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Fannie Mae 10-Q 2011 Documents found in this filing:Table of Contents
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File No.: 0-50231
Fannie Mae
Registrant’s telephone number, including area code:
(202) 752-7000
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T
(§ 232.405 of this chapter) during the preceding
12 months (or for such shorter period that the registrant
was required to submit and post such
files). Yes þ No o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
“large accelerated filer,” “accelerated
filer” and “smaller reporting company” in
Rule 12b-2
of the Exchange Act. (Check one):
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
As of September 30, 2011, there were
1,158,227,237 shares of common stock of the registrant
outstanding.
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We have been under conservatorship, with the Federal
Housing Finance Agency (“FHFA”) acting as conservator,
since September 6, 2008. As conservator, FHFA succeeded to
all rights, titles, powers and privileges of the company, and of
any shareholder, officer or director of the company with respect
to the company and its assets. The conservator has since
delegated specified authorities to our Board of Directors and
has delegated to management the authority to conduct our
day-to-day
operations. Our directors do not have any duties to any person
or entity except to the conservator and, accordingly, are not
obligated to consider the interests of the company, the holders
of our equity or debt securities or the holders of Fannie Mae
MBS unless specifically directed to do so by the conservator. We
describe the rights and powers of the conservator, key
provisions of our agreements with the U.S. Department of
the Treasury (“Treasury”), and their impact on
shareholders in our Annual Report on
Form 10-K
for the year ended December 31, 2010 (“2010
Form 10-K”)
in “Business—Conservatorship and Treasury
Agreements.”
You should read this Management’s Discussion and
Analysis of Financial Condition and Results of Operations
(“MD&A”) in conjunction with our unaudited
condensed consolidated financial statements and related notes
and the more detailed information in our 2010
Form 10-K.
This report contains forward-looking statements that are
based on management’s current expectations and are subject
to significant uncertainties and changes in circumstances.
Please review “Forward-Looking Statements” for more
information on the forward-looking statements in this report.
Our actual results may differ materially from those reflected in
these forward-looking statements due to a variety of factors
including, but not limited to, those described in “Risk
Factors” and elsewhere in this report and in “Risk
Factors” in our 2010
Form 10-K.
You can find a “Glossary of Terms Used in This
Report” in the “MD&A” of our 2010
Form 10-K.
Fannie Mae is a government-sponsored enterprise
(“GSE”) that was chartered by Congress in 1938 to
support liquidity, stability and affordability in the secondary
mortgage market, where existing mortgage-related assets are
purchased and sold. Our charter does not permit us to originate
loans or lend money directly to consumers in the primary
mortgage market. Our most significant activity is securitizing
mortgage loans originated by lenders into Fannie Mae
mortgage-backed securities that we guarantee, which we refer to
as Fannie Mae MBS. We also purchase mortgage loans and
mortgage-related securities for our mortgage portfolio. We use
the term “acquire” in this report to refer to both our
guarantees and our purchases of mortgage loans. We obtain funds
to support our business activities by issuing a variety of debt
securities in the domestic and international capital markets.
We are a corporation chartered by the U.S. Congress. Our
conservator is a U.S. government agency. Treasury owns our
senior preferred stock and a warrant to purchase 79.9% of our
common stock, and Treasury has made a commitment under a senior
preferred stock purchase agreement to provide us with funds
under specified conditions to maintain a positive net worth. The
U.S. government does not guarantee our securities or other
obligations.
Our common stock was delisted from the New York Stock Exchange
and the Chicago Stock Exchange on July 8, 2010 and since
then has been traded in the
over-the-counter
market and quoted on the OTC Bulletin Board under the
symbol “FNMA.” Our debt securities are actively traded
in the
over-the-counter
market.
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In the first nine months of 2011, we continued our work to
provide liquidity and support to the mortgage market, grow the
strong new book of business we have been acquiring since
January 1, 2009, and minimize losses on loans we acquired
prior to 2009.
Providing
Liquidity and Support to the Mortgage Market
Our
Liquidity and Support Activities
We provide liquidity and support to the U.S. mortgage
market in a number of important ways:
2011
Acquisitions and Market Share
In the first nine months of 2011, we purchased or guaranteed
approximately $445 billion in loans, measured by unpaid
principal balance, which includes approximately $51 billion
in delinquent loans we purchased from our single-family MBS
trusts. These activities enabled our lender customers to finance
approximately 1,826,000 single-family conventional loans and
loans for approximately 289,000 units in multifamily
properties during the first nine months of 2011.
We remained the largest single issuer of mortgage-related
securities in the secondary market during the third quarter of
2011, with an estimated market share of new single-family
mortgage-related securities issuances of 43.3%. Our estimated
market share of new single-family mortgage-related securities
issuances was 43.2% in the second quarter of 2011 and 44.5% in
the third quarter of 2010.
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We remained a constant source of liquidity in the multifamily
market. We owned or guaranteed approximately 20% of the
outstanding debt on multifamily properties as of June 30,
2011 (the latest date for which information was available).
Summary
of Our Financial Performance for the Third Quarter and First
Nine Months of 2011
Our financial results for the third quarter and the first nine
months of 2011 reflect the continued weakness in the housing and
mortgage markets, which remain under pressure from high levels
of unemployment, underemployment and the prolonged decline in
home prices since their peak in the third quarter of 2006.
Credit-related expenses continue to be a key driver of our net
losses for each period presented. Our credit-related expenses
vary from period to period primarily based on changes in home
prices, borrower payment behavior, the types and volumes of loss
mitigation activities completed, and actual and estimated
recoveries from our lender and mortgage insurer counterparties.
The decline in interest rates during the third quarter of 2011
had a significant impact on the company’s derivative
losses; however, these losses were mostly offset by fair value
gains in the period related to our hedged mortgage investments
for which only a portion are recorded at fair value in our
financial statements. Derivative instruments are an integral
part of how we manage interest rate risk and an inherent part of
the cost of funding and hedging our mortgage investments. We
expect high levels of
period-to-period
volatility in our results because our derivatives are recorded
at fair value in our financial statements while some of the
instruments they hedge are not recorded at fair value in our
financial statements.
Comprehensive
Loss
We recognized a total comprehensive loss of $5.3 billion in
the third quarter of 2011, consisting of a net loss of
$5.1 billion and other comprehensive loss of
$197 million. In comparison, we recognized a total
comprehensive loss of $2.9 billion in the second quarter of
2011, consisting of a net loss of $2.9 billion and other
comprehensive income of $2 million. We recognized a total
comprehensive loss of $429 million in the third quarter of
2010, consisting of a net loss of $1.3 billion and other
comprehensive income of $902 million (other comprehensive
income in the third quarter of 2010 was primarily driven by a
reduction in our unrealized losses due to significantly improved
fair value of
available-for-sale
securities).
Our total comprehensive loss for the first nine months of 2011
was $14.5 billion, consisting of a net loss of
$14.4 billion and other comprehensive loss of
$14 million. In comparison, we recognized a total
comprehensive loss of $10.1 billion in the first nine
months of 2010, consisting of a net loss of $14.1 billion
and other comprehensive income of $3.9 billion (other
comprehensive income in the first nine months of 2010 was
primarily driven by a reduction in our unrealized losses due to
significantly improved fair value of
available-for-sale
securities).
Net
Loss
Third Quarter 2011 vs. Second Quarter
2011. The $2.2 billion increase in our net
loss was primarily due to $4.5 billion in net fair value
losses in the third quarter of 2011 primarily driven by losses
on our risk management derivatives due to a significant decline
in swap interest rates during the quarter, compared with
$1.6 billion in net fair value losses in the second quarter
of 2011 driven by losses on risk management derivatives. In
addition, we recognized foreclosed property expense of
$733 million in the third quarter of 2011 compared with
foreclosed property income of $478 million in the second
quarter of 2011 because our estimate of amounts due to us
related to outstanding repurchase requests remained relatively
flat during the third quarter compared with a substantial
increase in the second quarter of 2011. These losses and
expenses were partially offset by a $2.4 billion decrease
in our provision for credit losses primarily driven by a lower
provision on individually impaired loans as the continued lower
interest rate environment improved our expected cash flow
projections on those loans, therefore reducing our estimated
impairment.
Third Quarter 2011 vs. Third Quarter 2010. The
$3.8 billion increase in our net loss was primarily due to
$4.5 billion in net fair value losses in the third quarter
of 2011 primarily driven by losses on our risk management
derivatives due to a significant decline in swap interest rates
during the quarter, compared with
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$525 million in net fair value gains in the third quarter
of 2010 primarily driven by gains on our trading securities.
These losses were partially offset by a $677 million
decrease in credit-related expenses which was primarily driven
by a lower provision on individually impaired loans as the
continued lower interest rate environment improved our expected
cash flow projections on those loans, therefore reducing our
estimated impairment. Additionally, there was a
$410 million increase in net interest income primarily from
lower interest expense on funding debt.
Nine Months of 2011 vs. Nine Months of
2010. Our net loss remained flat for the first
nine months of 2011 compared with the first nine months of 2010.
The key components of our net loss in both the first nine months
of 2011 and the first nine months of 2010 were credit-related
expenses and fair value losses, which were partially offset by
net interest income.
See “Consolidated Results of Operations” for more
information on our results.
Our net worth deficit of $7.8 billion as of
September 30, 2011 reflects the recognition of our total
comprehensive loss of $5.3 billion and our payment to
Treasury of $2.5 billion in senior preferred stock
dividends during the third quarter of 2011. The Acting Director
of FHFA will submit a request to Treasury on our behalf for
$7.8 billion to eliminate our net worth deficit.
In the third quarter of 2011, we received $5.1 billion in
funds from Treasury to eliminate our net worth deficit as of
June 30, 2011. Upon receipt of the additional funds
requested to eliminate our net worth deficit as of
September 30, 2011, the aggregate liquidation preference on
the senior preferred stock will be $112.6 billion, which
will require an annualized dividend payment of
$11.3 billion. The amount of this dividend payment exceeds
our reported annual net income for any year since our inception.
Through September 30, 2011, we have paid an aggregate of
$17.2 billion to Treasury in dividends on the senior
preferred stock.
Table 1 below displays our senior preferred stock dividend
payments to Treasury and Treasury draws since entering
conservatorship on September 6, 2008.
Table
1: Treasury Dividend Payments and Draw
Total
Loss Reserves
Our total loss reserves, which reflect our estimate of the
probable losses we have incurred in our guaranty book of
business, increased to $75.6 billion as of
September 30, 2011 from $74.8 billion as of
June 30, 2011 and increased from $66.3 billion as of
December 31, 2010. Our total loss reserve coverage to total
nonperforming loans was 37.07% as of September 30, 2011,
compared with 36.91% as of June 30, 2011 and 30.85% as of
December 31, 2010. The continued stress on a broad segment
of borrowers from continued high levels of unemployment and
underemployment and the prolonged decline in home prices have
caused our total loss reserves to remain high for the past few
years. Further, the shift in our nonperforming loan balance from
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loans in our collective reserve to loans that are individually
impaired has caused our coverage ratio to increase.
Our
Strong New Book of Business and Expected Losses on Our Legacy
Book of Business
We refer to the single-family loans we have acquired since the
beginning of 2009 as our “new single-family book of
business” and the single-family loans we acquired prior to
2009 as our “legacy book of business.” In this
section, we discuss our expectations regarding the profitability
of our new single-family book of business, as well as the
performance and credit profile of these loans to date. We also
discuss our expectations regarding losses on the loans in our
legacy book of business.
