Feb 17, 2017
Executives
Maureen Davenport - Senior Vice President and Chief Communications Officer Tim Mayopoulos - President, Chief Executive Officer, Director Dave Benson - Chief Financial Officer, Executive Vice President
Analysts
Joe Light - Bloomberg News Denny Gulino - Market News International
Operator
Thank you for joining Fannie Mae's fourth quarter and full 2016 financial results media call and webcast. I would now like to turn over to your host, Maureen Davenport, Fannie Mae's Senior Vice President and Chief Communications Officer.
Maureen Davenport
Thank you Angela. Good morning everyone.
Thank you for joining the media call and webcast to discuss Fannie Mae's fourth quarter and full year 2016 financial results. Please note that this call may include forward-looking statements, including statements about the company's future performance, business plans and strategy.
Future events may turn out to be very different from these statements. The Risk Factors and Forward-Looking Statements section in the company's 2016 Form 10-K filed today describe the factors that may lead to different results.
As a reminder, this call is being webcast and recorded by Fannie Mae and the recording 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 We ask that you do not record this call for public broadcast and that you do not publish any full transcript thereof.
At this point, I will turn it back over to our moderator to begin the call.
Operator
Thank you. Following remarks from Fannie Mae's President and CEO, Tim Mayopoulos, we will open the media conference call lines for questions.
[Operator Instructions]. In order to answer as many questions as possible we ask that reporters only to ask one question.
All lines will be muted unless you are asking a question. I would now like to turn the media conference call over to Fannie Mae's President and CEO, Tim Mayopoulos.
Tim Mayopoulos
Thank you and good morning everyone. Thanks for joining us today as we share our fourth quarter and full year financial results for 2016.
We ended the year as we began it with solid financial performance, ongoing improvement in credit fundamentals, and progress on making our company and the housing finance system stronger and more responsive to the housing market and the evolving needs of our customers. Today, I will summarize our quarterly and annual financial results.
Then I will highlight some of the significant changes we have made at Fannie Mae. While some of these changes began prior to 2016, they delivered real benefits this year to the customers we serve and the taxpayers and to the broader mortgage market.
First, let me review Fannie Mae's 2016 results. For the year, we reported net income of $12.3 billion and comprehensive income of $11.7 billion.
Fourth quarter net income was $5 billion and comprehensive income was $4.9 billion. This is an increase in both net income and comprehensive income from 2015 and the third quarter, respectively.
The fourth quarter increase in net income was driven primarily by fair value gains compared with fair value losses in the third quarter. These fourth quarter fair value gains were the result of increases in longer term interest rates, which positively affected the value of derivatives that we use to manage risk and our mortgage commitment derivatives.
This increase was partially offset by a provision for credit losses in the quarter compared with a benefit for credit losses in the third quarter. The fourth quarter provision was primarily due to an increase in actual and projected interest rates during the quarter.
For the full year, our net income increase was primarily driven by a swing from credit related expense in 2015 to credit related income in 2016. This was driven by both a higher benefit for credit losses and lower foreclosed property expense.
We also had lower fair value losses compared with 2015. As I have said in previous quarters, we do not control some of the important drivers of our financial results, such as changes in interest rates and home prices.
As today's numbers demonstrate, these factors can cause significant volatility in our financial results and they may have a positive or negative effect in any given quarter or year. As you know, the terms of the senior preferred stock we issue to the U.S.
Treasury do not permit us to retain capital. Our capital cushion has declined to $600 million and goes to zero in 2018.
While we expect to remain profitable on an annual basis for the foreseeable future, due to our limited and declining capital reserves and the potential for significant volatility in our financial results, we could experience a network deficit in a future quarter. As described in our 10-K which we filed today, future legislative or regulatory changes also could result in a network deficit in a future period.
If we experience a network deficit in a future quarter, we will be required to draw additional funds from Treasury in order to avoid being placed in receivership. We expect to pay Treasury a $5.5 billion dividend based on our fourth quarter results.
When Fannie Mae pays this dividend in March, we will have paid a total of $159.9 billion in dividends to taxpayers since 2008. Our financial results are attributable to strong performance in both our single-family and multifamily businesses during the past year.
