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Fannie Mae (FNM)Stock (Financial Services Industry, REIT - Mortgage Industry)
 This article should cite more sources.  The Federal National Mortgage Association (Fannie Mae), the second largest corporation in the United States in terms of assets, buys mortgages from banks and financial institutions and sells mortgage-backed securities, a type of bond, to investors of all sizes. Fannie was structured to play a dominant role in the secondary mortgage market and ensure a steady and reliable supply of funds for U.S. homebuyers. Created by the federal government in 1938, Fannie Mae was given a range of special privileges, including exemption from state and local taxes, a $2.25 billion line of credit with the U.S. Treasury, and the implicit backing of the federal government. Fannie Mae is a government sponsored entity, a hybridized enterprise endowed with an advantageous set of special privileges. Despite the privileges afforded by Fannie Mae's GSE status, the collapse of the U.S. subprime mortgage industry and concurrent credit crunch hit the company hard, resulting in net losses of over $9.4 billion between June 30, 2007, and June 30, 2008.[1] Fannie's business model is that it pays interests on its mortgage-backed securities using income from the mortgages it owns; rising default and foreclosure rates, however, meant that more and more of Fannie's mortgages weren't generating any income at all, forcing the company to write those mortgages off as losses on its income statement. In August 2008, the U.S. federal government's implicit backing of Fannie Mae became very explicit, with Treasury Secretary Henry Paulson announcing that Congress had approved a plan giving the Treasury the authority to bail out Fannie if its capital levels dipped too low. This move sought to reassure the markets that Fannie and its sister company, Freddie Mac (FRE), would be able to continue serving their purpose of providing liquidity in the U.S. housing market. Investors, who feared that a significant infusion of capital from the U.S. government would dilute the value of their holdings, punished Fannie's stock, which fell by as much as 90% in 2008.[2] On September 8, 2008, investors' fears were realized when Paulson announced a comprehensive plan to take Fannie and Freddie under "conservatorship", essentially placing the companies under temporary government control and giving the Treasury the right to pump as much as $100 billion into each company, as well as buy a 79.9% share of both Fannie and Freddie.[3]
[edit] Business Operations Fannie Mae is a nonbank financial institution created by the US government to make homeowning easier for Americans. Fannie Mae accomplishes this goal by expanding the supply of funds available for mortgages. When a bank lends out a mortgage, it normally has to wait until the loan is repaid before it can lend out another mortgage; Fannie Mae, however, steps in and buys out the mortgage from the bank. The bank can make a second loan, while Fannie Mae profits off the interest from the mortgage. Fannie Mae also sells bonds tied to the mortgages, called mortgage-backed securities. Whereas a mortgage might not be repaid, Fannie Mae guarantees full repayment of its bonds. This guarantee allows Fannie Mae to charge a security premium, which provides another basis of the company’s profit. Fannie Mae is therefore highly leveraged, as it loans out much of its surplus cash by buying mortgages, and then generates revenue by issuing additional securities. High leverage ensures a high return on equity, meaning that Fannie Mae makes a lot of money for every dollar it owns. On the other hand, this profit implies a lot of risk, since a default on one of the mortgages it bought can make Fannie unable to repay multiple bonds. To offset this risk, Fannie maintains some capital stock, or money on hand. Fannie can use these reserves to pay off debt in the event that a mortgage defaults. Though Fannie Mae has historically been fond of maintaining rather low capital stocks (opting instead to lend out more money to make higher profits), federal legislation now requires Fannie to hold a capital stock equal to 30% of its outstanding debt. This helps manage risk, though at the expense of potential profit. [edit] Government Sponsored EnterpriseFannie Mae was created as a government program by President Roosevelt in 1938 to expand the supply of funds available for purchasing a home. Fannie was separated from the government in 1968 and sold to stockholders; since then, it has maintained its status as a government sponsored enterprise. GSEs form a group of financial institutions that the government originally created. Although they do not have the backing, explicit or otherwise, of the federal government, investors tend to see them as less risky than other companies. Because of its GSE status, Fannie Mae has retained a strong financial rating throughout its ongoing accounting scandal. In 2004, the company received the highest possible AAA rating despite a debt-to-equity ratio of 78:1, far above the normal limit. With a current debt-to-equity ratio of about 18:1, Fannie remains highly leveraged, although not so much as before. Additionally, Fannie Mae's GSE status confers a unique benefit on it: the Fed is authorized to buy up to $2.25 billion in Fannie Mae securities every year; this represents an implicit subsidy, should the Fed choose to exercise it. [edit] SizeFannie Mae now holds $1.4 trillion in mortgage assets, which represents approximately 14% of all outstanding home loans in the U.S. As such, a failure at Fannie could wreak havoc in the residential housing market and the broader economy because many other large financial institutions hold Fannie bonds. Although the government is not obligated to assist Fannie Mae, the potential mayhem caused by Fannie's demise lead many to believe that the government will ensure Fannie Mae's continued viability. [edit] Reporting ProblemsIn 2004 Congress released a special report detailing Fannie Mae's violation of the Generally Accepted Accounting Principles. In particular, the report alleged that Fannie misreported losses and expenses from hedging activity. The report went on to charge the operating team in place at the time with poor management, accusing them of deliberately misrepresenting net earnings so as to maximize their bonuses. U.S. regulators have outstanding civil lawsuits against then-CEO Franklin Raines, then-CFO J. Timothy Howard, and former controller Leanne G. Spencer, with total damages sought in excess of $100 million. Shareholders also tried, through a civil suit, to force Fannie Mae to recuperate the bonuses from the outed executives. Aside from punitive repayment, Fannie Mae is now faced with the task of revising its financial statements. It recently reissued statements for 2005 and 2006 and is working toward becoming current with financial filings. This is technically a violation of New York Stock Exchange protocol, but Fannie's stock remains listed because of its pledge to update its books and its GSE status. The lack of financial reports makes it difficult to evaluate Fannie Mae quantitatively, as only estimates are available for recent performance. Finally, the accounting errors and lack of oversight have prompted Congress to consider additional legislation governing Fannie's operations. Congress has already imposed a 30% capital reserve requirement, which will force Fannie Mae to lower its debt-to-equity ratio. [edit] Operating StatisticsThe following table displays Fannie's performance over time, along a number of important dimensions. Because of Fannie's reporting problems, these data are subject to change with the re-release of reports.
