Government regulators say mortgage repurchasers Fannie Mae and Freddie Mac achieved “reasonable levels of profitability” in 2006 while maintaining adequate capitalization and managing potential credit losses from housing-price shock.
In their annual report assessing mortgage markets and the government-sponsored entities’ financial health, analysts at the Office of Federal Housing Enterprise Oversight (OFHEO) said Fannie and Freddie continue to work on issues related to accounting, systems and internal control problems.
Fannie Mae in December released restated financial results for 2002, 2003 and 2004, recording a decrease in retained earnings of $6.3 billion. Fannie Mae released financial statements for 2005 on May 2, 2007, and plans to release financials for 2006 later this year.
Under a May 2006 consent order with OFHEO, Fannie agreed to limit its net mortgage portfolio assets to the level held at year-end 2005 — $727.7 billion — until OFHEO approves an increase.
Until it returns to quarterly reporting of its results, Freddie Mac has voluntarily limited growth in its mortgage portfolio assets to one-half percent each quarter above the level at mid-year 2006 ($710.3 billion). Freddie did not issue quarterly financial reports in 2006 but released full-year 2006 results on March 23.
While Freddie and Fannie have agreed to limit their retained portfolios, their guarantee business remains unfettered. The volume of mortgage-backed securities (MBS) held by other investors and guaranteed by the GSEs jumped 13 percent to $2.9 trillion by the end of 2006.
The GSE’s combined books of business — which includes MBS held by other investors, plus mortgages and MBS held by each company — rose 8 percent in 2006 to $4.3 trillion.
At the same time, total U.S. residential mortgage debt outstanding grew 9 percent in 2006 to $11 trillion. Fannie and Freddie held or guaranteed 39.3 percent of that debt, down slightly from 39.9 percent at the end of 2005.
After declining for three years in a row, Freddie Mac’s net income increased 3.8 percent to $2.2 billion in 2006, OFHEO said.
Fannie Mae reported continued profitability in 2004 and 2005, despite a decline in net interest income and losses on derivatives. Net income declined 39 percent in 2004 to $5 billion and rose 28 percent in 2005 to $6.3 billion. Based on current estimates, OFHEO concluded Fannie Mae also was profitable in 2006.
At year-end, Fannie Mae’s estimated core capital of $42.3 billion exceeded its OFHEO-directed minimum requirement by $4.2 billion, for a 10.9 percent surplus.
Freddie Mac’s core capital of $36.2 billion exceeded its OFHEO-directed minimum requirement by $2.6 billion as of the end of the year, a 7.7 percent surplus.
Foreign investors boosted their share in MBS issued by the GSEs, from 14 percent in 2005 to 20 percent in 2006. Hedge funds, nonprofits and other groups held 30 percent, OFHEO said.
Interest-only loans made up a greater share of the GSE’s purchases of single-family mortgages — 15 percent for Fannie (up from 10 percent in 2005) and 16 percent for Freddie (up from 6 percent in 2005).
Refinance loans made up a smaller share of single-family mortgages purchased by the GSEs — 48 percent for Fannie, and 47 percent for Freddie. Refinance loans made up 53 percent of Fannie’s purchases in 2005 and 56 percent of Freddie’s.
With refinance loans making up a smaller share of loan purchases, the weighted loan-to-value (LTV) ratios of the GSE’s loan purchases rose to 73 percent for both enterprises compared with 72 percent for Fannie and 71 percent for Freddie in 2005.
Loans with greater than 90 percent LTV made up 10 percent of Fannie’s single-family mortgage purchases, and 6 percent of Freddie’s.
Adjustable-rate loans represented 17.7 percent of Fannie Mae’s loan purchases, down from 22 percent in 2005. Freddie Mac, on the other hand, boosted the ARM share of loan purchases from 17.8 percent in 2005 to 22 percent in 2006.
ARM loans and loans with higher LTVs generally have higher default rates. But Fannie and Freddie continue to have low estimated losses from housing-price shock, OFHEO said.
Freddie Mac estimated at the end of the year that a 5 percent decline in home values would increase lifetime losses on its loans by $770 million, or 2.1 percent of the company’s core capital and .04 percent of its book of business.
Fannie Mae estimated that at the end of 2006, a 5 percent decline in home values would increase losses by $1.4 billion, or 3.3 percent of the company’s core capital and .07 percent of its book of business.
