Bloomberg Article Fannie, Freddie Capital Shortfalls May Lead to Decade of Limbo
Fannie Mae and Freddie Mac likely face at least a decade of earnings retention -- despite comprehensive income up 35% and 19% last year, respectively -- before they'd be deemed well capitalized by regulators. Other catalysts might nudge the Biden administration to end the government-sponsored entities' conservatorship sooner if they're partly recapitalized. (03/12/24)
1. Freddie Needs $161 Billion to Make Up Shortfall
Freddie Mac Capital Shortfall
Source: Company Filings, Bloomberg Intelligence
Exhibit
Freddie Mac had an adjusted total capital shortfall of $161 billion at year-end vs. $163 billion in 2022, driven by growth in retained earnings in excess of risk-weighted assets. Freddie's applicable capital buffer rose $1 billion to $51 billion and its minimum capital requirement increased $9 billion to $81 billion, as risk-weighted assets rose 12% in 2023. To overcome its current $139 billion CET1 shortfall, the company would need about 13 years at its 2023 earnings pace. This could be shortened if refinancings pick back up with lower interest rates, assuming limited credit losses in such a scenario.
More proximate catalysts, such as the 2028 expiry of Treasury's common stock warrants, litigation or even housing-finance reform, might drive changes to the GSEs' ownership structure sooner. (03/12/24)
2. Fannie Still Needs $243 Billion to Close Gap
Fannie Mae Capital Shortfall
Source: Company Filings, Bloomberg Intelligence
Exhibit
Fannie Mae had an adjusted total capital shortfall of $243 billion in 4Q, down $15 billion (6%) from 2022. This was despite earnings growth of $4.5 billion (35%) and flat adjusted total assets of $4.5 trillion. Fannie's applicable capital buffer stayed flat at $79 billion, while risk-weighted assets were up 3.1%. Its current $214 billion CET1 shortfall -- which may be a compromise point to come out of conservatorship -- is equal to about 12 years of capital retention at its 2023 earnings pace, including a large reserve release.
Assuming credit losses remain limited by a tight housing supply and healthy household balance sheets, an eventual turn in rates could provide a boost to Fannie's earnings and reduce the time it may take the company to overcome its shortfall. (03/12/24)
3. FHFA Capital Rule Aids RWA Reduction
Early Evolution of GSE Capital Rule
Source: Federal Housing Finance Agency
Website
After loosening enterprise-risk capital requirements in early 2022, the FHFA continues to make minor tweaks to reduce required capital. Still, the shortfalls at Fannie Mae and Freddie Mac will likely need to be overcome at least partially -- 60% might be the minimum threshold, based on the Federal Reserve's Prompt Corrective Action framework -- before the regulator lets the GSEs return to private shareholders.
The FHFA revised its capital rule again in November 2023 to help Fannie and Freddie reduce risk-weighted assets (RWAs). Other tweaks since the initial rule include changing to a dynamic from fixed leverage buffer, lowering the risk-weighted floor for retained Credit Risk Transfer (CRT) exposures, and making CRT transactions more effective in decreasing RWAs. The rule may become even less restrictive over time. (03/12/24)
