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WIKI ANALYSIS
The Federal National Mortgage Association (Fannie Mae), the second largest corporation in the United States in terms of assets, buys mortgages from banks and financial institutions and sells mortgage backed securities (MBS), a type of bond, to investors of all sizes. Fannie Mae guarantees roughly a quarter of the entire $11.8 trillion U.S. home loans market.[1] In 2010, Fannie Mae had $16.4 billion in net interest income and a net loss of $22 billion.[2]
Investors' fears were realized when Paulson announced a comprehensive plan to take Fannie and Freddie under "conservatorship", essentially placing the companies under temporary government control and giving the Treasury the right to pump as much as $100 billion into each company, as well as buy a 79.9% share of both Fannie and Freddie.[3]
Company Overview
Fannie Mae is a Government Sponsored Enterprise (GSE) a hybridized enterprise founded by the U.S. Government endowed with an advantageous set of special privileges, such as exemption from state and local taxes, a $2.25 billion line of credit with the U.S. Treasury, and the implicit backing of the federal government.[4] Fannie Mae's business model is that it earns income from the mortgages it owns, using some of it to pay interest on its mortgage backed securities (MBS); rising default and foreclosure rates, however, meant that more and more of its mortgages weren't generating any income at all, forcing the company to write these mortgages off as losses on its income statement.
The purpose of Fannie Mae is to make it easier for Americans to own a home, and it accomplishes this goal by expanding the supply of funds available for mortgages. For example, when a bank lends out a mortgage, it normally has to wait until the loan is repaid before lending the funds out again. Fannie Mae, however, steps in and buys out the mortgage from the bank, allowing the bank to make a second loan sooner; Fannie Mae meanwhile earns the interest from the mortgage. Fannie Mae also sells bonds tied to the mortgages, called mortgage-backed securities. While the mortgage might not be repaid, Fannie Mae guarantees full repayment of its bonds, allowing Fannie Mae to charge a security premium.
Together, Fannie Mae and Freddie Mac (FRE) hold a substantial portion of the US residential mortgages.[5] Because of this high concentration, many thought a failure at Fannie Mae would wreak havoc in the residential housing market and the economy as a whole because many other large financial institutions held Fannie Mae bonds. Although the government was not obligated to assist Fannie Mae, the potential mayhem caused by Fannie's demise is what many believe led the to government ensure Fannie Mae's continued viability.
Business and Financial Metrics
Fannie Mae holds approximately $3.2 trillion in mortgages and other guarantees.[6] In 2010, Fannie Mae had $16.4 billion in net interest income, an increase from its 2009 net interest income of $14.5 billion.[2] As a result of this increased revenue, it was able to reduce its net loss from $74 billion in 2009 to $22 billion in 2010.[2]
Business Segments
Fannie Mae breaks its operations into three business segments: i) Single Family, ii) Housing and Community Development (HCD), and iii) Capital Markets Group.
Single Family
The main source of revenue for the Single Family business is guaranty fees.
Housing and Community Development (HCD)
In 2009 Fannie Mae's HCD segment also earns the bulk of its revenues from guaranty fees.
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Trends and Forces
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Fannie Mae has chased down many of its Non-performing Loans
A loan is generally considered non-performing after it has become delinquent for more than 90 days, meaning the borrower has fallen behind on payments by 90 days. Since Fannie Mae generates a significant portion of its revenues from mortgages, an increase in non-performing loans reduces its revenues and hurts earnings.
Fannie Mae has vigorously pursued banks and other lenders who have sold mortgages to Fannie Mae in which there was insufficient or improper documentation about a borrower's income as well as outright lies.[7] Fannie Mae has successfully forced banks to buy back $2.7 billion in loans sold to Fannie Mae. Fannie Mae reached a settlement with Bank of America (BAC) and will be paid $1.52 billion by Bank of America for loans it sold to Fannie Mae which failed to meet its underwriting criteria.[8]
Effect of Subprime Meltdown
Subprime loans are loans made to borrowers with poor credit scores or low incomes. These borrowers are obviously riskier, but this same reason enables banks to charge premium interest rates to compensate for the higher risk. However, the subprime sector has collapsed as repayment rates have dropped in response to rising mortgage payments and falling home values. About half of all current subprime mortgages have adjustable rates, meaning that the rate of the loan (and, subsequently, the monthly payments) are tied to interest rates. Fannie Mae was originally thought to have been safe from the subprime crisis; however, this has proven to be untrue.
Fixed interest rates decrease flexibility
The majority of the mortgages that Fannie Mae acquires are fixed rate mortgages, meaning that the amount a borrower pays back is based on the interest rate at the time the mortgage was signed. This can impact Fannie Mae in several ways. Much of Fannie's business involves selling bonds, and it cannot sell a bond at a rate much lower than the current prevailing rate. For instance, If interest rates rise, Fannie Mae's income from the fixed-rate mortgages it currently owns will remain unchanged, but it will be unable to earn money on these mortgages or use them to back securities. This is because if Fannie Mae holds a mortgage with an annual rate of 2.5% but current interest rates are at 5%, it will be unable to earn a profit because it only earns 2.5%, but must pay out 5% for any investor to purchase the bonds.
Competition
Because of Fannie Mae's relatively specific purpose and its GSE status, comparisons to other corporations are difficult to make. The best comparison would be to its sister company, Freddie Mac (FRE). Both have similar charters, are similar in size, and both hold status as GSEs.
References
- ↑ Fannie Taps Treasury for $15.3 Billion More After a 10th Loss. Dawn Kopecki. Bloomberg.
- ↑ 2.0 2.1 2.2 FNMA 10-K 2010 Item 6 Pg. 73
- ↑ U.S. seizes Fannie, Freddie, aims to calm markets | U.S. | Reuters.com
- ↑ Fannie Mae Charter Act.
- ↑ Fannie Mae, Freddie Mac Likely to Be Wound Down, Moody’s Says. Jody Shenn. Bloomberg.
- ↑ FNM 10-K 2009 Item 6 Pg. 70
- ↑ Fannie, Freddie Chase Bad Mortgages. Nick Timiraos. The Wall Street Journal.
- ↑ BofA in Settlement With Fannie Mae, Freddie Mac. Joe Rauch. ABC News.
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