Factors
that Could Cause Actual Results to be Materially Different from
Our Estimates and Expectations
We present a number of estimates and expectations in this
executive summary regarding the profitability of single-family
loans we have acquired, our single-family credit losses and
credit-related expenses, and our draws from and dividends to be
paid to Treasury. These estimates and expectations are
forward-looking statements based on our current assumptions
regarding numerous factors, including future home prices and the
future performance of our loans. Home prices are a key factor
affecting the amount of credit losses and profitability we
expect. As home prices decline, the
loan-to-value
ratios on our loans shift higher, and both the probability of
default and the severity of loss increase. Furthermore, the
level of regional variation in home price declines affects our
results, as we will incur greater credit losses if home prices
decline more significantly in regions where we have a greater
concentration of loans. Our future estimates of our performance,
as well as the actual amounts, may differ materially from our
current estimates and expectations as a result of the timing,
level and regional variation in home price changes, changes in
interest rates, unemployment, other macroeconomic variables,
direct and indirect consequences resulting from failures by
servicers to follow proper procedures in the administration of
foreclosure cases, government policy, changes in generally
accepted accounting principles (“GAAP”), credit
availability, social behaviors, the volume of loans we modify,
the effectiveness of our loss mitigation strategies, management
of our real-estate owned (“REO”) inventory and pursuit
of contractual remedies, changes in the fair value of our assets
and liabilities, impairments of our assets, and many other
factors, including those discussed in “Risk Factors,”
“Forward-Looking Statements” and elsewhere in this
report and in “Risk Factors” in our 2010
Form 10-K.
For example, if the economy were to enter a deep recession, we
would expect actual outcomes to differ substantially from our
current expectations.
Building
a Strong New Single-Family Book of Business
Expected
Profitability of Our Single-Family Acquisitions
Our new single-family book of business has a strong overall
credit profile and is performing well. While it is too early to
know how loans in our new single-family book of business will
ultimately perform, given their strong credit risk profile, low
levels of payment delinquencies shortly after acquisition, and
low serious delinquency rates, we expect that, over their
lifetime, these loans will be profitable, by which we mean our
fee income on these loans will exceed our credit losses and
administrative costs for them. Table 2 provides information
about whether we expect loans we acquired in 1991 through the
first nine months of 2011 to be profitable, and the percentage
of our single-family guaranty book of business represented by
these loans as of September 30, 2011. The expectations
reflected in Table 2 are based on the credit risk profile of the
loans we have acquired, which we discuss in more detail in
“Table 4: Credit Profile of Single-Family Conventional
Loans Acquired” and in “Table 36: Risk Characteristics
of Single-Family Conventional Business Volume and Guaranty Book
of Business.” These expectations are also based on numerous
other assumptions, including our expectations regarding home
price declines set forth in “Outlook” and other
macroeconomic factors. As shown in Table 2, we expect loans we
have acquired in 2009, 2010 and the first nine months of 2011 to
be profitable over their lifetime. If future macroeconomic
conditions turn out to be more adverse than our expectations,
these loans could become unprofitable. For example, we believe
that credit losses on these loans would exceed guaranty fee
revenue if home prices declined nationally by approximately 10%
from their September 2011 levels over the next five years based
on our home price index. See “Outlook” for our
expectations regarding home price declines.
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Table
2: Expected Lifetime Profitability of Single-Family
Loans Acquired in 1991 through the First Nine Months of
2011
As Table 2 shows, the years in which we acquired single-family
loans that we expect will be unprofitable are 2004 through 2008.
A substantial majority of our realized credit losses since the
beginning of 2009 were attributable to loans we acquired in 2005
through 2008. Although the 2004 vintage has been profitable to
date, we currently believe that this vintage will not be
profitable over its lifetime. While we previously believed the
2004 vintage would perform close to break-even, in 2011 our
expectations for long-term home price changes have worsened,
which has changed our expectation of future borrower behavior
regarding these loans. We expect the 2005 through 2008 vintages
to be significantly more unprofitable than the 2004 vintage. The
loans we acquired in 2004 were originated under more
conservative acquisition policies than loans we acquired from
2005 through 2008; however, because our 2004 acquisitions were
made during a time when home prices were rapidly increasing,
their performance is expected to suffer from the significant
decline in home prices since 2006. The ultimate long-term
performance and profitability of the 2004 vintage will depend on
many factors, including changes in home prices, other economic
conditions and borrower behavior.
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Loans we have acquired since the beginning of 2009 comprised 49%
of our single-family guaranty book of business as of
September 30, 2011. Our 2005 to 2008 acquisitions are
becoming a smaller percentage of our single-family guaranty book
of business, having decreased from 39% of our single-family
guaranty book of business as of December 31, 2010 to 33% as
of September 30, 2011. Our 2004 acquisitions constituted 5%
of our single-family guaranty book of business as of
September 30, 2011.
Serious
Delinquency Rates by Year of Acquisition
In our experience, an early predictor of the ultimate
performance of a portfolio of loans is the rate at which the
loans become seriously delinquent (three or more months past due
or in the foreclosure process) within a short period of time
after acquisition. Loans we acquired in 2009 and 2010 have
experienced historically low levels of delinquencies shortly
after their acquisition. Table 3 shows, for single-family loans
we acquired in each year from 2001 to 2010, the percentage that
were seriously delinquent as of the end of the third quarter
following the year of acquisition. Loans we acquired in 2011 are
not included in this table because they were originated so
recently that many of them could not yet have become seriously
delinquent. As Table 3 shows, the percentage of our 2009
acquisitions that were seriously delinquent as of the end of the
third quarter following their acquisition year was approximately
nine times lower than the average comparable serious delinquency
rate for loans acquired in 2005 through 2008. For loans
originated in 2010, this percentage was approximately ten times
lower than the average comparable rate for loans acquired in
2005 through 2008. Table 3 also shows serious delinquency rates
for each year’s acquisitions as of September 30, 2011.
Except for 2008 acquisitions, whose performance has been
affected by changes in underwriting and eligibility standards
that became effective during the course of 2008, and more recent
acquisition years, whose serious delinquency rates are likely
lower than they will be after the loans have aged, Table 3 shows
that the current serious delinquency rate generally tracks the
trend of the serious delinquency rate as of the end of the third
quarter following the year of acquisition. Below the table we
provide information about the economic environment in which the
loans were acquired, specifically home price appreciation and
unemployment levels.
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Table
3: Single-Family Serious Delinquency Rates by Year of
Acquisition
Credit
Profile of Our Single-Family Acquisitions
Single-family loans we purchased or guaranteed from 2005 through
2008 were acquired during a period when home prices were rising
rapidly, peaked, and then started to decline sharply, and
underwriting and eligibility standards were more relaxed than
they are now. These loans were characterized, on average and as
discussed
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below, by higher
loan-to-value
(“LTV”) ratios and lower FICO credit scores than loans
we have acquired since January 1, 2009. In addition, many
of these loans were Alt-A loans or had other higher-risk loan
attributes such as interest-only payment features. As a result
of the sharp declines in home prices, 34% of the loans that we
acquired from 2005 through 2008 had
mark-to-market
LTV ratios that were greater than 100% as of September 30,
2011, which means the principal balance of the borrower’s
primary mortgage exceeded the current market value of the
borrower’s home. This percentage is higher when second lien
loans are included. The sharp decline in home prices, the severe
economic recession that began in December 2007 and continued
through June 2009, and continuing high unemployment and
underemployment have significantly and adversely impacted the
performance of loans we acquired from 2005 through 2008. We are
continuing to take a number of actions to reduce our credit
losses. We discuss these actions and our strategy in
“Reducing Credit Losses on Our Legacy Book of
Business” and “Risk Management—Credit Risk
Management—Single-Family Mortgage Credit Risk
Management.”
In 2009, we began to see the effect of actions we took,
beginning in 2008, to significantly strengthen our underwriting
and eligibility standards and change our pricing to promote
sustainable homeownership and stability in the housing market.
As a result of these changes and other market dynamics, we
reduced our acquisitions of loans with higher-risk attributes.
Compared with the loans we acquired in 2005 through 2008, the
loans we have acquired since January 1, 2009 have had
better overall credit risk profiles at the time we acquired them
and their early performance has been strong. Our experience has
been that loans with characteristics such as lower original LTV
ratios (that is, more equity held by the borrowers in the
underlying properties), higher FICO credit scores and more
stable payments will perform better than loans with risk
characteristics such as higher original LTV ratios, lower FICO
credit scores, Alt-A underwriting and payments that may adjust
over the term of the loan.
Table 4 shows the credit risk profile of the single-family loans
we have acquired since January 1, 2009 compared to the
loans we acquired from 2005 through 2008.
Table
4: Credit Profile of Single-Family Conventional Loans
Acquired(1)
Improvements in the credit risk profile of our acquisitions
since the beginning of 2009 over acquisitions in prior years
reflect changes that we made to our pricing and eligibility
standards, as well as changes that mortgage insurers made to
their eligibility standards. We discuss these changes in our
2010
Form 10-K
in “Business—Executive Summary—Our Expectations
Regarding Profitability, the Single-Family Loans We Acquired
Beginning in 2009, and Credit Losses—Credit Profile of Our
Single-Family Acquisitions.”
The credit risk profile of our acquisitions since the beginning
of 2009 has been influenced further by the significant
percentage of refinanced loans. Historically, refinanced loans
generally have better credit profiles than purchase money loans.
As we discuss in “Outlook” below, we expect fewer
refinancings in 2011 and 2012 than in 2010.
Since 2009, our acquisitions have included a significant number
of loans refinanced under our Refi
Plustm
initiative, which provides expanded refinance opportunities for
eligible Fannie Mae borrowers. Our
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acquisitions under Refi Plus include our acquisitions under the
Home Affordable Refinance Program (“HARP”), which was
established by the Administration to help borrowers who may be
unable to refinance the mortgage loan on their primary residence
due to a decline in home values. The approximately 536,000 loans
we acquired under Refi Plus in the first nine months of 2011
constituted approximately 27% of our total single-family
acquisitions for the period, compared with approximately 23% of
total single-family acquisitions in all of 2010. Under Refi Plus
we acquire refinancings of performing Fannie Mae loans that have
current LTV ratios up to 125% and, in some cases, lower FICO
credit scores than we generally require. While it is too early
to determine whether loans with higher risk characteristics
refinanced under the Refi Plus program will perform differently
from other refinanced loans, we expect Refi Plus loans will
perform better than the loans they replace because Refi Plus
loans reduce the borrowers’ monthly payments or otherwise
should provide more sustainability than the borrowers’ old
loans (for example, by having a fixed rate instead of an
adjustable rate). Loans refinanced through the Refi Plus
initiative in the first nine months of 2011 reduced
borrowers’ monthly mortgage payments by an average of $171.
This figure reflects all refinancings under Refi Plus, even
those that involved a reduced term, and therefore higher monthly
payments.
The LTV ratios at origination for our 2010 and 2011 acquisitions
are higher than for our 2009 acquisitions, primarily due to our
acquisition of Refi Plus loans. The percentage of loans with LTV
ratios at origination greater than 90% has increased from 4% for
2009 acquisitions to 7% for 2010 acquisitions and 10% for
acquisitions in the first nine months of 2011. We expect our
acquisition of loans with high LTV ratios will increase in 2012
as a result of recently announced changes to HARP, which we
discuss in “Legislative and Regulatory
Developments—Changes to the Home Affordable Refinance
Program.”
Despite the increases in LTV ratios at origination associated
with Refi Plus, the overall credit profile of our 2010 and 2011
acquisitions, like that of our 2009 acquisitions, is
significantly stronger than the credit profile of our 2005
through 2008 acquisitions. Whether the loans we acquire in the
future will exhibit an overall credit profile similar to our
acquisitions since the beginning of 2009 will depend on a number
of factors, including our future eligibility standards and those
of mortgage insurers, the percentage of loan originations
representing refinancings, the volume and characteristics of
loans we acquire under the recently announced changes to HARP
terms, our future objectives, government policy, and market and
competitive conditions.
Expected
Losses on Our Legacy Book of Business
The single-family credit losses we realized from January 1,
2009 through September 30, 2011, combined with the amounts
we have reserved for single-family credit losses as of
September 30, 2011, as described below, total approximately
$135 billion. A substantial majority of these losses are
attributable to single-family loans we purchased or guaranteed
from 2005 through 2008.
