Federal National Mortgage Association : Fannie Mae Third Quarter 2022 Financial Results Media Call

Fannie Mae Moderator:

Good day, and welcome to the Fannie Mae Third Quarter 2022 Financial Results Conference Call. At this time, I will now turn it over to your host, Pete Bakel, Fannie Mae's Director of External Communications.

Pete Bakel:

Hello, and thank you all for joining today's conference call to discuss Fannie Mae's third quarter 2022 financial results. Please note this call includes forward-looking statements, including statements about Fannie Mae's expectations related to: economic and housing market conditions, their impact on our business and financial results, and the factors that will affect them; the future performance of the company's book of business; the company's business plans and their impact; and the company's financial results and the factors that will affect them. Future events may turn out to be very different from these statements.

The "Risk Factors" and "Forward-looking Statements" sections in the company's third quarter 2022 Form 10-Q, filed today, and its 2021 Form 10-K, filed February 15, 2022, describe factors that may lead to different results. A recording of this call may be posted on the company's website.

We ask that you do not record this call for public broadcast, and that you do not publish any full transcript.

I'd now like to turn the call over to Fannie Mae President and Interim Chief Executive Officer, David C. Benson, and Fannie Mae Chief Financial Officer, Chryssa C. Halley.

David C. Benson:

Welcome and Introduction

Thanks, Pete. And thanks to all of you for joining us as we review our third quarter financial results. We reported $2.4 billion in net income, compared to $4.7 billion in the previous quarter. These earnings resulted in an increase in our net worth to $58.8 billion. In a moment, Chryssa will do a deeper dive into our quarterly results and their main drivers, including the macroeconomic conditions impacting housing.

Macroeconomic Conditions

In the third quarter, inflationary pressures persisted. September data showed the consumer price index grew 8.2% year-over-year. The Federal Reserve continued to increase short-term interest rates in its attempt to tame inflation and reiterated a commitment to reducing its balance sheet. The 10-year Treasury rate increased 82 basis points over the course of the quarter, from 3.01% to 3.83%. And, while third quarter GDP increased by 2.6% on an annualized basis, we believe this boost is likely temporary and that full-year 2022 GDP will be essentially flat. All of these factors are having a direct impact on the housing finance system and on our business. The 30-year fixed-rate mortgage rate increased 100 basis points during the quarter, from 5.7% to 6.7% and, at October month-end, was at 7.08%. Following a period of rapid home price growth in 2020, 2021, and the first half of 2022, home prices declined 0.2% on a national basis in the third quarter. We estimate that home prices nationally rose 13.8% year-over-year in the third quarter, a deceleration from the revised 19.1% year-over-year growth we saw in the second quarter.

Now for borrowers, these price increases and rising interest rates mean that homes are significantly less affordable than they were a year ago. By our measure, affordability is worse than it was during the 2005 - 2007 period. As houses become less affordable, demand for housing slows. There were around 5.4 million new and existing home sales in the third quarter, a 10% decrease from the prior quarter, and a 21% decrease from the third quarter of last year. Renters also continued to face affordability challenges. We now expect annual rent growth across all classes to be in the 5% to 6% range in 2022, much of which has already taken place through the third quarter.

Mortgage lenders are seeing a dramatic reduction in origination volume. We estimate $514 billion in single-family mortgage originations in the third quarter, a 24% decrease from the prior quarter, and a 54% decrease from the third quarter of last year. Given rising interest rates, home loan application volume has dropped dramatically, and the mix of business has changed, with significantly fewer refinances than in previous quarters. As a result, the market is seeing notable impacts on lender business models and activities. Now consistent with this lower level of activity, Fannie Mae has seen less business volume. Our single-family acquisitions fell by 32% compared to the previous quarter and by 60% compared to the third quarter of 2021. 79% of our acquisition volumes in the third quarter were purchase mortgages, the highest share we have seen for at least two decades. In multifamily, our acquisitions declined to $15.9 billion, down from $18.7 billion the prior quarter.

Despite these headwinds, Fannie Mae provided $134 billion in financing in the third quarter to single-family and multifamily markets, which supported 527,000 units of housing. More than 45% of our single-family home purchase acquisitions in the third quarter of 2022 were to first-time homebuyers. And over 95% of the multifamily units we financed in the third quarter of 2022 that were potentially eligible for housing goals credit were affordable to those earning at or below 120% of the median income in their area, providing support for both workforce housing and affordable housing.

