Fannie Mae Third Quarter 2020 Earnings Media Call Remarks

Hugh R. Frater:

Welcome and good morning. Thank you for joining us to discuss our third-quarter results.

Our filing today takes place against a backdrop of great changes, great challenges, and considerable uncertainty. 

The pandemic, and its impact on society and the economy, are without precedent in our lifetimes. Calls for addressing historic injustices continue to reverberate across the country. And many areas are grappling with the effects of natural disasters.

I’m happy to report that so far, we are passing the tests 2020 is throwing at us.

Fannie Mae, as you know, has to balance at all times safety and soundness with fulfilling both our liquidity function and affordable housing mission. Our results through the third quarter illustrate our ability to do so successfully in a very challenging time.

Our ability to do so speaks to the reforms of the last decade and the many changes made to stabilize the housing finance system for future generations.

First, as the COVID-19 pandemic took hold, we were able to help lenders deliver forbearance plans at an unprecedented speed and scale. As an example, in February, roughly 6,000 Fannie Mae Single-Family home borrowers – out of 17 million total – were in an active forbearance plan. As of the end of September, we have initiated forbearance plans for more than 1.2 million Fannie Mae borrowers in 2020. Of those, about 56 percent remain active.

On the Multifamily side, we have worked closely with our network of Delegated Underwriters and Servicers to assess the needs of low- and moderate-income renters. And we continue to take what steps we can to protect them from eviction due to COVID-19-related hardship. We’ve also ramped up our Disaster Response Network to help renters in Fannie Mae-financed properties access federal and local support services.

And we’ve reached out to both homeowners and renters through our Here to Help campaign. Here to Help is a multi-channel campaign to educate borrowers and renters on their options and provide them with tools to navigate a COVID-19-related hardship. Our KnowYourOptions.com website has had approximately 2.8 million visitors and more than 7.4 million page-views. And we have designed simplified paths out of forbearance that are easy for borrowers to understand and easy for servicers to implement.

Second, Fannie Mae has provided record levels of critical liquidity and funding to the mortgage market through one of the most severe and sudden economic shocks in a century.

Even as unemployment spiked to nearly 15% nationally, we ensured that mortgages continued to flow to creditworthy borrowers. We are helping millions of homeowners refinance and save money on their mortgages in a time of need. And we continue to fund a robust market for home purchase loans.

In the first nine months of the year, our single-family acquisition volume was more than $900 billion. This puts 2020 on track to be one of the largest volume years in our history. More than $500 billion of this volume came through our whole loan conduit, which is a vital tool for small- and medium-sized lenders.

We placed a premium on speed and agility. We were able to quickly adapt the servicing tools we’ve developed over the past decade to meet the needs of the current crisis.

The investments we’ve made in our technology — and changes in how we develop and deploy technology solutions — really paid off, with dramatic increases in e-signing and e-notarization, as examples. Together, these investments and changes allowed us to respond to COVID-19 with commercial speed and agility.

And yet, for all the progress made, enormous challenges remain ahead of us.

I don’t know that we will return to the pre-pandemic state of affairs, not Fannie Mae, nor the broader housing market that we serve. And, in an important sense, I don’t think we should be looking for a return to normal. Because if we did, a generational opportunity would be lost.

We can no longer put off action to address big challenges, such as the creation of the housing supply our country so desperately needs – housing that is resilient, sustainable, and, most importantly, affordable.

The "new normal" for our business will also mean tackling the legacy of racism in housing and the growing risk of floods and fires in many parts of our country.

Fannie Mae cannot solve these challenges alone, but we have a meaningful role to play, and we want to fulfill that role to our utmost ability. The housing finance system of the future will need to be more dynamic, more innovative, and more digitized. Above all, it must be more responsive to the needs of families of all incomes and backgrounds.

And on all those counts, conservatorship limits our ability to innovate and contribute to that better system.

While the status quo may suit some, it is unsustainable, and the status quo is not what our housing system will need in the years to come. Housing needs GSEs that are reliable in all markets, well-regulated, well-capitalized, and innovative. This is why we believe a thoughtful and responsible end to conservatorship – our regulator’s stated goal – is vitally important. It’s why we look forward to FHFA finalizing the GSE capital rule and working with FHFA to implement our new capital standards.

We believe our affordable housing mission and the mortgage market overall would be best served by a re-capitalized Fannie Mae. A Fannie Mae that is out of conservatorship, well-regulated, well-capitalized, and able to deliver the dynamic and innovative solutions the market will demand. We believe this result will put us in the best possible position to fulfill our chartered role in housing finance in both good times and in bad.

We look forward to working closely with FHFA, and all of our stakeholders, to achieve that end.

With that, I’ll turn it over to Celeste, who will take us through the quarter’s numbers. And then Celeste and I will be happy to answer any questions you have before wrapping up today’s call. Celeste, take it away.

Celeste Mellet Brown:

Thanks Hugh, and good morning.