While loans we acquired in 2005 through 2008 will give rise to
additional credit losses that we will realize when the loans are
charged off (upon foreclosure or our acceptance of a short sale
or
deed-in-lieu
of foreclosure), we estimate that we have reserved for the
substantial majority of the remaining losses on these loans.
Even though we believe a substantial majority of the credit
losses we have yet to realize on these loans has already been
reflected in our results of operations as credit-related
expenses, our credit-related expenses remain high as weakness in
the housing and mortgage markets continues. We also expect that
future defaults on loans in our legacy book of business and the
resulting charge-offs will occur over a period of years. In
addition, given the large current and anticipated supply of
single-family homes in the market, we anticipate that it will
take years before our REO inventory is reduced to pre-2008
levels.
We show how we calculate our realized credit losses in
“Table 15: Credit Loss Performance Metrics.” Our
reserves for credit losses described in this discussion consist
of (1) our allowance for loan losses, (2) our
allowance for accrued interest receivable, (3) our
allowance for preforeclosure property taxes and insurance
receivables, and (4) our reserve for guaranty losses
(collectively, our “total loss reserves”), plus the
portion of fair value losses on loans purchased out of
unconsolidated MBS trusts reflected in our condensed
consolidated balance sheets that we estimate represents
accelerated credit losses we expect to realize. For more
information on our reserves for credit losses, see “Table
12: Total Loss Reserves.”
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The fair value losses that we consider part of our reserves are
not included in our “total loss reserves.” We recorded
the majority of these fair value losses prior to our adoption in
2010 of accounting standards on the transfers of financial
assets and the consolidation of variable interest entities.
Before we adopted these standards, upon our acquisition of
credit-impaired loans out of unconsolidated MBS trusts, we
recorded fair value loss charge-offs against our reserve for
guaranty losses. The amount of these charge-offs was the amount
by which the acquisition cost of these loans exceeded their
estimated fair value. We expect to realize a portion of these
fair value losses as credit losses in the future (for loans that
eventually involve charge-offs or foreclosure), yet these fair
value losses have already reduced the mortgage loan balances
reflected in our condensed consolidated balance sheets and have
effectively been recognized in our condensed consolidated
statements of operations and comprehensive loss through our
provision for guaranty losses. We consider these fair value
losses as an “effective reserve,” apart from our total
loss reserves, to the extent that we expect to realize credit
losses on the acquired loans in the future.
Reducing
Credit Losses on Our Legacy Book of Business
To reduce the credit losses we ultimately incur on our legacy
book of business, we have been focusing our efforts on the
following strategies:
As we work to reduce credit losses, we also seek to assist
distressed borrowers, help stabilize communities, and support
the housing market. In dealing with distressed borrowers, we
first seek home retention solutions before turning to
foreclosure alternatives. When there is no viable home retention
solution or foreclosure alternative that can be applied, we seek
to move to foreclosure expeditiously. Prolonged delinquencies
can hurt local home values and destabilize communities, as these
homes often go into disrepair. As a general rule, the longer
borrowers remain delinquent, the greater our costs.
Reducing Defaults. Home retention solutions
are a key element of our strategy to reduce defaults, and the
majority of our home retention solutions are loan modifications.
Successful modifications allow borrowers who were having
problems making their pre-modification mortgage payments to
remain in their homes. While loan modifications contribute to
higher credit-related expenses in the near term, we believe that
successful modifications (those that enable borrowers to remain
current on their loans) will ultimately reduce our credit losses
over the long term from what they otherwise would have been if
we had taken the loans to foreclosure. We completed
approximately 161,000 loan modifications in the first nine
months of 2011, bringing the total number of loan modifications
we have completed since January 2009 to over 660,000. The
substantial majority of these modifications involved deferring
or lowering borrowers’ monthly mortgage payments, which we
believe increases the likelihood borrowers will be able to
remain current on their modified loans. Whether our
modifications are ultimately successful depends heavily on
economic factors, such as unemployment rates, household wealth
and income, and home prices. See “Table 40: Statistics on
Single-Family Loan Workouts” and the accompanying
discussion for additional information on our home retention
efforts, including our modifications, as well as our foreclosure
alternatives. For a description of the impact of modifications
on our credit-related expenses, see “Consolidated Results
of Operations—Credit-Related Expenses—Provision for
Credit Losses.”
Pursuing Foreclosure Alternatives. If we are
unable to provide a viable home retention solution for a
distressed borrower, we seek to offer a foreclosure alternative
and complete it in a timely manner. Our
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foreclosure alternatives are primarily preforeclosure sales,
which are sometimes referred to as “short sales,” as
well as
deeds-in-lieu
of foreclosure. These alternatives are intended to reduce the
severity of our loss resulting from a borrower’s default
while enabling the borrower to avoid going through a
foreclosure. We provide information about the volume of
foreclosure alternatives we completed in the first nine months
of 2011 in “Table 5: Credit Statistics, Single-Family
Guaranty Book of Business.”
Managing Timelines for Workouts and
Foreclosures. We refer to home retention
solutions and foreclosure alternatives as “workouts.”
We believe that home retention solutions are most effective in
preventing defaults when completed at an early stage of
delinquency. Similarly, our foreclosure alternatives are more
likely to be successful in reducing our loss severity if they
are executed expeditiously. Accordingly, it is important to us
for our servicers to work with delinquent borrowers early in the
delinquency to determine whether home retention solutions or
foreclosure alternatives will be viable and, where no workout
solution is viable, to reduce delays in proceeding to
foreclosure.
Circumstances in the foreclosure environment have resulted in
foreclosures proceeding at a slow pace. As a result of the
housing market downturn that began in 2006 and significantly
worsened in 2008, the volume of foreclosures to be processed by
servicers and states significantly increased in 2009 and the
first nine months of 2010. In October 2010, a number of
single-family mortgage servicers temporarily halted some or all
of the foreclosures they were processing after discovering
deficiencies in their foreclosure processes and the processes of
their service providers. In response to the foreclosure process
deficiencies, some states changed their foreclosure processes to
require additional review and verification of the accuracy of
pending and future foreclosure filings. Some states also added
requirements to the foreclosure process, including mediation
processes and requirements to file new affidavits. Further, some
state courts have issued rulings calling into question the
validity of some existing foreclosure practices. These actions
halted or significantly delayed not only existing, but new
foreclosures. As an example, in December 2010, the New Jersey
Supreme Court halted all uncontested residential foreclosure
proceedings by six large loan servicers for a period of
approximately nine months until those servicers demonstrated
that their foreclosure processes were compliant with law. New
Jersey also imposed a new requirement that counsel certify the
accuracy of all pending and future foreclosure complaints. In
addition, in August 2011 a New Jersey appellate decision held
that defects in notices of intent to foreclose required
dismissal and restart of the pending foreclosure process rather
than simply correcting the defective notices. We had more than
22,000 loans in foreclosure in New Jersey as of the beginning of
the third quarter of 2011, but foreclosures during the quarter
led to our acquiring only 151 REO properties.
While servicers have generally ended their outright foreclosure
halts, they continue to process foreclosures at a slow pace as
they update their procedures to remediate their process
deficiencies and meet new legislative, regulatory and judicial
requirements. In addition, servicers and states are dealing with
the backlog of foreclosures resulting from these delays and from
the elevated level of foreclosures resulting from the housing
market downturn. For foreclosures completed in the third quarter
of 2011, measuring from the last monthly period for which the
borrowers fully paid their mortgages to when we added the
related properties to our REO inventory, the average number of
days it took in each state to ultimately foreclose ranged from
374 days in Missouri to 906 days in Florida. Florida
accounted for 29% of our loans that were in the foreclosure
process as of September 30, 2011.
These extended time periods to complete foreclosures increase
our costs of holding these loans. In addition, to the extent
home prices decline while foreclosure proceedings are drawn out,
the proceeds we ultimately receive from the sale of the
foreclosed properties will be lower. Slower foreclosures also
result in loans remaining seriously delinquent in our book of
business for a longer time, which has caused our serious
delinquency rate to decrease more slowly in the last year than
it would have if the pace of foreclosures had been faster. We
believe the changes in the foreclosure environment discussed
above will continue to negatively affect our single-family
serious delinquency rates, foreclosure timelines and
credit-related expenses. Moreover, we believe these conditions
will delay the recovery of the housing market because it will
take longer to clear the market’s supply of distressed
homes. Distressed homes typically sell at a discount compared to
non-distressed homes and, therefore, a lingering population of
distressed homes will continue to negatively affect overall home
prices. See “Risk Factors” for further information
about the potential impact of the foreclosure
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process deficiencies and resulting changes in the foreclosure
environment on our business, results of operations, financial
condition and net worth.
Improving Servicing Standards and
Execution. The performance of our mortgage
servicers is critical to our success in reducing defaults,
completing foreclosure alternatives and managing workout and
foreclosure timelines efficiently, because servicers are the
primary point of contact with borrowers. Improving servicing
standards is therefore a key aspect of our strategy to reduce
our credit losses. We have taken a number of steps to improve
the servicing of our delinquent loans.
While we believe these steps will improve the servicing on our
loans, ultimately we are dependent on servicers’
willingness, efficiency and ability to implement our home
retention solutions and foreclosure alternatives, and to manage
timelines for workouts and foreclosures.
Managing Our REO Inventory. Efficient
management of our REO inventory of homes acquired through
deed-in-lieu
of foreclosure or foreclosure is another critical element of our
strategy for reducing credit losses. Since January 2009, we have
strengthened our REO sales capabilities by increasing resources
in this area, as we continue to manage our REO inventory to
reduce costs and maximize sales proceeds. As Table 5 shows, in
the first nine months of 2011 we have already disposed of as
many properties as we did in all of 2010, and our dispositions
in 2010 represented a 51% increase over our dispositions in 2009.
Neighborhood stabilization is a core principle in our approach
to managing our REO inventory. In the first nine months of 2011,
we completed repairs to approximately 69,300 properties sold
from our single-family REO inventory, at an average cost of
$6,122 per property. Repairing REO properties increases sales to
owner occupants and increases financing options for REO buyers.
In addition, our “First Look” marketing period
contributes to neighborhood stabilization by encouraging
homeownership. During this “First Look” period, owner
occupants, some nonprofit organizations and public entities may
submit offers and purchase properties without competition from
investors. During the first nine months of 2011, approximately
113,900 of the single-family properties we sold were purchased
by owner-occupants, nonprofit organizations or public entities.
We currently lease properties to tenants who occupied the
properties before we acquired them into our REO inventory, which
can minimize disruption by providing additional time to find
alternate housing, help stabilize local communities, provide us
with rental income, and support our compliance with federal and
state laws protecting tenants in foreclosed properties. As of
September 30, 2011, approximately 10,000 tenants leased our
REO properties.
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The changing foreclosure environment discussed above has delayed
our acquisitions of REO properties. Given the large number of
seriously delinquent loans in our single-family guaranty book of
business and the large existing and anticipated supply of
single-family homes in the market, we expect it will take years
before our REO inventory approaches pre-2008 levels.
Pursuing Contractual Remedies. We conduct
targeted reviews of our loans and, when we discover loans that
do not meet our underwriting or eligibility requirements, we may
make demands for lenders to repurchase these loans or compensate
us for losses sustained on the loans. We also make demands for
lenders to repurchase or compensate us for loans for which the
mortgage insurer rescinds coverage. The volume of our repurchase
requests rose in 2010 as compared with 2009 and has remained
high through the first nine months of 2011. During the first
nine months of 2011, lenders repurchased from us or reimbursed
us for losses on approximately $8.8 billion in loans,
measured by unpaid principal balance, pursuant to their
contractual obligations. In addition, as of September 30,
2011, we had outstanding requests for lenders to repurchase from
us or reimburse us for losses on $9.5 billion in loans, of
which 25.4% had been outstanding for more than 120 days.
