DBRS, Inc. (Morningstar DBRS) has assigned initial credit ratings to Federal National Mortgage Association (Fannie Mae or the Company), including a Long-Term Issuer Rating and Long-Term Senior Debt credit rating of AAA.
The trend on all ratings is Stable. The Company's position under conservatorship and strong implicit support from the U.S. federal government results in Fannie Mae's final credit ratings being equalized with the Long-Term Local Currency - Issuer Rating of the United States of America (the U.S.), as well as being assigned a SA1 Support Assessment.
KEY CREDIT RATING CONSIDERATIONS
Despite the lack of an explicit guarantee from the U.S. government, the Long-Term Issuer rating of Fannie Mae is equalized with the sovereign rating of the United States of America given the very strong and ongoing systemic support in place from the U.S. government. In our view, Fannie Mae is essential to the functioning of the U.S. housing market given its scale and critical role it serves. The equalization also considers the Company's irreplicable market position, access to funding commitments from the U.S. Treasury, and conservatorship status under the Federal Housing Finance Agency (FHFA).
Fannie Mae is systemically important given its role in supporting the very large U.S. housing finance ecosystem, which would likely experience higher levels of volatility in the absence of this support, resulting in more severe/disruptive systemic shocks across the broader U.S. economy in times of stress. This essentiality was demonstrated by the successful performance of the Government-Sponsored Entities (GSEs) when private secondary market liquidity for residential mortgage-related assets evaporated during the 2008/2009 financial crisis and the COVID-19 pandemic. The Company's strong market position (the two housing GSEs effectively operate as a duopoly) is also a consideration given its entrenched market position and scale economies (driven by its large established platform). There are currently no other entities that could readily perform this specific role outside of the two housing GSEs, in our view.
Fannie Mae's position, not only in the U.S. housing market but the global debt capital markets, was also considered in the assessment of the Company's essentiality. The debt of the Company is also widely held throughout the global financial system, likely incentivizing the U.S. government to help avoid any defaults given the likely significant repercussions. Indeed, as of April 3, 2024, the U.S. Federal Reserve Bank held $2.4 trillion (32% of the Fed's total balance sheet and second only to U.S. Treasuries of $4.6 trillion) of agency debt and agency MBS.
We also consider Fannie Mae's high degree of access to financial support given its existing funding commitment from the U.S. Treasury that allows the Company to draw funds should net worth turn negative. Although there is a limit to what remains drawable ($113.9 billion as of YE23), continued support from the U.S. government is assumed to be timely should the need arise. Fannie Mae also has strong government oversight given its conservatorship status under the FHFA. Although there are no government officials on the Company's Board of Directors, the FHFA reconstituted the Board after becoming conservator, directing the Board to owe its fiduciary obligations solely to the FHFA (and not to the Company or shareholders). Any new product offerings also require FHFA approval, effectively limiting the scope of the Company's current and future business activities.
The Stable trend primarily reflects that of the U.S. sovereign credit rating. Given the size of capital required to meet regulatory capital standards put in place in 2021 and the current U.S. housing market that is facing substantial headwinds, we foresee Fannie Mae remaining in conservatorship for the length of the credit rating outlook period.
CREDIT RATING DRIVERS
Given the current credit ratings of Fannie Mae are at the highest level in our long-term rating scale, there is no potential for a credit ratings upgrade. Conversely, the credit ratings would be downgraded should we lower the Long-Term Local Currency - Issuer Rating of the United States. The credit ratings would also be downgraded should we view the support from the U.S. Treasury to have been diminished, or the expectation of support to be less timely.
CREDIT RATING RATIONALE
Franchise Strength
Fannie Mae's franchise is unique given the implicit backing from the U.S. government. The Company does not originate loans or lend directly to borrowers, but it owned/guaranteed approx. 26% of all U.S. residential mortgage debt outstanding (as of September 30, 2023), reflecting a significant share of the market and the scale of its operations. The Company's business model revolves around guaranteeing payments on the mortgage loans it acquires/securitizes, and the mortgage backed securities it issues are highly sought after in the capital markets. Although the Company's reputation was tarnished during the Great Financial Crisis, it nonetheless operates under a highly visible brand, with Freddie Mac considered its closest peer.
Fannie Mae operates across two business segments (single family and multifamily), with single family accounting for the majority of net revenues (84% in 2023). The Company must obtain FHFA approval prior to any new product offerings, resulting in limitations on its current and future business activities. The Company's business is also closely tied to the cyclical U.S. housing market, resulting in various macroeconomic factors that can influence its financial results (interest rates, home prices, housing activity, GDP, etc.).
Earnings Power
Fannie Mae's earnings power is substantial given the size of its operations, but can also be volatile given its ties to the cyclical U.S. housing market. The Company's primary source of net interest income is the guaranty fees received for managing the credit risk on loans underlying the Company's agency MBS. Given the business model revolves around securitization as opposed to direct lending/loan origination, borrower relationships are more transactional, though services are provided under a highly visible/well-known brand.