The third quarter was one of contrasts. The country continues to grapple with the ongoing social and economic impact of the pandemic, yet the housing market has remained remarkably strong. Record low interest rates produced some of the highest refinance volumes we’ve seen, while housing prices continued to rise due to an overall supply and demand imbalance and the ongoing impact of low rates.

Those trends drove our strong results this quarter. However, we remain cautious. While the economy continues to recover, there remains much uncertainty. COVID-19 infection levels are rising again both in the US and overseas. Large segments of the country are struggling economically and there is little clarity on whether we will see additional stimulus measures.

Nevertheless, we remain focused on our role and mission as we navigate these extraordinary times.

First, we are committed to managing risk and ensuring that we maintain the quality of our guaranty book through this period of record acquisition volumes.

Second, we remain a source of significant liquidity to the market, as has particularly been the case for our whole loan conduit, which primarily supports small- to medium-sized lenders. Conduit volumes increased approximately 150% from the third quarter of 2019 to average $3.4 billion per day this quarter.

Third, and critically important, we are working tirelessly with the FHFA and our servicers to find solutions for those homeowners in forbearance that will allow them to stay in their homes whenever possible.

Let me now turn to our results.

Overall Results
We reported $6.7 billion of net revenues in the third quarter, a 15% increase from the prior quarter. Comprehensive income was $4.2 billion, up $1.7 billion from the second quarter as the operating environment was strong and our results benefited from the redesignation and sale of a portfolio of reperforming loans.

In the quarter, interest rates again declined as the 30-year fixed mortgage rate dipped below 3%, while home prices increased by 2.6%.

These trends contributed to strong activity levels, particularly refinance volume, which drove a $760 million increase in net amortization income.

Additionally, we redesignated $5.7 billion of re-performing loans from held-for-investment to held-for-sale in the quarter. We sold a first pool of these loans and plan to sell the second pool in the fourth quarter. This sale generated approximately $420 million of investment gains, while the redesignation generated approximately $500 million of credit-related income through the release of the associated credit allowance.

In total, credit-related income improved by approximately $450 million from the second quarter driven by the RPL redesignations as well as improved home prices, partially offset by the impact of continued uncertainty about COVID-19 on the credit allowance. I will discuss credit in more detail shortly.

Lastly, fair value losses in the third quarter were approximately $700 million lower than the second, driven by lower losses on debt held at fair value and higher gains on credit enhancement derivatives.

Segment Results
Now I will turn to our segment results.

Single-Family
Our Single-Family business earned $3.8 billion in net income in the third quarter, up $1.7 billion from the second quarter driven by higher amortization income, higher credit-related income, lower fair value losses, and higher investment gains.

Single-family acquisitions of $391 billion increased 11% from the second quarter. While refinance volume remained high in the third quarter, purchase volume increased to 32% of total acquisitions from 26% in the second quarter. For comparison, mortgage acquisitions doubled from the same quarter in 2019.

The credit profile of our acquisitions remained strong as loan-to-values (LTVs) have decreased from 77% to 71%, and FICO scores increased by nearly 11 points to 762 from the year earlier.

The single-family serious delinquency rate increased 55 basis points from the second quarter to 320 basis points, largely due to loans in a COVID-19-related forbearance. As a reminder, we do not classify loans as "seriously delinquent" until they are 90 days past due. Thus, some loans that had previously opted into our forbearance program only recently became SDQ this quarter. Excluding loans in COVID-19-related forbearance, the SDQ rate would have been 65 basis points in the quarter, up 6 basis points from the second quarter.

Multifamily
Turning to Multifamily, net income of $460 million in the third quarter was relatively flat to the second quarter, as lower credit-related expenses were offset by lower net interest income and a shift from fair value gains to fair value losses. While overall net interest income was down for the quarter driven by lower yield maintenance income, guaranty fee income was up driven by a growing book of business and strong pricing.

Multifamily’s allowance declined in the third quarter, though credit losses increased quarter-over-quarter due to a charge-off for a large seniors portfolio that defaulted out of forbearance.

Multifamily acquisitions of $15 billion decreased from $20 billion in the second quarter. We enter the fourth quarter with $33 billion of capacity remaining under the FHFA’s $100 billion volume cap.

Multifamily’s third quarter serious delinquency rate increased to 112 basis points, up 12 basis points from the second largely due to the impact of COVID-19-related forbearance, consistent with single-family. Excluding loans in forbearance, the third quarter SDQ rate would have been down 5 basis points from 9 in the second quarter.

COVID-19/Forbearance
Let me now provide an update on COVID-19 forbearance and related impacts.

Cumulative COVID-19 forbearance take-up rates through the end of September were 7.3% for single-family (based on loan count) and 1.4% for multifamily (based on unpaid principal balance [UPB]). Forbearance trends remain better than we had initially forecast at the onset of the pandemic.

For single-family, of the 1.2 million loans that have entered forbearance this year, 44% have already exited, leaving approximately 700,000 loans, or 4.1% of the single-family guaranty book based on loan count, in active forbearance. And of the loans that remain in forbearance, 20% are still current and paying their monthly principal and interest. For multifamily, approximately half of the $5 billion of UPB that has entered forbearance to date, or 0.6% of the UPB in the Multifamily book, has since exited and entered a repayment plan.

