's hurricanes. However, it is possible that SDQ rates may increase in the near term as a result of hurricanes occurring in the past few months. We are currently assessing the damage from the recent storms and the potential impacts to loans on our guaranty book. However, we do not believe that the hurricanes so far in 2018, individually or in aggregate, will have a material impact on our credit losses or credit reserves.
Finally, our multifamily business posted net income of $549 million in the third quarter, up from $504 million last quarter. The increase was driven by higher guaranty fee revenue due to growth in the multifamily book of business. In addition, fee and other income of $192 million increased in the third quarter primarily driven by higher yield maintenance as a result of prepayment activity. Our multifamily credit-related expense remains low because of strong fundamentals, with our SDQ rate remaining below 10 basis points in the third quarter.
Multifamily business volume in the first nine months of the year was $44 billion, and we continue to be a leader in affordable workplace rental housing. More than 90% of the multifamily units we supported in the third quarter were affordable to families earning at or below 120% of area median income.
You can find more information on the drivers of our third quarter results in our press release, our financial supplement, and our Form 10-Q, which we filed today.
I’d like to thank all of you for joining today's call.