These dollar amounts represent the unpaid principal balance of
the loans underlying the repurchase requests, not the actual
amounts we have received or requested from the lenders. When
lenders pay us for these requests, they pay us either to
repurchase the loans or else to make us whole for our losses in
cases where we have acquired and disposed of the property
underlying the loans. Make-whole payments are typically for less
than the unpaid principal balance because we have already
recovered some of the balance through the sale of the REO. As a
result, our actual cash receipts relating to these outstanding
repurchase requests are significantly lower than the unpaid
principal balance of the loans.
We are also pursuing contractual remedies from providers of
credit enhancement on our loans, including mortgage insurers. We
received proceeds under our mortgage insurance policies for
single-family loans of $4.6 billion for the first nine
months of 2011. See “Risk Management—Credit Risk
Management—Institutional Counterparty Credit Risk
Management” for a discussion of our repurchase and
reimbursement requests and outstanding receivables from mortgage
insurers, as well as the risk that one or more of these
counterparties fails to fulfill its obligations to us.
We believe the actions we have taken to stabilize the housing
market and minimize our credit losses will reduce our future
credit losses below what they otherwise would have been.
However, continuing change in broader market conditions makes it
difficult to predict how effective these actions ultimately will
be in reducing our credit losses. Moreover, it will be difficult
to measure the ultimate impact of our actions, given that
current conditions in the housing market are unprecedented.
For more information on the strategies and actions we are taking
to minimize our credit losses, see “Risk
Management—Credit Risk Management—Single-Family
Mortgage Credit Risk Management” in our 2010
Form 10-K
and in this report.
Table 5 presents information for each of the last seven quarters
about the credit performance of mortgage loans in our
single-family guaranty book of business and our workouts. The
workout information in Table 5 does not reflect repayment plans
and forbearances that have been initiated but not completed, nor
does it reflect trial modifications that have not become
permanent.
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Table
5: Credit Statistics, Single-Family Guaranty Book of
Business(1)
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Our single-family serious delinquency rate has decreased each
quarter since the first quarter of 2010. This decrease is
primarily the result of home retention solutions, as well as
foreclosure alternatives and completed foreclosures. The
decrease is also attributable to our acquisition of loans with
stronger credit profiles since the beginning of 2009, as these
loans have become an increasingly larger portion of our
single-family guaranty book of business, resulting in a smaller
percentage of our loans becoming seriously delinquent.
Although our single-family serious delinquency rate has
decreased significantly since the first quarter of 2010, our
serious delinquency rate and the period of time that loans
remain seriously delinquent has been negatively affected in
recent periods by the increase in the average number of days it
is taking to complete a foreclosure. As described in
“Reducing Credit Losses on Our Legacy Book of
Business—Managing Timelines for Workouts and
Foreclosures,” high levels of foreclosures, continuing
issues in the servicer foreclosure process, changes in state
foreclosure laws, and new court rules and proceedings have
lengthened the time it takes to foreclose on a mortgage loan in
many states. We expect serious delinquency rates will continue
to be affected in the future by home price changes, changes in
other macroeconomic conditions, the length of the foreclosure
process, the volume of loan modifications, and the extent to
which borrowers with modified loans continue to make timely
payments.
We provide additional information on our credit-related expenses
in “Consolidated Results of Operations—Credit-Related
Expenses” and on the credit performance of mortgage loans
in our single-family book of business and our loan workouts in
“Risk Management—Credit Risk
Management—Single-Family Mortgage Credit Risk
Management.”
During the third quarter of 2011, economic activity picked up
from the pace of the second quarter. The inflation-adjusted
U.S. gross domestic product, or GDP, rose by 2.5% on an
annualized basis during the quarter, according to the Bureau of
Economic Analysis advance estimate. The overall economy gained
an estimated 389,000 jobs in the third quarter as a result of
employment growth in the private sector. According to the
U.S. Bureau of Labor Statistics, as of October 2011, over
the past 12 months through September there has been an
increase of 1.6 million non-farm jobs. The unemployment
rate was 9.1% in September 2011, compared with 9.2% in June
2011, based on data from the U.S. Bureau of Labor
Statistics. Employment will likely need to post sustained
improvement for an extended period to have a positive impact on
housing. We estimate the likelihood of a recession by the end of
next year at close to 50%.
Existing home sales remained weak during the third quarter of
2011, averaging slightly below second quarter levels. Sales of
foreclosed homes and short sales (“distressed sales”)
continued to represent an outsized portion of the market.
Distressed sales accounted for 30% of existing home sales in
September 2011, down from 35% in September 2010, according to
the National Association of
REALTORS®.
New home sales during the third quarter of 2011 were also below
second quarter levels, remaining at historically low levels.
The overall mortgage market serious delinquency rate has trended
down since peaking in the fourth quarter of 2009 but has
remained historically high at 7.9% as of June 30, 2011,
according to the Mortgage Bankers Association National
Delinquency Survey. While the supply of new single-family homes
as measured by the inventory/sales ratio declined to its
long-term average level in September, the inventory/sales ratio
for existing single-family homes remained above average.
Properties that are vacant and held off the market, combined
with the portion of properties backing seriously delinquent
mortgages not currently listed for sale, represent a significant
shadow inventory putting downward pressure on home prices.
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We estimate that home prices on a national basis decreased by
0.2% in the third quarter of 2011 and have declined by 21.0%
from their peak in the third quarter of 2006. We recently
enhanced our method for estimating home price changes to exclude
a greater portion of foreclosed home sales, as we discuss below
in “Outlook.” If these enhancements had been in place
last quarter, instead of reporting a 21.6% decline in home
prices through the second quarter of 2011 from their peak, we
would have reported a 20.9% decline. Our home price estimates
are based on preliminary data and are subject to change as
additional data become available. The decline in home prices has
left many homeowners with “negative equity” in their
mortgages, which means their principal mortgage balance exceeds
the current market value of their home. According to CoreLogic,
approximately 11 million, or 23%, of all residential
properties with mortgages were in a negative equity position in
the second quarter of 2011. This increases the risk that
borrowers might walk away from their mortgage obligations,
causing the loans to become delinquent and proceed to
foreclosure.
During the third quarter of 2011, national multifamily market
fundamentals, which include factors such as effective rents and
vacancy rates, continued to improve, benefiting from rental
demand. Based on preliminary third-party data, we estimate that
the national multifamily vacancy rate fell to 6.50% in the third
quarter of 2011, after having fallen to 6.75% in the second
quarter of 2011. In addition, we estimate that average asking
rents increased for the sixth quarter in a row, climbing by 1.0%
in the third quarter of 2011 on a national basis. As indicated
by data from Axiometrics, Inc., multifamily concession rates,
the rental discount rate as a percentage of asking rents,
declined to about -3.0% as of September 2011. The increase in
overall rental demand was also reflected in an estimated
increase of 36,000 units in the net number of occupied
rental units during the third quarter of 2011, according to
preliminary data from Reis, Inc. Although national multifamily
market fundamentals continued to improve, certain local markets
and properties continued to underperform compared to the rest of
the country due to localized underlying economic conditions.
Overall Market Conditions. We expect weakness
in the housing and mortgage markets to continue in the fourth
quarter of 2011. The high level of delinquent mortgage loans
will ultimately result in high levels of foreclosures, which is
likely to add to the excess housing inventory. Home sales are
unlikely to rise before the unemployment rate improves further.
We expect that single-family default and severity rates, as well
as the level of single-family foreclosures, will remain high in
2011. Despite signs of multifamily sector improvement at the
national level, we expect multifamily charge-offs in 2011 to
remain generally commensurate with 2010 levels as certain local
markets and properties continue to exhibit weak fundamentals.
Conditions may worsen if the unemployment rate increases on
either a national or regional basis.
Although we expect the recently announced changes to HARP will
result in our acquiring more refinancings in 2012 than we would
have acquired in the absence of the changes, we expect fewer
refinancings overall in each of 2011 and 2012 than in 2010 as a
result of the high number of mortgages that have already
refinanced to low rates in recent years. As a result, we expect
the pace of our loan acquisitions for each of 2011 and for 2012
will be lower than in 2010. Our loan acquisitions also could be
negatively affected by the decrease in the fourth quarter of
2011 in the maximum size of loans we may acquire in specified
high-cost areas from $729,750 to $625,500. In addition, if the
Federal Housing Administration (“FHA”) continues to be
the lower-cost option for some consumers, and in some cases the
only option, for loans with higher LTV ratios, our market share
could be adversely impacted. As our acquisitions decline, our
future revenues will be negatively impacted.
We estimate that total originations in the
U.S. single-family mortgage market in 2011 will decrease
from 2010 levels by approximately 23%, from an estimated $1.7
trillion to an estimated $1.3 trillion, and that the amount of
originations in the U.S. single-family mortgage market that
are refinancings will decline from approximately $1.1 trillion
to approximately $905 billion. Refinancings comprised
approximately 74% of our single-family business volume in the
first nine months of 2011, compared with 78% for all of 2010.
Home Price Declines. While the rate of decline
in home prices has moderated in recent quarters, we continue to
expect that home prices on a national basis will decline further
before stabilizing in 2012. We
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currently expect a
peak-to-trough
home price decline on a national basis ranging from 22% to 28%,
and that it would take the occurrence of an additional adverse
economic event to reach the high end of the range. Future home
price changes may be very different from our estimates as a
result of significant inherent uncertainty in the current market
environment, including uncertainty about the effect of actions
the federal government has taken and may take with respect to
housing finance reform; the management of the Federal
Reserve’s MBS holdings; and the impact of those actions on
home prices, unemployment and the general economic and interest
rate environment. Because of these uncertainties, the actual
home price decline we experience may differ significantly from
these estimates. We also expect significant regional variation
in home price declines and stabilization.
Our estimates of home price declines are based on our home price
index, which is calculated differently from the
S&P/Case-Shiller U.S. National Home Price Index and
therefore results in different percentages for comparable
declines. Our 22% to 28%
peak-to-trough
home price decline estimate corresponds to an approximate 32% to
40%
peak-to-trough
decline using the S&P/Case-Shiller index method. Our
estimates differ from the S&P/Case-Shiller index in two
principal ways: (1) our estimates weight expectations by
number of properties, whereas the S&P/Case-Shiller index
weights expectations based on property value, causing home price
declines on higher priced homes to have a greater effect on the
overall result; and (2) the S&P/Case-Shiller index
includes sales of foreclosed homes while our estimates attempt
to exclude foreclosed home sales, because we believe that
differing maintenance practices and the forced nature of the
sales make foreclosed home prices less representative of market
values. We believe, however, that the impact of sales of
foreclosed homes is indirectly reflected in our estimates as a
result of their impact on the pricing of non-distressed sales.
We recently enhanced our home price estimates to identify and
exclude a greater portion of foreclosed home sales. As a result,
some period to period comparisons of home prices differ from
those indicated by our prior estimates. We calculate the
S&P/Case-Shiller comparison numbers by modifying our
internal home price estimates to account for weighting based on
property value and the impact of foreclosed property sales. In
addition to these differences, our estimates are based on our
own internally available data combined with publicly available
data, and are therefore based on data collected nationwide,
whereas the S&P/Case-Shiller index is based on publicly
available data, which may be limited in certain geographic areas
of the country. Our comparative calculations to the
S&P/Case-Shiller index provided above are not modified to
account for this data pool difference.
Credit-Related Expenses and Credit Losses. Our
credit-related expenses, which include our provision for credit
losses, reflect our recognition of losses on our loans. Through
our provision for credit losses, we recognize credit-related
expenses on loans in the period in which we determine that we
have incurred a probable loss on the loans as of the end of the
period, or in which we have granted concessions to the
borrowers. Accordingly, our credit-related expenses are affected
by changes in home prices, borrower payment behavior, the types
and volumes of loss mitigation activities we complete, and
estimated recoveries from our lender and mortgage insurer
counterparties. Our credit losses, which include our
charge-offs, net of recoveries, reflect our realization of
losses on our loans. We realize losses on loans, through our
charge-offs, when foreclosure sales are completed or when we
accept short sales or deeds in lieu of foreclosure. We expect
our credit losses in 2011 to be lower than in 2010, as delays in
foreclosures keep us from realizing credit losses until later
periods. We describe our credit loss outlook above under
“Our Strong New Book of Business and Expected Losses on our
Legacy Book of Business—Expected Losses on Our Legacy Book
of Business.”