Managing Our Business

As these numbers demonstrate, we are intently focused on our role as a liquidity provider through all market conditions, including today's. In order to fulfill that role responsibly for the renters and borrowers we serve - and for the broader housing finance system - we need to successfully manage risk on both our acquisitions and our $4 trillion book of business. We have in place strong underwriting and loan quality standards and improved technology, which makes us, and the housing finance system, better prepared for a potential downturn.

Let me call out a couple examples about our single-family guaranty book of business to support this: Fixed-rate loans comprised 99% of our book at the end of the third quarter. This means that these borrowers will not be subject to payment shocks on their mortgages in a rising interest rate environment. And, looking at the credit quality of our book as of the end of the third quarter, you'll see a weighted average mark-to-market loan-to-value ratio of 50% and a weighted average credit score at origination of 752. Beyond the credit quality of our book, we also have effective, proven tools to support homeowners who experience financial hardship. They also help to manage Fannie Mae's book against defaults.

Mission

By effectively managing risk and strengthening the company, we're also strengthening our ability to deliver on our mission. We strongly believe that safety and soundness and mission reinforce each other. In this economic environment, the industry is looking to Fannie Mae to be a stable pillar for the market - and also for our leadership on housing affordability and equity. Recently, FHFA announced some changes aimed at enhancing affordability and transparency while also maintaining safety and soundness. These include revisions to our pricing framework and an update to the credit score model we, and others in the industry, use as part of the mortgage process. We will be working with FHFA and the industry to implement these enhancements.

Looking Ahead

So as we move through this period of economic uncertainty, we're doing so from a position of relative strength, but we also know we can't be complacent. While we currently expect GDP growth to be essentially flat for 2022, we continue to believe that a modest recession is likely to occur beginning in the first quarter of next year. We expect mortgage rates to stay elevated through the end of this year and in 2023. We expect additional home price declines in the fourth quarter of 2022. More specifically, we expect national home price declines of 1.9% in the second half of this year and home price declines of 1.5% next year. This is a shift from our expectations last quarter, when we forecasted home price growth in these periods.

We project that elevated mortgage rates and a slowing economy will continue to challenge affordability and constrain home sales and single-family housing starts through the remainder of this year, and into next year, we expect single-family and multifamily housing starts to further decline compared with 2022 due to the economic constraints already discussed.

So now I'll turn it over to Chryssa to address our third quarter results in more detail.

Chryssa C. Halley

Thank you, Dave. As Dave mentioned, we reported $2.4 billion of net income in the third quarter, a decrease of $2.2 billion compared to the second quarter of 2022. We also reported $7.2 billion of net revenues this quarter, an 8% decrease compared to the $7.9 billion of net revenues in the second quarter. I'll reflect on two primary drivers of our results for the quarter, both of which were impacted primarily by the macroeconomic factors Dave addressed in his remarks.

First, credit-related expense: Credit-related expense increased from $251 million in the second quarter to $2.5 billion in the third quarter of 2022. Our credit-related expense in the third quarter was primarily driven by the decreases in actual and forecasted home prices Dave discussed. While borrowers have built up strong equity in their homes as seen in the average mark-to-market loan-to-value ratio of our book of business, lower home prices increase the likelihood that loans will default and increase the amount of credit loss on loans that do default, which impacts our estimate of losses and increases our provision for credit losses. As part of our ongoing analysis of our loss allowance, we also reviewed our provision for credit losses as a result of recent hurricanes. We expect that some borrowers affected by the hurricanes will become seriously delinquent on their loans. It is also possible that the unpaid principal balance of our single-family loans in forbearance may increase as a result of borrowers affected by the hurricanes requesting forbearance. Despite these factors, we concluded that our credit loss models appropriately reflect the potential impact of these recent hurricanes based on our historical loss experience and our current assessment of conditions. We will continue to monitor the impacts of Hurricanes Ian and Fiona. We'll be looking at loan performance, changes to expectations surrounding insurance coverage, and also the amount and availability of federal and state assistance to affected borrowers. These factors could change our estimate of credit losses relating to the hurricanes in future periods.

Second, net interest income: Net interest income declined $684 million from $7.8 billion to $7.1 billion compared to the second quarter, primarily driven by reduced amortization income. Amortization income was lower because the higher interest-rate environment resulted in lower refinancing activity and thus fewer loan prepayments.