They also reflect a number of significant changes that we have taken at Fannie Mae in recent years. These changes fall into two broad categories.
First, we are delivering more innovations, more simplicity, and more certainty to our customers in the mortgage market and second, we have improved our business model in fundamental ways. Together these changes have better prepared Fannie Mae to meet the rapidly evolving needs of the housing market and our customers.
I will start with the ways we are delivering more value to lenders, investors, and servicers. In 2016, the most tangible and visible expression of this value was our Day 1 Certainty initiative.
Day 1 Certainty is a suite of innovations that represent a step forward in the digitization of the mortgage process. It offers data validation services and improved collateral underwriting services that achieved two major improvements to the mortgage process.
These tools improve the speed and efficiency of the process helping lenders serve borrowers with more speed and ease. They also provide lenders greater certainty that when they sell a loan to Fannie Mae, it will stay sold.
This is vitally important to lenders to allow them to reduce the risk that Fannie Mae will require them to repurchase loans down the line and help them confidently lend to more borrowers. We believe that Day 1 Certainty is a major step in creating a fully digitized mortgage process.
We continue to look for ways to improve (indiscernible) Day 1 Certainty, including expanding our sources of data validation. Our ambitious innovation agenda includes working with lenders, technology companies, and others to find new ways to make the mortgage process easier, faster, more accurate and ultimately, safer.
The other long-term change to Fannie Mae that I want to highlight is the evolution of our business model. Let me call out several of these changes.
For starters, our revenue is now largely driven by our guarantee business and not from returns on mortgage investments. Historically, returns on our mortgage investments were the single biggest generator of our revenues.
Today, it is our guarantee business. This represents a fundamental change in our business model and you will see it reflected in several ways in today's filing.
It is reflected in our net interest income. More than two-thirds of our net interest income in 2016 came from our guarantee business and less than one-third came from our retained mortgage portfolio.
It's also reflected in the size and shape of our retained mortgage portfolio. In 2004, this portfolio contained more than $900 billion [ph] dollars of mortgage assets, nearly all of it investment assets.
At the end of 2016, the portfolio had declined to $272 billion. And most of today's portfolio does not consist of investment assets.
In fact, the bulk of the portfolio consists of loans that we purchased out of mortgage-backed securities trusts in order to modify those loans. Finally, this change to our business model is reflected in our disclosures and our financial reporting.
We have added new disclosures to bring more transparency to the composition of our retained mortgage portfolio. Today's 10-K includes information that shows how much of the portfolio supports the liquidity needs of our single-family and multifamily businesses, how much it supports loss mitigation activities and how much are investment assets.
In total, our retained mortgage portfolio represents 9% of our mortgage credit book of business. The investment asset portion represents only 2% and it is getting smaller.
Given this change in our business model, we have realigned our reporting. In the past, we reported of results of three business segments, single-family, multifamily, and capital markets.
We now report just single-family and multifamily results, which incorporate the capital markets activities that support each business segment. These businesses have been strong performers overall since 2012 and our single-family serious delinquency rate has declined for 27 straight quarters.
As well, our credit risk management tools have also undergone significant evolution, which speaks to another way the company's business model has changed. We began entering the credit risk transfer deals in 2013.
Since then, our ability to syndicate credit risk to private market participants has grown significantly. Investors in our credit risk transfer deals appreciate our role as a trusted intermediary.
They have a high degree of respect for our ability to manage credit risk, including our sophisticated risk analytics. Credit risk transfers allow us to move some of our credit risk to other investors while ensuring that our interests stay aligned with those investors.
We retain a portion of the credit risk in every credit risk transfer deal. As of December 31, 2016 year-end, nearly $650 billion of the single-family loans in our book of business were included in a reference pool for a credit risk transfer deal.
This represents 23% of our total single-family conventional guarantee book. The market for our credit risk transfer deals continues to mature and to grow.
We expect that a larger portion of our single-family guarantee book will be covered by credit risk transfer transactions over time. Together, these two fundamental changes along with our stronger underwriting and eligibility standards represent a significant shift from our prior business model.
We believe these changes will help make the mortgage market more resilient, more liquid and more stable. They will make our company more responsive and adaptive to changing needs of the market and our customers.