Uncertainty Regarding our Long-Term Financial Sustainability
and Future Status. There is significant
uncertainty in the current market environment, and any changes
in the trends in macroeconomic factors that we currently
anticipate, such as home prices and unemployment, may cause our
future credit-related expenses and credit losses to vary
significantly from our current expectations. Although
Treasury’s funds under the senior preferred stock purchase
agreement permit us to remain solvent and avoid receivership,
the resulting dividend payments are substantial. We do not
expect to earn profits in excess of our annual dividend
obligation to Treasury for the indefinite future. We expect to
request additional draws under the senior preferred stock
purchase agreement in future periods, which will further
increase the dividends we owe to Treasury on the senior
preferred stock. We expect that, over time, our dividend
obligation to Treasury will
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constitute an increasing portion of our future draws under the
senior preferred stock purchase agreement. As a result of these
factors, there is significant uncertainty about our long-term
financial sustainability.
In addition, there is significant uncertainty regarding the
future of our company, including how long we will continue to be
in existence, the extent of our role in the market, what form we
will have, and what ownership interest, if any, our current
common and preferred stockholders will hold in us after the
conservatorship is terminated. We expect this uncertainty to
continue. On February 11, 2011 Treasury and the Department
of Housing and Urban Development (“HUD”) released a
report to Congress on reforming America’s housing finance
market. The report states that the Administration will work with
FHFA to determine the best way to responsibly wind down both
Fannie Mae and Freddie Mac. The report emphasizes the importance
of providing the necessary financial support to Fannie Mae and
Freddie Mac during the transition period. We cannot predict the
prospects for the enactment, timing or content of legislative
proposals regarding long-term reform of the GSEs. See
“Legislative and Regulatory Developments” in this
report and “Legislation and GSE Reform” in our 2010
Form 10-K
for discussions of recent legislative reform of the financial
services industry and proposals for GSE reform that could affect
our business. See “Risk Factors” in this report for a
discussion of the risks to our business relating to the
uncertain future of our company.
As required by the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the “Dodd-Frank Act”), on
February 11, 2011, Treasury and HUD released their report
to Congress on ending the conservatorships of Fannie Mae and
Freddie Mac and reforming the housing finance market. The report
provides that the Administration will work with FHFA to
determine the best way to responsibly reduce Fannie Mae’s
and Freddie Mac’s role in the market and ultimately wind
down both institutions.
The report identifies a number of policy steps that could be
used to wind down Fannie Mae and Freddie Mac, reduce the
government’s role in housing finance and help bring private
capital back to the mortgage market. These steps include
(1) increasing guaranty fees, (2) gradually increasing
the level of required down payments so that any mortgages
insured by Fannie Mae or Freddie Mac eventually have at least a
10% down payment, (3) reducing conforming loan limits to
those established in the Federal Housing Finance Regulatory
Reform Act of 2008 (the “2008 Reform Act”),
(4) encouraging Fannie Mae and Freddie Mac to pursue
additional credit loss protection and (5) reducing Fannie
Mae’s and Freddie Mac’s portfolios, consistent with
Treasury’s senior preferred stock purchase agreements with
the companies.
In addition, the report outlines three potential options for a
new long-term structure for the housing finance system following
the wind-down of Fannie Mae and Freddie Mac. The first option
would privatize housing finance almost entirely. The second
option would add a government guaranty mechanism that could
scale up during times of crisis. The third option would involve
the government offering catastrophic reinsurance behind private
mortgage guarantors. Each of these options assumes the continued
presence of programs operated by FHA, the Department of
Agriculture and the Veterans Administration to assist targeted
groups of borrowers. The report does not state whether or how
the existing infrastructure or human capital of Fannie Mae may
be used in the establishment of such a reformed system. The
report emphasizes the importance of proceeding with a careful
transition plan and providing the necessary financial support to
Fannie Mae and Freddie Mac during the transition period. A copy
of the report can be found on the Housing Finance Reform section
of Treasury’s Web site, www.Treasury.gov. We are providing
Treasury’s Web site address solely for your information,
and information appearing on Treasury’s Web site is not
incorporated into this quarterly report on
Form 10-Q.
We expect that Congress will continue to hold hearings and
consider legislation in the remainder of 2011 and in 2012 on the
future status of Fannie Mae and Freddie Mac. Several bills have
been introduced that would place the GSEs into receivership
after a period of time and either grant federal charters to new
entities to engage in activities similar to those currently
engaged in by the GSEs or leave secondary mortgage market
activities to entities in the private sector. For example,
legislation has been introduced in both the House of
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Representatives and the Senate that would require FHFA to make a
determination within two years of enactment whether the GSEs
were financially viable and, if the GSEs were determined not to
be financially viable, to place them into receivership. As
drafted, these bills may upon enactment impair our ability to
issue securities in the capital markets and therefore our
ability to conduct our business, absent the federal government
providing an explicit guarantee of our existing and ongoing
liabilities.
In addition to bills that seek to resolve the status of the
GSEs, numerous bills have been introduced and considered in the
House of Representatives that could constrain the current
operations of the GSEs or alter the existing authority that FHFA
or Treasury have over the enterprises. The Subcommittee on
Capital Markets and Government Sponsored Enterprises of the
Financial Services Committee has approved bills that would:
We expect additional legislation relating to the GSEs to be
introduced and considered by Congress in the remainder of 2011
and in 2012. We cannot predict the prospects for the enactment,
timing or content of legislative proposals regarding the future
status of the GSEs.
In sum, there continues to be uncertainty regarding the future
of our company, including how long we will continue to be in
existence, the extent of our role in the market, what form we
will have, and what ownership interest, if any, our current
common and preferred stockholders will hold in us after the
conservatorship is terminated. See “Risk Factors” for
a discussion of the risks to our business relating to the
uncertain future of our company. Also see “Risk
Factors” in our 2010
Form 10-K
for a discussion of how the uncertain future of our company may
adversely affect our ability to retain and recruit
well-qualified employees, including senior management.
Changes
to the Home Affordable Refinance Program
On October 24, 2011, FHFA, Fannie Mae, and Freddie Mac
announced changes to HARP aimed at making refinancing under the
program easier and potentially less expensive for qualifying
homeowners and
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encouraging lenders to participate in the program. While HARP
previously limited eligibility to borrowers with mortgage loans
that had LTV ratios no greater than 125%, the new HARP
guidelines remove that ceiling when a borrower refinances into a
new fixed-rate mortgage. Other changes to HARP include:
We are working with FHFA to finalize the fees that we will
charge for loans refinanced under HARP’s new terms. We
expect these fees to be announced in the fourth quarter of 2011.
At this time, we do not know how many eligible borrowers are
likely to refinance under the program and, therefore, how many
HARP loans we will acquire.
We may incur additional credit-related expenses as a result of
these changes to HARP. However, we believe the expanded
refinance opportunities for borrowers under HARP may help
prevent future delinquencies and defaults, because loans
refinanced under the program reduce the borrowers’ monthly
payments or otherwise should provide more sustainability than
the borrowers’ old loans (for example, by having a fixed
rate instead of an adjustable rate). The extent to which these
factors will impact our results of operations will depend on a
number of factors, including the terms, credit profile and
volume of our acquisitions under the revised program. See
“Risk Factors” for a discussion of how efforts we may
undertake in support of the housing market may affect us.
Discontinuation
of Our Retained Attorney Network
On October 18, 2011, FHFA directed us to phase out the
practice of requiring mortgage servicers to use our network of
retained attorneys to perform default- and foreclosure-related
legal services for our loans. FHFA also directed us to work with
Freddie Mac, through FHFA’s Servicing Alignment Initiative,
to develop and implement consistent requirements, policies and
processes for default- and foreclosure-related legal services.
As set forth in FHFA’s directive, we will conduct these
activities over a transitional period and will seek to minimize
disruption to pending matters. During the transitional period,
servicers will continue to be directly responsible for managing
the foreclosure process and monitoring network firm performance,
in accordance with our current requirements and contractual
arrangements. Phasing out the use of our retained attorney
network may make it more difficult for us to oversee the
performance of default- and foreclosure-related legal services
for our loans, which may adversely impact our efforts to reduce
our credit losses.
Proposed
Changes to Our Single-Family Guaranty Fee Pricing
Consistent with the recommendation in the Administration’s
report on ending the conservatorships of Fannie Mae and Freddie
Mac, we expect that single-family guaranty fees will increase in
the coming years, although we do not know the timing, form or
extent of these increases. There have been recent public
discussions of potential fee increases by the Administration,
members of Congress, and FHFA. On September 23, 2011, the
Administration submitted a legislative proposal to the Joint
Select Committee on Deficit Reduction which would, among other
matters, mandate FHFA to require Fannie Mae and Freddie Mac to
impose an additional fee, the Conservatorship Recoupment
Guarantee Fee, on all single-family mortgages guaranteed on or
after January 1, 2013. The proposal requires that the new
fee be not less than 10 basis points. The proposal also
provides discretion for FHFA to mandate the imposition of a
delivery fee in lieu of a guaranty fee increase. Certain members
of Congress have also recommended that the Joint Select
Committee on Deficit Reduction mandate that FHFA require the
GSEs to increase their guaranty fees. In addition, FHFA’s
Acting Director expressed in a public speech in September 2011
that he expects guaranty fees to increase beginning in 2012.
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Servicing
Compensation Initiative
In September 2011, FHFA issued a discussion paper to propose and
seek comments on two new possible mortgage servicing
compensation structures in connection with its joint initiative
on servicing compensation announced earlier this year. The joint
initiative, which FHFA directed Fannie Mae and Freddie Mac to
work on in coordination with FHFA and HUD, was established to
consider alternatives for future mortgage servicing structures
and servicing compensation for single-family mortgage loans. One
possible structure presented in the discussion paper, which FHFA
described as representing a modest change to the current model,
provides for a reduced minimum servicing fee accompanied by a
reserve account. The reserve account would be available to
offset unexpectedly high servicing costs resulting from
extraordinary deteriorations in industry conditions. The second
possible structure, which FHFA characterized as a fundamental
change to the current model, introduces a fee for service
structure that provides for a base servicing fee for performing
loans and incentive compensation and compensatory fees for
servicing non-performing loans, with the possibility of avoiding
capitalization of mortgage servicing rights. We provide
additional information on FHFA’s initiative on servicing
compensation in “Business—Business
Segments—Single-Family Business—Single-Family Mortgage
Servicing” in our 2010
Form 10-K.
For additional information on legislative and regulatory matters
affecting us, refer to “Business—Legislation and GSE
Reform” and “Business—Our Charter and Regulation
of Our Activities” in our 2010
Form 10-K,
“MD&A—Legislative and Regulatory
Developments—Proposed Rules Implementing the
Dodd-Frank Act” in our quarterly report for the quarter
ended March 31, 2011 (“First Quarter 2011
Form 10-Q”),
and “MD&A—Legislative and Regulatory
Developments” in our quarterly report for the quarter ended
June 30, 2011 (“Second Quarter 2011
Form 10-Q”).
The preparation of financial statements in accordance with GAAP
requires management to make a number of judgments, estimates and
assumptions that affect the reported amount of assets,
liabilities, income and expenses in the condensed consolidated
financial statements. Understanding our accounting policies and
the extent to which we use management judgment and estimates in
applying these policies is integral to understanding our
financial statements. We describe our most significant
accounting policies in “Note 1, Summary of Significant
Accounting Policies” of this report and in our 2010
Form 10-K.