We now forecast that the ultimate COVID-19 forbearance take-up rate will be approximately 9% for single-family and 5% for multifamily, with loans continuing to enter forbearance throughout 2021.

Let me briefly recap the impact of forbearance on our financial results. As we have previously noted, we continue to accrue interest on delinquent loans impacted by COVID-19, which contributed over $750 million of net interest income in the third quarter, and $2.2 billion year-to-date. That recorded interest was partially offset by an increase in our credit valuation allowance of approximately $400 million in the third quarter and nearly $600 million for the year. This allowance is in addition to the amounts we reserve for COVID-19 as part of our regular loan loss allowance.

Additionally, while loans are in forbearance, we advance forborne principal and interest payments to servicers. Those advances have totaled under half a billion dollars since the start of the pandemic.

Also, if loans enter a flex modification or are non-performing for a prolonged period, we are required to purchase them out of trust. Thus far, these purchases have been limited but we anticipate they will be significant in 2021.

We have issued debt in anticipation of funding expected P&I advances and loan buyouts in addition to maintaining our elevated support of the whole loan conduit. As a result of this issuance, our debt outstanding was $290 billion at the end of the third quarter, just under the $300 billion PSPA-mandated cap, and compared to $214 billion a year ago.

As I mentioned before, credit-related income was approximately $430 million in the third quarter, primarily due to the roughly $500 million impact of releasing reserves from the RPL portfolio that we redesignated in the quarter. Excluding that activity, credit-related income was relatively flat for the quarter, as improvements in the housing market were offset by continued economic uncertainty.

Capital
Turning to net worth and capital, comprehensive income of $4.2 billion increased our net worth to $20.7 billion at the end of the third quarter.

Also in the quarter, our conservatorship capital requirement increased $3.3 billion to $90.8 billion from the second quarter, driven mainly by historically strong acquisition volumes, a reduction in credit risk transfer (CRT) benefit, and the impact of loans in forbearance, which offset a reduction in capital from the impact of continued home price appreciation and an improved acquisition profile.

We anticipate the finalization of FHFA’s proposed capital rule late this year or early next. We estimate that our total regulatory capital requirements under the proposed rule as written would be approximately $160 billion, which includes over $120 billion of Common Equity Tier 1 capital. The increase in capital requirements as compared to conservatorship capital reflects our new buffer requirements, the risk weight floor, and reduced capital relief from CRT.

Outlook
Now I’d like to turn briefly to our outlook, both for the economy and housing, and how that may affect Fannie Mae’s future financial performance.

We currently project full-year 2020 GDP to decline by 2.6%. This forecast assumes that there will not be an additional round of stimulus this year, which recently led us to downgrade our Q4 GDP growth estimate.

However, our outlook for home prices has improved since the second quarter. We now forecast full year 2020 home price growth of 7.0%, all of which has already been realized through the third quarter. We forecast home price growth of 1.7% in 2021.

We expect interest rates to remain extremely low through 2021.

Because of these trends, we have meaningfully revised upward our market originations forecast for 2020 to $4.1 trillion, surpassing the prior record from 2003 when market originations were $3.7 trillion. We expect 2021 originations to decrease to $2.6 trillion, driven by a decrease in refinance activity.

On the multifamily side, we have seen purchase activity recover since the start of the pandemic, while refinance volumes have remained strong. Thus, our outlook for multifamily has improved and we expect to see strong volumes through the rest of the year.

Looking forward:

• We believe refinance activity, as I mentioned, will remain high through the rest of the year and into next. We estimate that approximately 66% of outstanding single-family first-lien loan balances have rates at least half a percentage point above current levels and thus would economically benefit by refinancing. As a result, we expect high levels of amortization income to continue into the fourth quarter and likely through the first half of 2021.
• As I also mentioned previously, we anticipate having to purchase a significant number of COVID-19-affected loans out of trust in 2021. This will further boost amortization income, since we recognize net unamortized premiums on the related MBS debt as the security pays down.
• While we are likely to benefit from robust activity levels, our credit reserves may continue to be affected by the uncertain outlook as the risk of a COVID-19 resurgence grows. The economic impact of the pandemic and lack of clarity around additional government stimulus measures remain significant risks.
• As a final note, we plan to implement hedge accounting in the first quarter of 2021, which we expect will reduce earnings volatility related to interest rate exposure, though our exposure to spread movements will remain.

Closing Comments
As Hugh noted in his remarks, Fannie Mae serves multiple roles:  we ensure the safety and soundness of the housing finance system; we provide needed liquidity in good times and bad; and we have a unique focus on our mission to support homeowners, particularly in times of crisis.

As we continue to navigate the extraordinary cross currents of the pandemic, with record levels of mortgage acquisitions but also a significant number of homeowners in forbearance, we will continue to focus on fulfilling these important roles.