[edit] Trends and Forces[edit] Effect of Subprime MeltdownThe mortgage industry expanded in the late 1990s and early 2000s as the market for subprime loans grew rapidly. Fewer than 100,000 subprime loans were made in 1995, but in 2004, over 1.5 million loans written were considered subprime. Banks make subprime loans to borrowers with less than perfect credit scores or low incomes. The nature of the borrowers makes these loans risky, but the very same reason enables banks to charge premium interest rates to compensate for the higher risk. In the early 2000s, banks began pooling mortgages to spread the risk, making subprime loans seem even more lucrative and further expanding the market for them. In the last year, however, the subprime sector has collapsed as repayment rates have dropped in response to rising mortgage payments and falling home values. About half of all current subprime mortgages have adjustable rates, meaning that the rate of the loan (and, subsequently, the monthly payments) are tied to interest rates. In March of 2007, 13.5% of all subprime mortgages were delinquent, up from 11.5% the year before. Fannie Mae was originally thought to have been safe from the subprime crisis, however, in November 2007, it reported a $1.39 billion loss as a result of an increasingly large number of defaulting mortgages. Fannie posted another loss of $3.6 billion for the fourth quarter, leading to a $2.05 billion loss for 2007. This has led investors to question Fannie's insulation from the market turmoil, which has negatively impacted the company's stock price. [edit] US housing market disappointsIn 2007, new and used home sales have declined to their lowest level since 2001. For the year, a projected 6.28 million homes were sold, down 7.1% from last year and only just higher than the 6.2 million sold in 2001. This decrease in the number of home sales will lead to a corresponding drop in the number of mortgages written, which could spell trouble for Fannie Mae and other mortgage companies. Although Fannie does not write mortgages itself, the fall in mortgage demand implies falling interest rates. As a lender, Fannie won't make as much profit on the mortgages it acquires if interest rates drop, compounding the impact of the housing market on Fannie Mae's profit. Additionally, Fannie's monthly summary for April 2008 showed that the serious delinquency rate for single-family mortgages had risen from 0.62% in March of 2007 to 1.15% in March of 2008, a significant increase.[4] [edit] Risk of full government regulation/re-management to improve Fannie's financial healthAs mentioned, the government has considered regulating Fannie Mae, as evidenced by its imposition of the 30% capital surplus requirement. This is a mild version of the more stringent measures the government could use to improve Fannie's responsibility and financial health. A more severe approach would call for Fannie Mae to utterly relinquish its mortgage portfolio, gradually selling it off in the form of mortgage-backed securities. This would go along with revoking its status as a government sponsored enterprise. The potential revocation of Fannie Mae's GSE status remains the government's most powerful threat since, without its GSE status, Fannie could not justify the high interest rates it charges on bonds. Historically, however, Democrats have been kinder to Fannie than have Republicans; they created the company and have since expanded its mandate. The Democrats' control of Congress should limit Fannie Mae's exposure to debilitating legislation.  [edit] Fixed interest rates decrease flexibilityThe majority of the mortgages that Fannie Mae acquires have fixed rates, meaning that the amount a borrower pays back is based on the interest rate at the time the mortgage was signed. This can impact Fannie Mae in several ways. Much of Fannie's business involves selling bonds, and Fannie cannot sell a bond at a rate much lower than the current prevailing rate. If interest rates rise, Fannie's income from the fixed-rate mortgages it currently owns will remain unchanged, but its ability to capitalize on those mortgages, or use them to back securities, will fall. For example, if Fannie holds a mortgage with an annual rate of 2.5% but current interest rates are at 5%, it can't sell a security backed by that mortgage and still make a profit (unless it can find someone to buy the bond). On the other hand, mortgages acquired after the interest rate hike may well be more profitable, since they would be signed with a higher rate. At the moment, the federal funds rate stands at 2.25% after a series cuts in late 2007 and early 2008. [edit] CompetitionFannie Mae's GSE status and its lack of recent financial data make it difficult to compare to other corporations. Its sister company Freddie Mac, however, makes for an apt comparison. The two have similar charters, are similar in size, and both hold status as GSEs. Freddie Mac, however, has remained free and clear of scandal, which has been a problem for Fannie Mae in recent years. The following table compares the two companies using several key statistics. The numbers are unofficial projections; these are the best data available for Fannie, and for comparability, the same data are used for Freddie.
Though they both play massive roles in the U.S. mortgage market (combined, they hold around half of the country's outstanding mortgages and support 55% of all new mortgage originations), Fannie Mae is slightly larger and more highly leveraged than Freddie Mac. Historically, it has also had a larger return-on-equity, which measures net interest income as a fraction of capital on hand. This advantage implies a higher profitability for Fannie.
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