We evaluate our critical accounting estimates and judgments
required by our policies on an ongoing basis and update them as
necessary based on changing conditions. Management has discussed
any significant changes in judgments and assumptions in applying
our critical accounting policies with the Audit Committee of our
Board of Directors. We have identified three of our accounting
policies as critical because they involve significant judgments
and assumptions about highly complex and inherently uncertain
matters, and the use of reasonably different estimates and
assumptions could have a material impact on our reported results
of operations or financial condition. These critical accounting
policies and estimates are as follows:
See “MD&A—Critical Accounting Policies and
Estimates” in our 2010
Form 10-K
for a detailed discussion of these critical accounting policies
and estimates. We provide below information about our
Level 3 assets and liabilities as of September 30,
2011 as compared with December 31, 2010. We also describe
any significant changes in the judgments and assumptions we made
during the first nine months of 2011 in applying our critical
accounting policies and significant changes to critical
estimates.
The use of fair value to measure our assets and liabilities is
fundamental to our financial statements and is a critical
accounting estimate because we account for and record a portion
of our assets and liabilities at fair
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value. In determining fair value, we use various valuation
techniques. We describe the valuation techniques and inputs used
to determine the fair value of our assets and liabilities and
disclose their carrying value and fair value in
“Note 13, Fair Value.”
The assets and liabilities that we have classified as
Level 3 consist primarily of financial instruments for
which there is limited market activity and therefore little or
no price transparency. As a result, the valuation techniques
that we use to estimate the fair value of Level 3
instruments involve significant unobservable inputs, which
generally are more subjective and involve a high degree of
management judgment and assumptions. Our Level 3 assets and
liabilities consist of certain mortgage- and asset-backed
securities and residual interests, certain mortgage loans,
certain acquired property, certain long-term debt arrangements
and certain highly structured, complex derivative instruments.
Table 6 presents a comparison of the amount of financial assets
carried in our condensed consolidated balance sheets at fair
value on a recurring basis (“recurring assets”) that
were classified as Level 3 as of September 30, 2011
and December 31, 2010. The availability of observable
market inputs to measure fair value varies based on changes in
market conditions, such as liquidity. As a result, we expect the
amount of financial instruments carried at fair value on a
recurring basis and classified as Level 3 to vary each
period.
Assets measured at fair value on a nonrecurring basis and
classified as Level 3, which are not presented in the table
above, primarily include mortgage loans and acquired property.
The fair value of Level 3 nonrecurring assets totaled
$62.2 billion during the nine months ended
September 30, 2011 and $63.0 billion during the year
ended December 31, 2010.
Financial liabilities measured at fair value on a recurring
basis and classified as Level 3 consisted of long-term debt
with a fair value of $1.1 billion as of September 30,
2011 and $1.0 billion as of December 31, 2010, and
other liabilities with a fair value of $173 million as of
September 30, 2011 and $143 million as of
December 31, 2010.
Total
Loss Reserves
Our total loss reserves consist of the following components:
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These components can be further divided into single-family
portions, which collectively make up our single-family loss
reserves, and multifamily portions, which collectively make up
our multifamily loss reserves.
In the third quarter of 2011, we updated our allowance for loan
loss models for individually impaired loans to incorporate more
home price data at the regional level rather than at the
national level. We believe this approach is a better estimation
of possible home price paths and related default expectations;
it has resulted in a decrease to our allowance for loan losses
and a reduction of credit-related expenses of approximately
$800 million.
In the second quarter of 2011, we updated our loan loss models
to incorporate more recent data on prepayments of modified
loans, which resulted in an increase to our allowance for loan
losses and an increase to credit-related expenses of
approximately $1.5 billion. The change resulted in slower
expected prepayment speeds, which extended the expected lives of
modified loans and lowered the present value of cash flows on
those loans. Also in the second quarter of 2011, we updated our
estimate of the reserve for guaranty losses related to
private-label mortgage-related securities that we have
guaranteed to increase our focus on earlier stage delinquency,
rather than foreclosure trends, as the primary driver in
estimating incurred losses. We believe delinquencies are a
better indicator of incurred losses compared to foreclosure
trends because the recent delays in the foreclosure process have
interrupted the normal flow of delinquent mortgages into
foreclosure. This update resulted in an increase to our reserve
for guaranty losses included within “Other
liabilities” and an increase to credit related-expenses of
approximately $700 million.
In this section we discuss our condensed consolidated results of
operations for the periods indicated. You should read this
section together with our condensed consolidated financial
statements, including the accompanying notes.
Table 7 summarizes our condensed consolidated results of
operations for the periods indicated.
Table
7: Summary of Condensed Consolidated Results of
Operations
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Table 8 presents an analysis of our net interest income, average
balances, and related yields earned on assets and incurred on
liabilities for the periods indicated. For most components of
the average balances, we used a daily weighted average of
amortized cost. When daily average balance information was not
available, such as for mortgage loans, we used monthly averages.
Table 9 presents the change in our net interest income between
periods and the extent to which that variance is attributable
to: (1) changes in the volume of our interest-earning
assets and interest-bearing liabilities or (2) changes in
the interest rates of these assets and liabilities. In the
fourth quarter of 2010, we changed the presentation to
distinguish the change in net interest income of Fannie Mae from
the change in net interest income of consolidated trusts. We
have revised the presentation of results for prior periods to
conform to the current period presentation.
Table
8: Analysis of Net Interest Income and
Yield
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26
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Table
9: Rate/Volume Analysis of Changes in Net Interest
Income
Net interest income increased in the third quarter and first
nine months of 2011, as compared with the third quarter and
first nine months of 2010, due to lower interest expense on
debt, which was partially offset by lower interest income on
loans and securities. The primary drivers of these changes were:
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Additionally, our net interest income and net interest yield
were higher than they would have otherwise been in both the
third quarter and first nine months of 2011 and 2010 because our
debt funding needs were lower than would otherwise have been
required as a result of funds we received from Treasury under
the senior preferred stock purchase agreement. Further,
dividends paid to Treasury are not recognized in interest
expense.
Table 10 displays the interest income not recognized for loans
on nonaccrual status and the resulting reduction in our total
yield from mortgage loans.
Table
10: Impact of Nonaccrual Loans on Net Interest
Income
For a discussion of the interest income from the assets we have
purchased and the interest expense from the debt we have issued,
see the discussion of our Capital Markets group’s net
interest income in “Business Segment Results.”
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Fair
Value (Losses) Gains, Net
Table 11 presents the components of our fair value gains and
losses.
Table
11: Fair Value (Losses) Gains, Net
We supplement our issuance of debt securities with derivative
instruments to further reduce duration and prepayment risks. We
recorded risk management derivative fair value losses in the
third quarter and first nine months of 2011 primarily as a
result of a decrease in the fair value of our pay-fixed
derivatives due to a significant decline in swap interest rates
during the period.
We recorded risk management derivative gains in the third
quarter of 2010 primarily due to gains on our foreign currency
swaps, which were partially offset by time decay on our
purchased options. Gains on our foreign currency swaps generally
offset the fair value losses on our foreign currency denominated
debt.
We recorded risk management derivative losses in the first nine
months of 2010 primarily as a result of: (1) time decay on
our purchased options; (2) a decrease in the fair value of
our pay-fixed derivatives during the first quarter of 2010 due
to a decline in swap interest rates during that period; and
(3) a decrease in implied interest rate volatility, which
reduced the fair value of our purchased options.
We present, by derivative instrument type, the fair value gains
and losses on our derivatives for the three and nine months
ended September 30, 2011 and 2010 in “Note 9,
Derivative Instruments.”
Commitments to purchase or sell some mortgage-related securities
and to purchase single-family mortgage loans are generally
accounted for as derivatives. For open mortgage commitment
derivatives, we include changes in their fair value in our
condensed consolidated statements of operations and
comprehensive loss. When derivative purchase commitments settle,
we include the fair value of the commitment on the settlement
date in the cost basis of the loan or security we purchase. When
derivative commitments to sell securities settle, we include the
fair value of the commitment on the settlement date in the cost
basis of the security we sell. Purchases of securities issued by
our consolidated MBS trusts are treated as extinguishments of
debt; we
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recognize the fair value of the commitment on the settlement
date as a component of debt extinguishment gains and losses.
Sales of securities issued by our consolidated MBS trusts are
treated as issuances of consolidated debt; we recognize the fair
value of the commitment on the settlement date as a component of
debt in the cost basis of the debt issued.
We recognized losses on our mortgage commitments in the third
quarter and first nine months of both 2011 and 2010 primarily
due to losses on commitments to sell mortgage-related securities
as a result of a decline in interest rates during the commitment
period.
Losses from our trading securities in the third quarter of 2011
were primarily driven by the widening of credit spreads on
commercial mortgage-backed securities (“CMBS”).
However, these credit spreads narrowed over the first nine
months of 2011, which primarily drove gains on trading
securities for the nine-month period.
Gains from our trading securities in the third quarter and first
nine months of 2010 were primarily driven by a decrease in
interest rates and narrowing of credit spreads on CMBS.
We refer to our provision for loan losses and the provision for
guaranty losses collectively as our “provision for credit
losses.” Credit-related expenses consist of our provision
for credit losses and foreclosed property expense.
Our total loss reserves provide for an estimate of credit losses
incurred in our guaranty book of business as of each balance
sheet date. We establish our loss reserves through the provision
for credit losses for losses that we believe have been incurred
and will eventually be reflected over time in our charge-offs.
When we determine that a loan is uncollectible, typically upon
foreclosure, we record a charge-off against our loss reserves.
We record recoveries of previously charged-off amounts as a
reduction to charge-offs, which results in an increase to our
loss reserves.
Table 12 displays the components of our total loss reserves and
our total fair value losses previously recognized on loans
purchased out of unconsolidated MBS trusts reflected in our
condensed consolidated balance sheets. Because these fair value
losses lowered our recorded loan balances, we have fewer
inherent losses in our guaranty book of business and
consequently require lower total loss reserves. For these
reasons, we consider these fair value losses as an
“effective reserve,” apart from our total loss
reserves, to the extent that we expect to realize credit losses
on the acquired loans in the future. We estimate that
approximately two-thirds of this amount, as of
September 30, 2011, represents credit losses we expect to
realize in the future and approximately one-third will
eventually be recovered, either through net interest income for
loans that cure or through foreclosed property income for loans
where the sale of the collateral exceeds our recorded investment
in the loan. We exclude these fair value losses from our credit
loss calculation as described in “Credit Loss Performance
Metrics.”
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Table
12: Total Loss Reserves
We refer to our allowance for loan losses and reserve for
guaranty losses collectively as our combined loss reserves. We
summarize the changes in our combined loss reserves in Table 13.
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Table
13: Allowance for Loan Losses and Reserve for
Guaranty Losses (Combined Loss Reserves)
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33
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The continued stress on a broad segment of borrowers from
continued high levels of unemployment and underemployment and
the prolonged decline in home prices have caused our total loss
reserves to remain high for the past few years. Our provision
for credit losses continues to be a key driver of our net losses
for each period presented. The amount of provision for credit
losses varies from period to period based on changes in home
prices, borrower payment behavior, the types and volumes of loss
mitigation activities completed, and actual and estimated
recoveries from our lender and mortgage insurer counterparties.
Our provision for credit losses decreased in the third quarter
of 2011 compared with the third quarter of 2010 primarily due to
a lower provision on individually impaired loans. The lower
provision was driven, in part, by accelerated expected
prepayment speeds due to the lower interest rate environment,
which reduced the expected lives of loans and increased the
present value of cash flows expected on those loans. In
addition, our provision decreased in the third quarter of 2011
compared with the third quarter of 2010 because of an increase
in estimated amounts due to us or received by us for outstanding
repurchase requests. The decrease in the provision for credit
losses in the third quarter of 2011 was partially offset by:
(1) the implementation of a new accounting standard that
increased our troubled debt restructuring (“TDR”)
population, which increased the number of loans that are
individually impaired; and (2) a decrease in the estimated
recovery amount from mortgage insurance coverage. A TDR is a
loan restructuring that grants a concession to a borrower
experiencing financial difficulties. For a detailed discussion
of our mortgage insurer counterparties and the estimated
recovery of mortgage insurance, see “Risk
Management—Credit Risk Management—Institutional
Counterparty Risk Management—Mortgage Insurers.”