The Company reported 2023 net income of $17.4 billion (up 35% YoY) as the strength of home prices drove a $1.7 billion benefit for credit losses for the year (vs. a $6.3 billion provision for credit losses in 2022). Given rising mortgage rates in 2023, Fannie Mae saw significantly lower single family volumes across both purchase and refinance mortgages. Single family acquisitions decreased by 49% YoY (from $615 billion in 2022 to $316 billion in 2023) given the higher rate environment, and multifamily new business volume was down 24% YoY (from $69 billion in 2022 to $53 billion in 2023). The Company expects single-family mortgage originations to grow in 2024 with purchases continuing to dominate given the interest rate environment, and multifamily origination volumes to remain relatively subdued.
Risk Profile
Fannie Mae is exposed to both national and regional housing downturns given its sizeable share of the U.S. housing market. Nonetheless, the Company's single-family guaranty book is geographically diversified, and credit has remained strong with serious delinquency rates (SDQs) remaining near historical lows of 55 basis points (bps) at YE23. Credit has also remained relatively benign in the Company's well-diversified multifamily guaranty book, though SDQs have recently ticked up slightly (from 24 bps at YE22 to 46 bps at YE23), largely driven by stress in senior housing loans. The Company transfers a portion of its single-family credit risk to third parties through the use of mortgage insurance and credit risk transfer transactions, and utilizes credit enhancements (both front-end and back-end) across its multi-family credit exposures.
The Company has sound operational risk oversight, and has maintained a good track record of identifying and managing these risks. Fannie Mae has a comprehensive and well-designed risk management framework/process for setting its risk appetite and monitoring. Cybersecurity risk has significantly increased in recent years and the Company has, from time to time, been the target of attempted cyber-attacks. However, there have been no reported breaches to date.
Funding and Liquidity
Fannie Mae has a broad and deep funding base comprised of a wide range of securities tailored to meet the needs of the global investor base. The Company finances its mortgage purchases by selling debt securities in both the domestic and international capital markets, and offers debt structures to meet the needs of virtually every type of investor segment. The majority of the Company's balance sheet is encumbered given that 97% of total debt is comprised of securitization related debt. Nonetheless, as the Company's agency MBS amortizes with the underlying pools of mortgages, the majority of its funding base is well-aligned with its assets. The remaining funding is issued as unsecured corporate debt, the majority of which is fixed rate (97% of total), with maturities that are laddered appropriately.
In a severely stressed operating environment, Fannie Mae is unlikely to meet its sizeable liquidity requirements (given the scale of its operations) without support from the U.S. Treasury. The Company had $17.3 billion of short-term corporate debt, and $114.3 billion in its corporate liquidity portfolio (consisting of $35.8 billion in cash and equivalents, $47.8 billion in US Treasury securities, and $30.7 billion in securities purchased under repos).
Capitalization
Although Fannie Mae is gradually rebuilding its capital base, capital levels remains substantially below regulatory requirements. Fannie Mae is subject to the enterprise regulatory capital framework (ERCF), though capital requirements have been waived during conservatorship. While Fannie Mae had a GAAP positive net worth of $78 billion at YE23, the ERCF excludes the stated value of the senior preferred stock ($120.8 billion), as well as a portion of deferred tax assets, resulting in the Company being significantly undercapitalized. Indeed, at YE23, the shortfall to adjusted capital requirements totaled $243 billion, with the Company reporting negative regulatory capital ratios given deficit for each tier of capital. Given covenants under the PA, Fannie Mae also does not have access to equity funding except through draws from the U.S. Treasury (and only when total liabilities exceed total assets).
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Credit rating actions on the United States of America are likely to have an impact on this credit rating. ESG factors that have a significant or relevant effect on the credit analysis of United States of America are discussed separately at https://dbrs.morningstar.com/issuers/12866. However, there were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.
A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings from (January 23, 2024) at https://dbrs.morningstar.com/research/427030/morningstar-dbrs-publishes-updated-methodology-for-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.
Notes:
All figures are in U.S. dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 1, 2023): https://dbrs.morningstar.com/research/420144/global-methodology-for-rating-non-bank-financial-institutions. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings: https://dbrs.morningstar.com/research/427030/morningstar-dbrs-publishes-updated-methodology-for-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.
The following methodologies have also been applied:
Global Methodology for Rating Government-Related Entities (February 27, 2024): https://dbrs.morningstar.com/research/428633/global-methodology-for-rating-government-related-entities
The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.
The primary sources of information used for this credit rating include Morningstar, Inc., U.S. Federal Reserve, Federal Housing Finance Agency and company documents. Morningstar DBRS considers the information available to it for the purposes of providing this credit rating was of satisfactory quality.
The credit rating was not initiated at the request of the rated entity.
The rated entity or its related entities did participate in the credit rating process for this credit rating action.
Morningstar DBRS did not have access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.
This is a solicited credit rating.
This credit rating is endorsed by DBRS Ratings Limited for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:
This credit rating concerns a newly rated issuer. This is the first Morningstar DBRS credit rating on this issuer.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.
With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.
For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.
Lead Analyst: Eric Chan, Vice President, NA Financial Institution Ratings
Rating Committee Chair: Michael Driscoll, Managing Director, NA Financial Institution Ratings
Initial Rating Date: April 18, 2024
For more information on this credit or on this industry, visit dbrs.morningstar.com.
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