OFHEO said Fannie and Freddie continued to manage the credit risk of single-family mortgages using automated underwriting systems to evaluate the credit quality of new purchases, and by obtaining credit enhancements on higher-risk loans.
Automated underwriting systems combine LTV ratios, credit scores, debt-to-income ratios, and other loan and borrower characteristics to classify loans in terms of their risk of default.
The percentage of loans processed through Freddie Mac’s Loan Prospector dropped to 46 percent in 2006, down from 52 percent in 2005. Fannie Mae evaluated 61 percent of its single-family mortgage purchases using its Desktop Underwriter system, up slightly from 60 percent in 2005.
Mortgage markets
Higher interest rates and cooling home sales made 2006 a difficult year for many lenders. The commitment rate on 30-year fixed-rate mortgages averaged 6.42 percent, up significantly from 5.87 percent in 2005. Adjustable-rate mortgages (ARMs) indexed to the one-year Treasury rate averaged 5.54 percent, up more than a percentage point.
Although single-family mortgage originations were down 4.5 percent from the year before, to $2.98 trillion, that was still the third-highest volume ever. While interest rates were up, they remained relatively low by historical standards, and lenders generated record volumes of low-documentation and home equity loans
Most of those loans were bundled and sold as collateral for mortgage-backed securities marketed to Wall Street investors. MBS issuance totaled $2.1 trillion in 2006, down 5 percent from the year before. Fannie and Freddie’s combined share of MBS issuance fell slightly, to 40.7 percent. But MBS issuance by private-label lenders fell for the first time since 2000, by 4 percent to $1.1 trillion.
Alt-A lending was up 5.3 percent in 2006 to $400 billion, and home equity lending increased 18 percent to $430 billion. Alt-A loans represented 13.4 percent of 2006 total originations, with home equity loans accounting for 14.4 percent of originations.
The trend of increasing consolidation in the mortgage lending industry continued for the 12th straight year in 2006, OFHEO said, with the top 25 lenders originating 87 percent of single-family mortgages, up from 83 percent in 2005. That compares to a one-third market share for the top 25 lenders in 1994.
But in addition to their retail channels, the biggest lenders also rely on independent mortgage brokers and correspondent lenders for originations. Countrywide Financial’s retail channel accounted for $156 billion of the lender’s $463 billion in originations for the year, while mortgage brokers and correspondent lenders generated $307 billion in loans for Countrywide.
Industrywide, the retail channel accounted for 37.8 percent of total single-family originations in 2006, down from 41 percent in 2003 and 2004. Within the wholesale market, correspondent lenders boosted their market share to 32.8 percent in 2006, topping broker originations for the first time in three years. The broker share of originations fell to 29.4 percent in 2006 from 31.3 percent in 2005.
Refinance loans accounted for 43.3 percent of originations in 2006, down slightly from 44 percent in 2005 and 46 percent in 2004. Homeowners who refinanced in 2006 increased their mortgage rates by 6 percent on average, compared with a decrease of 7 percent in 2005. The amount of equity cashed out through the refinancing of prime, first-lien conventional mortgages totaled $322 billion in 2006, up from $242 billion in 2005.
The subprime share of single-family originations increased slightly in 2006, to 20.1 percent — more than double the 8 percent share recorded in 2002.
Nearly 75 percent of subprime mortgages in 2006 were ARMs, and ARM originations — prime and subprime — totaled $1.34 trillion, or 45 percent of all single-family mortgages, OFHEO said, citing the industry publication Inside Mortgage Finance. ARM loans made up a larger share of originations in 2005 (47.8 percent) and 2004 (50.1 percent).
Prime conventional mortgages with balances below the conforming loan limit of $417,000 fell 9 percent to $990 billion in 2006, representing only 33 percent of total originations. Prime jumbo loan originations dropped nearly 16 percent from 2005 levels to $480 billion.
At $80 billion, loans insured by the Federal Housing Administration (FHA) and guaranteed by the Department of Veterans Affairs (VA) represented just 2.7 percent of all single-family originations, their lowest level in years.
Existing-home sales volume declined nearly 8 percent from 2005, but the 6.5 million units sold represented the third-highest level ever. New-home sales totaled 1.1 million, the fourth-best year on record.
Investment properties and vacation homes accounted for a smaller percentage of total home sales in 2006 — just 36 percent, compared with 40 percent in 2005. Sales of investment homes fell nearly 29 percent, as the weaker markets reduced speculation. Nearly 64 percent of all residential transactions in 2006 were sales of primary residences, up from 60 percent in 2005.