Our provision for credit losses slightly increased in the first
nine months of 2011 compared with the first nine months of 2010.
In addition to the reasons described above, our provision for
credit losses in the first nine
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months of 2011 was negatively impacted by higher loss severity
rates and an increase in the average number of days loans remain
delinquent.
In addition, during the third quarter and first nine months of
2011 and 2010 our provision for credit losses and loss reserves
have been impacted by updates to our allowance for loan loss
models that we use to estimate our loss reserves. For further
information on estimates and assumptions that are used to
calculate our loan loss reserves and the impacts of specific
changes in estimates during 2010 and the first nine months of
2011, see “MD&A—Critical Accounting Policies and
Estimates” in our 2010
Form 10-K
and “Critical Accounting Policies and Estimates” in
this report.
Because of the substantial volume of loan modifications we
completed and the number of loans that entered a trial
modification period in 2010 and the first nine months of 2011,
approximately two-thirds of our total loss reserves are
attributable to individual impairment rather than the collective
reserve for loan losses. Individual impairment for a TDR is
based on the restructured loan’s expected cash flows over
the life of the loan, taking into account the effect of any
concessions granted to the borrower, discounted at the
loan’s original effective interest rate. The individual
impairment model includes forward-looking assumptions using
multiple scenarios of the future economic environment, including
interest rates and home prices. Based on the structure of the
modifications, in particular the size of the concession granted,
and the performance of modified loans combined with the
forward-looking assumptions used in our model, the allowance
calculated for an individually impaired loan has generally been
greater than the allowance that would be calculated under the
collective reserve. Further, if we expect to recover our
recorded investment in an individually impaired loan through
probable foreclosure of the underlying collateral, we measure
the impairment based on the fair value of the collateral.
In April 2011, the Financial Accounting Standards Board
(“FASB”) issued a new accounting standard regarding
TDRs effective for the third quarter of 2011 that applies
retrospectively to January 1, 2011. In the third quarter of
2011, we recognized an incremental increase of $514 million
in our provision for credit losses due to loans that were
reassessed as TDRs upon adoption of the new TDR standard. For
additional information on the new TDR accounting standard, see
“Note 1, Summary of Significant Accounting
Policies.”
For additional discussion of our loan workout activities,
delinquent loans and concentrations, see “Risk
Management—Credit Risk Management—Single-Family
Mortgage Credit Risk Management—Problem Loan
Management.” For a discussion of our charge-offs, see
“Credit Loss Performance Metrics.”
Our balance of nonperforming single-family loans remained high
as of September 30, 2011 due to both high levels of
delinquencies and an increase in TDRs. When a TDR occurs, the
loan may return to a current status, but it will continue to be
classified as a nonperforming loan as the loan is not performing
in accordance with the original terms. The composition of our
nonperforming loans is shown in Table 14, which is based on the
carrying value of both our single-family and multifamily
held-for-investment
and
held-for-sale
mortgage loans. For individually impaired loans, the amount
displayed is net of any impairment amount. For information on
the impact of TDRs and other individually impaired loans on our
allowance for loan losses, see “Note 3, Mortgage
Loans.”
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Foreclosed property expense is displayed in Table 15. The
decrease in foreclosed property expense in the third quarter and
first nine months of 2011 compared with the third quarter and
first nine months of 2010 was due, in part, to an increase in
estimated amounts due to or received by us for outstanding
repurchase requests. These amounts were recognized in our
provision for credit losses and foreclosed property expense. In
addition, we recorded lower valuation adjustments on our
acquired property inventory in the third quarter and first nine
months of 2011 because: (1) the rate of decline in home
prices has moderated in recent quarters; and (2) the
decrease in our REO inventory compared with the third quarter
and first nine months of 2010 resulted in fewer properties
subject to valuation adjustments. The decrease in foreclosed
property expense was partially offset by a decrease in the
estimated recovery amount from mortgage insurance coverage.
Foreclosed property expense in the first nine months of 2010
reflected the recognition of cash fees of $796 million from
the cancellation and restructuring of some of our pool mortgage
insurance coverage. The cancelled and restructured policies
covered approximately $42 billion in unpaid principal
balance. The fees represented an acceleration of, and discount
on, claims expected to be received pursuant to the coverage net
of premiums expected to be paid. These cancellations and
restructurings resulted in operational savings from
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reduced claims processing and mitigated our counterparty credit
risk given the weakened financial condition of our mortgage
insurer counterparties.
Our credit-related expenses should be considered in conjunction
with our credit loss performance. Our credit loss performance
metrics, however, are not defined terms within GAAP and may not
be calculated in the same manner as similarly titled measures
reported by other companies. Because management does not view
changes in the fair value of our mortgage loans as credit
losses, we adjust our credit loss performance metrics for the
impact associated with the acquisition of credit-impaired loans.
We also exclude interest forgone on nonperforming loans in our
mortgage portfolio,
other-than-temporary
impairment losses resulting from deterioration in the credit
quality of our mortgage-related securities and accretion of
interest income on acquired credit-impaired loans from credit
losses.
Historically, management viewed our credit loss performance
metrics, which include our historical credit losses and our
credit loss ratio, as indicators of the effectiveness of our
credit risk management strategies. As our credit losses are now
at such high levels, management has shifted focus to our loss
mitigation strategies and the reduction of our total credit
losses and away from the credit loss ratio to measure
performance. However, we believe that credit loss performance
metrics may be useful to investors as the losses are presented
as a percentage of our book of business and have historically
been used by analysts, investors and other companies within the
financial services industry. They also provide a consistent
treatment of credit losses for on- and off-balance sheet loans.
Moreover, by presenting credit losses with and without the
effect of fair value losses associated with the acquisition of
credit-impaired loans, investors are able to evaluate our credit
performance on a more consistent basis among periods. Table 15
details the components of our credit loss performance metrics as
well as our average single-family and multifamily default rate
and initial charge-off severity rate.
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The decrease in our credit losses in the third quarter and first
nine months of 2011 compared with the third quarter and first
nine months of 2010 was driven by a decrease in net charge-offs
primarily due to a decrease in the number of defaults and an
increase in estimated amounts due to or received by us related
to outstanding repurchase requests. While charge-offs remain
high, charge-offs in the third quarter and first nine months of
2011 were lower than they otherwise would have been due to
delays in the foreclosure process.
Our 2009, 2010 and 2011 vintages accounted for approximately 3%
of our single-family credit losses for the third quarter of 2011
and 2% of our single-family credit losses for the first nine
months of 2011. Typically, credit losses on mortgage loans do
not peak until later years in the loan cycle following
origination. We provide more detailed credit performance
information, including serious delinquency rates by geographic
region, statistics on nonperforming loans and foreclosure
activity in “Risk Management—Credit Risk
Management—Mortgage Credit Risk Management.”
Regulatory
Hypothetical Stress Test Scenario
Under a September 2005 agreement with FHFA’s predecessor,
the Office of Federal Housing Enterprise Oversight, we are
required to disclose on a quarterly basis the present value of
the change in future expected
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credit losses from our existing single-family guaranty book of
business from an immediate 5% decline in single-family home
prices for the entire United States. Although other provisions
of the September 2005 agreement were suspended in March 2009 by
FHFA until further notice, this disclosure requirement was not
suspended. For purposes of this calculation, we assume that,
after the initial 5% shock, home price growth rates return to
the average of the possible growth rate paths used in our
internal credit pricing models. The sensitivity results
represent the difference between future expected credit losses
under our base case scenario, which is derived from our internal
home price path forecast, and a scenario that assumes an
instantaneous nationwide 5% decline in home prices.
Table 16 compares the credit loss sensitivities for the periods
indicated for first lien single-family whole loans we own or
that back Fannie Mae MBS, before and after consideration of
projected credit risk sharing proceeds, such as private mortgage
insurance claims and other credit enhancements.
Because these sensitivities represent hypothetical scenarios,
they should be used with caution. Our regulatory stress test
scenario is limited in that it assumes an instantaneous uniform
5% nationwide decline in home prices, which is not
representative of the historical pattern of changes in home
prices. Changes in home prices generally vary on a regional, as
well as a local, basis. In addition, these stress test scenarios
are calculated independently without considering changes in
other interrelated assumptions, such as unemployment rates or
other economic factors, which are likely to have a significant
impact on our future expected credit losses.
Because we already own or guarantee the original mortgages that
we refinance under HARP, our expenses under that program have
consisted mostly of limited administrative costs. However, under
recently announced changes to HARP we may incur additional
losses. See “Legislative and Regulatory Developments,”
for a discussion on the recent changes to HARP.
We reduced our individually impaired allowance that relates to
loans that had entered a trial modification under the Home
Affordable Modification Program (“HAMP”) by
$906 million during the third quarter of 2011 compared with
impairments of $2.0 billion during the third quarter of
2010. Loans receiving a trial modification under HAMP are
accounted for as TDRs and assessed individually for impairment.
The reduction of our
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allowance on HAMP loans in the third quarter of 2011 was due to
improved cash flow projections on existing HAMP loans, which
more than offset the volume of new HAMP trial modifications
during the period. We incurred impairments related to loans that
had entered a trial modification under HAMP of $4.3 billion
during the first nine months of 2011, compared with
$11.8 billion during the first nine months of 2010. These
include impairments on loans that entered into a trial
modification under the program but that have not yet received,
or that have been determined to be ineligible for, a permanent
modification under the program. These impairments have been
included in the calculation of our provision for loan losses in
our condensed consolidated results of operations and
comprehensive loss. The impairments do not include the reduction
in our collective loss reserves which occurred as a result of
beginning to individually assess the loan for impairment upon
entering a trial modification. Please see
“MD&A—Consolidated Results of
Operations—Financial Impact of the Making Home Affordable
Program on Fannie Mae” in our 2010
Form 10-K
for a more detailed discussion on these impairments.
We paid or accrued HAMP incentive fees for servicers of
$86 million during the third quarter of 2011 compared with
$93 million during the third quarter of 2010. We paid or
accrued HAMP incentive fees for servicers of $254 million
during the first nine months of 2011, compared with
$276 million during the first nine months of 2010. These
fees were related to loans modified under HAMP, which we
recorded as part of “Other expenses.” Borrower
incentive payments are included in the calculation of our
allowance for loan losses for individually impaired loans.
Additionally, our expenses under HAMP also include
administrative costs.
Because of the unprecedented nature of the circumstances that
led to the Making Home Affordable Program, we cannot quantify
what the impact would have been on Fannie Mae if the Making Home
Affordable Program had not been introduced. We do not know how
many loans we would have modified under alternative programs,
what the terms or costs of those modifications would have been,
how many foreclosures would have resulted nationwide, and at
what pace, or the impact on housing prices if the program had
not been put in place. As a result, the amounts we discuss above
are not intended to measure how much the program is costing us
in comparison to what it would have cost us if we did not have
the program at all. See “Risk Factors” for a
discussion of how efforts we may undertake in support of the
housing market may affect us.
Results of our three business segments are intended to reflect
each segment as if it were a stand-alone business. Under our
segment reporting structure, the sum of the results for our
three business segments does not equal our condensed
consolidated results of operations as we separate the activity
related to our consolidated trusts from the results generated by
our three segments. In addition, because we apply accounting
methods that differ from our condensed consolidated results for
segment reporting purposes, we include an
eliminations/adjustments category to reconcile our business
segment results and the activity related to our consolidated
trusts to our condensed consolidated results of operations. We
describe the management reporting and allocation process used to
generate our segment results in our 2010
Form 10-K
in “Notes to Consolidated Financial
Statements—Note 15, Segment Reporting.” We are
working on reorganizing our company by function rather than by
business in order to improve our operational efficiencies and
effectiveness. In future periods, we may change some of our
management reporting and how we report our business segment
results.