I'd now like to highlight a few notable trends in our single-family business. As Dave mentioned, 79% of our acquisition volumes in the third quarter were purchase mortgages. As the share of home purchase acquisitions increased, we saw a relative increase in the percentage of our single-family loan acquisitions with loan-to-value ratios over 80%, from 34% of acquisitions in the second quarter of 2022 to 38% in the third quarter of 2022. Acquisition FICO® scores averaged 746 in the third quarter of 2022, flat compared with the second quarter of 2022.

While Dave provided some statistics on the health of our overall single-family guaranty book of business, I'll also add that our serious delinquency, or SDQ, rate decreased 12 basis points to 0.69% as of September 30, 2022, compared with 0.81% as of June 30, 2022. This decrease is primarily attributable to loans continuing to successfully exit forbearance mainly through loan modifications and payment deferrals. And, as we continue to manage the credit risk on our single-family book of business, Fannie Mae entered into six single-family credit risk transfer transactions during the quarter, referencing $134 billion in unpaid principal balance at the time we entered the transactions.

Now, turning to our multifamily business. We acquired $15.9 billion of multifamily loans in the third quarter of 2022, a decrease of $2.8 billion compared with the second quarter of 2022. The bulk of these acquisitions provided vital support for both workforce and affordable housing. As of the end of the third quarter, approximately $27 billion remained under our $78 billion multifamily volume cap for 2022.

The credit profile of our multifamily book of business remained strong, with a weighted average original loan-to-value ratio of 65% and a weighted average debt service coverage ratio of 2.2 times. Our multifamily SDQ rate declined to 26 basis points as of September 30, 2022, from 34 basis points as of June 30, 2022, as loans continue to recover from the COVID-19 pandemic. The multifamily SDQ rate, excluding loans that have received a forbearance since the start of the pandemic, was 4 basis points as of September 30, 2022. In addition, in September, we entered into a new CRT deal transferring $339 million of credit risk on a $13 billion reference pool of acquisitions through our MCIRT program. This will be our only multifamily CRT deal of the year.

Next, I'd like to touch upon our capital position. As of September 30, 2022, we had a $258 billion shortfall to the amount of capital needed to be fully capitalized, a $4 billion improvement from June 30, 2022. This improvement was primarily the result of an increase in our retained earnings and lower capital requirements. Lower capital requirements were due to single-family CRT issuances as well as home price changes that occurred in the second quarter, as our capital calculations incorporate home price changes on a one-quarter lagged basis. It's important to note that the calculation of available capital under the enterprise regulatory capital framework excludes the stated value of our senior preferred stock and deferred tax assets, both of which are included in the calculation of our net worth.

I'll now expand on a few of Dave's remarks on the broader economy and impacts to Fannie Mae. As a result of higher mortgage interest rates and inflation continuing to weigh on affordability, we further revised downward our forecast for 2022 single-family mortgage market originations. We now expect 2022 single-family mortgage market originations of $2.3 trillion, a 49% decrease from 2021, with approximately 70% of activity for the full year of 2022 expected to come from purchase originations. We currently project a further decline in single-family mortgage market originations in 2023, to $1.7 trillion, with 77% of that activity coming from purchase originations. We expect that multifamily mortgage market originations for 2022 will be between $400 billion and $430 billion, down from the $475 billion we estimated at the start of this year, due primarily to rising interest rates and a slowing in multifamily property sales. Given the amount of credit-related expense we recognized in the first nine months of 2022, we expect significant credit-related expense in 2022 compared with significant credit-related income in 2021. We also expect much lower amortization income in 2022 compared with 2021, driven by significantly less refinancing activity in 2022 due to a higher mortgage interest-rate environment; however, we expect this decline in amortization income to be largely offset by increases in net interest income from portfolios and increases in base guaranty fee income. We expect these factors to result in lower net income in 2022 compared with 2021.

Before I turn it back to Dave, I'd like to remind our audience that we provide additional data and commentary on our economic and housing outlook on our website. We have also published a financial supplement with today's filing that provides additional insights into our business. With that, I'll turn it back to you, Dave.

David C. Benson:

Before we sign off, I would like to mention that this will be my final quarterly earnings call as Interim CEO. We are excited to welcome our new CEO, Priscilla Almodovar, who will be with us beginning in December. It's been a pleasure to serve Fannie Mae and promote its important mission these last several months, and I look forward to supporting our new CEO as I continue in my role as Fannie Mae's president. Thank you again for joining us. We look forward to speaking with you again next quarter.

Fannie Mae Moderator:

Thank you, ladies and gentlemen. That concludes today's call. You may disconnect.