(Bloomberg) -- Fannie Mae and Freddie Mac face strong headwinds from the mayhem coronavirus has spread through the mortgage market, complicating the Trump administration’s plans to free them from U.S. control anytime soon.
The companies, which backstop roughly $5 trillion of mortgages, might have to set aside huge amounts of money to cover the risk of souring home loans. They may also take a hit from the pain being inflicted on nonbank mortgage servicers as millions of borrowers delay making their monthly loan payments. Meanwhile, the outlook for the U.S. housing market -- the engine that powers Fannie and Freddie’s profits -- looks bleak.
Wall Street will get its first look at the pandemic’s impact on Fannie and Freddie when they report first quarter results later this week. Weak earnings or discouraging revelations about the extent of the mortgage mess would be a setback for the White House, according to analysts. Administration officials and regulators have repeatedly said Fannie and Freddie need solid financials and a healthy U.S. economy to eventually raise the tens of billions of dollars they require from investors to survive outside the government’s grip.
“This crisis is dashing hopes for a quick exit from conservatorship,” said Jaret Seiberg, an analyst at Cowen & Co. “If there’s not a lot of clarity on their losses or capital it’s hard to envision the market providing the $100 billion of fresh capital they would need to raise down the road.”
Slumping Shares
Fannie and Freddie shares have tumbled more than 30% since the end of February, a sign of investor jitters over how they’re faring during the pandemic. Freddie reports results Thursday, followed by Fannie on Friday.
Fannie and Freddie spokesmen declined to comment.
The fate of the companies is the main unresolved issue from the last financial crisis, when taxpayers rescued them with a bailout in 2008 and the U.S. put them in conservatorship. Federal Housing Finance Agency Director Mark Calabria, Fannie and Freddie’s regulator, is among Republicans who are eager to free them to shrink the government’s role in housing.
Other interested parties include hedge funds that own billions of dollars of Fannie and Freddie shares and have been lobbying the administration for years to release the companies. Even before coronavirus, the funds were concerned that President Donald Trump might lose re-election and a Democratic successor would put plans to end the conservatorships on ice.
Essential Role
Fannie and Freddie are essential to the housing market because they keep financing readily available and make mortgages affordable. They do so by buying loans from lenders and packaging them into trillions of dollars of bonds with government guarantees that are sold to investors.
If it looks like borrowers might default on their mortgages, Fannie and Freddie have to set aside reserves to cover potential losses. Loan defaults might not turn out as badly as the companies expected, allowing them to release reserves down the line. But in the near-term, Fannie and Freddie financial results would take a hit.
While Fannie and Freddie were allowed to retain a small amount of capital in 2017, the FHFA and Treasury Department didn’t permit them to really start building up those buffers until after Calabria was sworn in last year. Fannie had $14.6 billion in capital at the end of 2019 to protect against losses, while Freddie had $9.1 billion.
Risks are rising that Fannie and Freddie might need a cash injection from the Treasury in the coming months should losses exceed those cushions or if the companies can’t fund payments that borrowers are skipping.
‘More Reliant’
If that happens, hedge funds’ preferred method for freeing Fannie and Freddie -- so-called recap and release in which the government allows the companies to build up their capital and then ends the conservatorships -- becomes more difficult, said B. Riley FBR analyst Randy Binner.
“Politically, a draw would make recap and release impossible,” said Binner, who downgraded Fannie and Freddie to “sell” earlier this month. “A draw is the opposite of releasing them. It means they are even more reliant on government.”
Before coronavirus halted U.S. economic growth, Calabria had predicted that by mid-2021 Fannie and Freddie might be ready to exit U.S. control and seek cash infusions from new investors through massive share sales.
The companies can withstand the impact of coronavirus and the rise in the number of borrowers delaying mortgage payments assuming the economy is open by June, Calabria said in an April 10 interview. But if the slowdown persists, the FHFA may have to take additional steps, he said. Calabria added that the FHFA does not expect Fannie and Freddie to need a draw from the Treasury at this point.
Rising Forbearance
Congress, in the $2 trillion stimulus legislation approved last month, allowed homeowners to postpone mortgage payments for up to a year. As of April 19, forbearance rates on mortgages backed by Fannie and Freddie had risen to 5.46%, according to the Mortgage Bankers Association.
Fannie and Freddie may be in trouble if that number reaches 10%, said KBW analyst Bose George. That’s because nonbank servicers, which collect monthly payments from borrowers and then funnel money to investors who own mortgage bonds, would face a high risk of failing. If that happened, Fannie and Freddie would have to transfer servicing rights to other companies, which could end up costing them money.
Compass Point analyst Isaac Boltansky argues that even if coronavirus delays efforts to end the conservatorships, it’s also helping to make the case that Fannie and Freddie should be released because that’s the best way to build up their capital buffers.
“This actually strengthens the argument that Fannie and Freddie would benefit from having more private capital,” he said. “This story is not going to end this year, but then again it never was. The path to ending the GSE conservatorships has always been long and winding.”
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