In this section, we summarize our segment results for the third
quarter and first nine months of 2011 and 2010 in the tables
below and provide a comparative discussion of these results.
This section should be read together with our comparative
discussion of our condensed consolidated results of operations
in “Consolidated Results of Operations.” See
“Note 10, Segment Reporting” of this report for a
reconciliation of our segment results to our condensed
consolidated results.
Single-Family
Business Results
Table 17 summarizes the financial results of our Single-Family
business for the periods indicated. The primary sources of
revenue for our Single-Family business are guaranty fee income
and fee and other income. Expenses primarily include
credit-related expenses, net interest loss and administrative
expenses.
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Table
17: Single-Family Business Results
Net
Interest Loss
Net interest loss for the Single-Family business segment
primarily consists of: (1) the cost to reimburse the
Capital Markets group for interest income not recognized for
loans in our mortgage portfolio on nonaccrual status;
(2) the cost to reimburse MBS trusts for interest income
not recognized for loans in consolidated trusts on nonaccrual
status; and (3) income from cash payments received on loans
that have been placed on nonaccrual status.
Net interest loss decreased in the third quarter and first nine
months of 2011 compared with the third quarter and first nine
months of 2010 primarily due to a significant decrease in
interest income not recognized for loans on nonaccrual status
because of a decline in the total number of loans on nonaccrual
status. This decline is due to loan workouts and foreclosures
since the third quarter of 2010.
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Guaranty fee income increased in the third quarter and first
nine months of 2011 compared with the third quarter and first
nine months of 2010 due to an increase in the amortization of
risk based pricing adjustments, reflecting the impact of higher
risk based pricing associated with our more recent acquisition
vintages.
Our average single-family guaranty book of business was
relatively flat period over period despite our continued high
market share because of the decline in U.S. residential
mortgage debt outstanding, which is primarily due to
foreclosures. Our estimated market share of new single-family
mortgage-related securities issuances, which is based on
publicly available data and excludes previously securitized
mortgages, remained high at 43.3% for the third quarter and
45.5% for the first nine months of 2011.
Credit-related expenses and credit losses in the Single-Family
business represent the substantial majority of our consolidated
totals. We provide a discussion of our credit-related expenses
and credit losses in “Consolidated Results of
Operations—Credit-Related Expenses.”
Multifamily
Business Results
Table 18 summarizes the financial results of our Multifamily
business for the periods indicated. The primary sources of
revenue for our Multifamily business are guaranty fee income and
fee and other income. Expenses and other items that impact
income or loss primarily include credit-related expenses,
administrative expenses and net operating losses from our
partnership investments.
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Table
18: Multifamily Business Results
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Multifamily guaranty fee income increased in the third quarter
and first nine months of 2011 compared with the third quarter
and first nine months of 2010 primarily due to higher fees
charged on new acquisitions in recent years. New acquisitions
with higher guaranty fees have become an increasingly large part
of our multifamily guaranty book of business.
Credit-Related
(Expense) Income
Multifamily credit-related expenses increased in the third
quarter and the first nine months of 2011 compared with 2010
primarily due to a stable allowance for loan losses in 2011
compared to a decrease in 2010. Although national multifamily
market fundamentals continued to improve in the third quarter
and first nine months of 2011, certain local markets and
properties continued to underperform compared to the rest of the
country due to localized economic conditions. In comparison,
Multifamily credit-related expense in the third quarter of 2010
and credit-related income in the first nine months of 2010 were
due to a decrease in the allowance for loan losses as credit
trends stabilized.
Multifamily credit losses, which consist of net charge-offs and
foreclosed property expense, were $76 million for the third
quarter of 2011 compared with $187 million for the third
quarter of 2010, and $280 million for the first nine months
of 2011 compared with $394 million for the first nine
months of 2010.
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(Losses)
Gains from Partnership Investments
We incurred losses from partnership investments in the third
quarter of 2011 compared with gains in the third quarter of
2010. Overall, the multifamily market has shown improvement but
certain properties continued to show stress in the third quarter
of 2011 resulting in a loss from partnership investments for the
current quarter. Losses from partnership investments were lower
in the first nine months of 2011 compared with the first nine
months of 2010 as properties experienced improved operating
performance due to stronger national multifamily market
fundamentals.
In the second quarter of 2011, we reached an effective
settlement of issues with the Internal Revenue Service relating
to tax years 2007 and 2008, which reduced our total corporate
tax liability. However, the reduction in our tax liability also
reduced the low-income housing tax credits we were able to use,
resulting in a provision for federal income taxes for the
Multifamily segment in the first nine months of 2011.
Capital
Markets Group Results
Table 19 summarizes the financial results of our Capital Markets
group for the periods indicated. Following the table we discuss
the Capital Markets group’s financial results and describe
the Capital Markets group’s mortgage portfolio. For a
discussion of the debt issued by the Capital Markets group to
fund its investment activities, see “Liquidity and Capital
Management.” For a discussion of the derivative instruments
that Capital Markets uses to manage interest rate risk, see
“Consolidated Balance Sheet Analysis—Derivative
Instruments” in this report and “Risk
Management—Market Risk Management, Including Interest Rate
Risk Management—Derivative Instruments” and
“Notes to Consolidated Financial
Statements—Note 10, Derivative Instruments and Hedging
Activities” in our 2010
Form 10-K.
The primary sources of revenue for our Capital Markets group are
net interest income and fee and other income. Expenses and other
items that impact income or loss primarily include fair value
gains and losses, investment gains and losses, allocated
guaranty fee expense,
other-than-temporary
impairment and administrative expenses.
Table
19: Capital Markets Group Results
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The Capital Markets group reports interest income and
amortization of cost basis adjustments only on securities and
loans that are held in our portfolio. For mortgage loans held in
our mortgage portfolio, when interest income is no longer
recognized in accordance with our nonaccrual accounting policy,
the Capital Markets group recognizes interest income
reimbursements that the group receives, primarily from
Single-Family, for the contractual interest due. The interest
expense recognized on the Capital Markets group’s statement
of operations is limited to our funding debt, which is reported
as “Debt of Fannie Mae” in our condensed consolidated
balance sheets. Net interest expense also includes a cost of
capital charge allocated among the three business segments.
The Capital Markets group’s net interest income decreased
in the third quarter of 2011 compared with the third quarter of
2010 primarily due to a decline in interest income from our
mortgage portfolio that more than offset the decline in funding
costs as we replaced higher cost debt with lower cost debt.
Interest income from our mortgage portfolio decreased primarily
due to the reduction in our balance of mortgage-related
securities. Additionally, the interest rate earned on our
mortgage loans decreased due to the decrease in the contractual
rate of modified loans. Loan modifications subsequently led to a
decrease in reimbursements from the Single-Family business for
contractual interest income on non-accrual loans.
The Capital Markets group’s net interest income increased
in the first nine months of 2011 compared with the first nine
months of 2010 primarily due to a decline in funding costs as we
replaced higher cost debt with lower cost debt. This increase in
net interest income due to lower funding costs was partially
offset by a decline in interest income from our mortgage
portfolio. The reimbursements of contractual interest due on
nonaccrual loans from the Single-Family business were a
significant portion of the Capital Markets group’s interest
income during the first nine months of 2011. However, the
increase in these reimbursements was offset by the decline in
interest income on our mortgage-related securities because our
securities portfolio balance has declined.
Our net interest income and net interest yield were higher than
they would have otherwise been in the third quarter and first
nine months of both 2011 and 2010 because our debt funding needs
were lower than would otherwise have been required as a result
of funds we received from Treasury under the senior preferred
stock purchase agreement. Further, dividends paid to Treasury
are not recognized in interest expense.
We supplement our issuance of debt with interest rate-related
derivatives to manage the prepayment and duration risk inherent
in our mortgage investments. The effect of these derivatives, in
particular the periodic net interest expense accruals on
interest rate swaps, is not reflected in Capital Markets’
net interest income but is included in our results as a
component of “Fair value (losses) gains, net” and is
shown in “Table 11: Fair Value (Losses) Gains, Net.”
If we had included the economic impact of adding the net
contractual interest accruals on our interest rate swaps in our
Capital Markets’ interest expense, Capital Markets’
net interest income would have decreased by $497 million
for the third quarter of 2011 compared with a decrease of
$673 million for the third quarter of 2010, and would have
decreased $1.8 billion for the first nine months of 2011
compared with a decrease of $2.3 billion for the first nine
months of 2010.
Investments
Gains, Net
Investment gains decreased in the third quarter of 2011 compared
with the third quarter of 2010 primarily due to a higher volume
of securitizations in 2010. Investment gains decreased in the
first nine months of 2011 compared with the first nine months of
2010 primarily due to decreased gains on sale of
available-for-sale
securities.
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Net
Other-Than-Temporary
Impairments
The net
other-than-temporary
impairments recognized by the Capital Markets group are
consistent with the amount reported in our condensed
consolidated results of operations. See “Note 5,
Investments in Securities” for information on our
other-than-temporary
impairments by major security type and primary drivers for
other-than-temporary
impairments recorded in the third quarter and first nine months
of 2011.
Fair
Value (Losses) Gains, Net
The derivative gains and losses that are reported for the
Capital Markets group are consistent with the derivative gains
and losses reported in our condensed consolidated results of
operations. We discuss details of these components of fair value
gains and losses in “Consolidated Results of
Operations—Fair Value (Losses) Gains, Net.”
The
Capital Markets Group’s Mortgage Portfolio
The Capital Markets group’s mortgage portfolio consists of
mortgage loans and mortgage-related securities that we own.
Mortgage-related securities held by Capital Markets include
Fannie Mae MBS and non-Fannie Mae mortgage-related securities.
The Fannie Mae MBS that we own are maintained as securities on
the Capital Markets group’s balance sheets.
Mortgage-related assets held by consolidated MBS trusts are not
included in the Capital Markets group’s mortgage portfolio.
We are restricted by our senior preferred stock purchase
agreement with Treasury in the amount of mortgage assets that we
may own. Each year on December 31, we are required to
reduce our mortgage assets to 90% of the maximum allowable
amount that we were permitted to own as of December 31 of the
immediately preceding calendar year, until the amount of our
mortgage assets reaches $250 billion. The maximum allowable
amount of mortgage assets we may own was reduced to
$810 billion as of December 31, 2010 and will be
reduced to $729 billion as of December 31, 2011. As of
September 30, 2011, we owned $722.2 billion in
mortgage assets, compared with $788.8 billion as of
December 31, 2010.
Table 20 summarizes our Capital Markets group’s mortgage
portfolio activity for the periods indicated.
Table
20: Capital Markets Group’s Mortgage Portfolio
Activity(1)
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Purchases of mortgage loans decreased in the third quarter and
first nine months of 2011 compared with both the third quarter
and first nine months of 2010 because we purchased fewer loans
that were four or more months delinquent from MBS trusts in the
third quarter and first nine months of 2011. We significantly
increased our purchases of delinquent loans in 2010 and
purchased the substantial majority of our delinquent loan
population during the first half of 2010, which included
$127 billion of loans that were four or more months
delinquent as of December 31, 2009.
We expect to continue to purchase loans from MBS trusts as they
become four or more consecutive monthly payments delinquent
subject to market conditions, economic benefit, servicer
capacity, and other factors including the limit on the mortgage
assets that we may own pursuant to the senior preferred stock
purchase agreement. We purchased approximately 293,000
delinquent loans with an unpaid principal balance of
approximately $51 billion from our single-family MBS trusts
in the first nine months of 2011. As of September 30, 2011,
the total unpaid principal balance of all loans in single-family
MBS trusts that were delinquent as to four or more consecutive
monthly payments was $5.9 billion. In October 2011, we
purchased approximately 31,000 delinquent loans with an unpaid
principal balance of $5.3 billion from our single-family
MBS trusts.
Table 21 shows the composition of the Capital Markets
group’s mortgage portfolio as of September 30, 2011
and December 31, 2010.
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Table
21: Capital Markets Group’s Mortgage Portfolio
Composition(1)
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