They increase the role of private capital in the mortgage market and they reduce the overall credit risk to Fannie Mae and by extension to taxpayers. By becoming a stronger company, we are at a far better position to help our partners confidently expand access to affordable homeownership and rental options for more American families.
In summary, this was another strong year and another strong quarter. Our business has evolved significantly.
We continue to work to strengthen the market we serve in ways that provide value and protect taxpayers, and we will continue to drive innovations both within Fannie Mae and in the broader market. I appreciate your time and I am happy to open it up for your questions.
Operator
[Operator Instructions]. Our first question comes from Joe Light with Bloomberg News.
Joe Light
Good morning. Thanks for taking the question.
I saw that your reserve for loan losses ticked up a little bit. It also looks like it is the first-time it's ticked up since the recovery actually.
So I was wondering if you could talk about what drove that, how much you believe loan losses have further to go down? And kind of more generally whether you are seeing any softness in the mortgage market anywhere?
Tim Mayopoulos
Okay. Thanks, Joe, for the question and I will ask Dave Benson, who is on the line here with us to talk about some of the specific questions you had about the loan loss reserve.
But overall, I would say that we think that mortgage market conditions are good and stable and we think they will continue to be for the foreseeable future. But Dave, do you want to take up Joe's question, specifically about the loan loss reserve?
Dave Benson
Sure. Hi Joe.
The major effect this quarter was actually an interest rate effect. A good portion of our loss reserves are due to concessions that we have given borrowers when we have modified loans.
When interest rates go up, the loans are modeled to have extended in their average life. That extension means that we believe that those loans in being outstanding for longer, we have to carry more of a reserve for that concession, which will go on for a longer time.
We estimate that the extension of that book was about six months just due to the interest rate change. So that was really the primary driver for the increase.
It really was not related to the underlying condition of the housing market.
Joe Light
Okay. Thank you.
Operator
Our next question comes from Denny Gulino with Market News International.
Denny Gulino
Hi. Good morning.
Is there any appreciable impact on your performance this year between the two said scenarios, one quarter-point hike and a three quarter-point hike?
Tim Mayopoulos
Let me to give some introductory remarks to that and then I will ask Dave again to comment on that. But the primary driver of our revenues is our existing book of business.
So that book of business obviously is likely to stay in place in a rising interest rate environment. In other words, people are less likely to refinance that business and so it's much more likely that those loans will stay with us.
And assuming that housing market conditions do not deteriorate, we would expect borrowers to continue to make their payments and we continue to collect the guarantee fees on that book of business. So in terms of the fundamentals of the business, a rising interest rate environment doesn't necessarily mean anything negative for us.
Now it does have some implications for our loan loss reserves, as Dave mentioned, for some of those reasons and for some others, which I will let him talk about but the move from between the two scenarios that you outlined that the Fed has articulated wouldn't have a significant effect on our business. But Dave, do you want to speak to that issue?
Dave Benson
Yes. First off, I would really like to say that we hedge our interest rate risk on an economic basis.
So from an economic standpoint, we don't view ourselves as being particularly exposed, one way or another, to movement in, whether it's the Fed interest rates that they control or the other market rates. We try to neutralize all of that economically as close as we can.
Now the way that our accounting financial results come out, we are sensitive in the various line items that you see there. As we mentioned earlier, our loan loss reserves are sensitive to interest rates.
Obviously, our fair value line is very sensitive to interest rates given our derivative position and other items. And our net interest income will also be sensitive to interest rates as well.
How that all comes out of the wash is sort of hard to say as it relates to the Fed, specifically because what really would matter is not only what's happening with the Fed funds rate, but also what's happening with other various parts of the yield curve that go into our calculations for those various line items. So the long and short of it is that we have sensitivity to the way both yield curve and interest rates move from a financial reporting perspective, but we hedge that the best we can from an economic basis.
Denny Gulino
Okay. Thanks.
Operator
[Operator Instructions]
Tim Mayopoulos
Well, if there are no other questions, we appreciate your time. Thank you very much and we look forward to talk with you again next quarter.
Thanks a lot. Take care.
Operator
Thank you for your participation in today's conference. Please disconnect at this time.