Feb 14, 2019
Operator
Ladies and gentlemen, welcome, and thank you for joining Fannie Mae’s Fourth Quarter and Full Year 2018 Financial Results Media Call. Please note that all connections are presently muted and questions will be taken from the media following the formal presentation.
I will now turn the call over to your host, Duncan Burns, Fannie Mae’s Vice President and Head of Communications.
Duncan Burns
Hello, and thank you all for joining today’s media call to discuss Fannie Mae’s fourth quarter and full year 2018 financial results. Please note, this call may include forward-looking statements, including statements about the Company’s future dividend payments, capital requirements and reserves, financial and business results, actions, business plans, healthy market forecasts 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 2018 Form 10-K filed today describe factors that may lead to different results.
As a reminder, this call is being 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 We ask that you do not record this call for public broadcast and you do not publish any full transcript.
I’d now like to turn the call over to Fannie Mae Interim Chief Executive Officer, Hugh Frater; and Chief Financial Officer, Celeste Mellet Brown.
Hugh Frater
Thank you, Tony. And thank you, Duncan, and good morning.
Thanks for joining us to discuss Fannie Mae’s results for the fourth quarter and full year 2018. I’m joined today by our Chief Financial Officer, Celeste Brown.
At the moment, Celeste will review our 2018 performance, the economic outlook and capital. After that, we’ll be glad to address any questions you have.
First, however, I would like to review a few Fannie Mae’s priorities for the year ahead, and on a high level, how we see some of the major trends in our business and the market we serve. First, our customer focus has helped us deliver a stream of innovations that are improving the experience of being a Fannie Mae customer and helping make the mortgage process more efficient for their customers.
These innovations include, our Day 1 Certainty tools that are cutting costs and time out of the loan production process. They also include new servicing tools that are making it easier and less costly to service a Fannie Mae residential loan.
In the Multifamily space, we have green financing to support cost-effective environmental improvements and reduced utility cost for residents, and we have enhanced delegations that streamline DUS Multifamily origination process. Second, as part of our strategy, we’re continuing to strengthen our business model.
In 2018, for example, we continued to expand our credit risk transfer programs. Through this work, we are bringing more private capital into the housing finance system and are moving risk away from the tax payers.
As a result of these strategic choices, Fannie Mae heads into 2019 with a strong market position and stable business model. Our priorities for 2019 are clear.
First, we’re working to ensure a smooth transition to the uniform mortgage-backed security. While we’re still testing underway, we expect that Fannie Mae and Freddie Mac will begin issuing the new UMBS in June.
We have been working with Freddie Mac, FHFA, our customers, investors and many other market stakeholders to help ensure that this process is orderly and transparent. Second, in 2019, we’re to going to continue to drive progress toward our vision of an all-digital mortgage process.
We believe we are still in the early stages of a technological trend that will drastically improve the quality, efficiency, speed and safety of the mortgage process. We believe the potential benefits to our customers and the housing market are enormous, and that Fannie Mae is in a unique position to help enable this digital transformation.
The third area of focus in 2019 is capital, which Celeste will address in more detail in a moment. As you know, a regulator has put forth a proposed capital rule, and we have provided comments on a proposal.
Obviously, capital is critically important to our business and our mission. A robust and sensible capital regime for the GSEs is necessary to both protect tax payers and sustainably attract private capital to the housing finance system.
And last, but far from least, in 2019, Fannie Mae will direct more of its energy and focus to helping address the significant shortage of affordable housing in the United States. The supply of homes that are affordable to working and lower-income families has been on a decade-long decline due to the combination of growing demand and inadequate supply.
Fannie Mae wants to put both its intellectual capital and its real capital to work to help reverse this trend, but due so in a way that is consistent with our charter, mindful of risk and beneficial to the market. This is why we’re working with innovators in the housing and mortgage markets to explore new ways to build, maintain and finance homes and multifamily properties that are fundamentally less costly to the end user.
It is also why we’ve committed to helping develop a secondary market for manufactured housing loans. A housing supply challenge is not something that Fannie Mae alone can overcome.
It will require collaboration with and focus by many stakeholders, including those operating at the national and the local levels. But Fannie Mae has a role to play.
We’re committed to participating, and where appropriate, leading efforts to increase the supply of affordable housing in the United States. It took more than a decade for housing scare city problems to develop and it may take as long to fix them.
Before I turn it over to Celeste, I want to mention that 2019 will be a year of transition and change for the industry and for Fannie Mae. This year of transition and the leadership team at FHFA, as our regulator and conservator, FHFA played a very influential role in our business.
We’ve built a strong and constructive relationship with FHFA over the years, and we will focus on maintaining that relationship in 2019. It is also a year of transition for Fannie Mae consistent with its plans, our Board continues the selection process for a permanent Chief Executive Officer.
And as Celeste will discuss, we’re keeping close tabs on a number of trends in the overall economy and in the housing market this year. Whatever changes may come, Fannie Mae’s focus remains the same.
We’ll maintain a strong book of business, prudently manage our risk and continue to build the company that is ready to meet the changing needs of the housing finance system. With that, let me turn it over to Celeste, and we will leave time at the end for your questions.
Celeste Mellet Brown
Thank you, Hugh, and good morning, everyone. First, I’m going to review our financial highlights for the quarter and the year.
I will then turn to our outlook, and finally, discuss capital. With a very solid financial performance in 2018 was net income of $16 billion and comprehensive income of $16.6 billion.
For the fourth quarter, we earned $3.2 billion of net income and comprehensive income. Based on these results, we ended 2018 with a net worth of $6.2 billion and expect to pay a $3.2 billion dividend treasury by the end of March.
That will leave us with a net worth of $3 billion, which is the maximum capital buffers specified on a senior preferred stock purchase agreement. Consolidated Fannie Mae revenue for the fourth quarter declined versus the third quarter.
First, while fee revenue increased on a larger book size, revenue declines were primarily driven by lower amortization income due to lower mortgage prepayment activity as the steady increase in interest rates during most of 2018 resulted in fewer people refinancing their homes. In fact, 30% of the new Single-Family loans we guaranteed in the first quarter were refinancers compared to 46% in the fourth quarter of 2017 when average mortgage rates were 86 basis points lower.
Second, credit-related incomes increased compared to the third quarter, primarily driven by lower projected future interest rates as well as higher forecasted home prices. And finally, we have fair value losses in the fourth quarter and compared to gains in the third quarter, driven by a decrease in interest rates, particularly, late in the quarter.
Turning to our Single-Family business. Our pre-tax income declined by $1 billion in the fourth quarter versus the third, primarily driven by the factors that drove our overall results.
This Single-Family guaranty book of business continued to grow in the fourth quarter, up 23 basis points in the quarter, and 155 basis points in 2018. Average charge fees on acquisitions net of TCCA decreased to 48.5 basis points in the fourth quarter from 49.7 in the third, driven by increased competition in our acquisition product mix.
However, fourth quarter charge fees were more than 6 basis points higher than they were in the fourth quarter of 2017. The average charge fee on the book overall increased slightly to 43 basis points in the fourth quarter.
The Single-Family delinquency rate was 76 basis points at the end of 2018 continuing the downward trend at the peak of the financial crisis. Turning to Multifamily, net income increased in the fourth quarter versus the third, driven by growth in fee revenue due to a larger book size, with the book up 3% over $300 billion in the quarter, and up 10% in 2018.
We continue to see downward pressure on our acquisition charge fees in our Multifamily business due to competitive market dynamics, driven by increased demand from capital markets investors for credit risk. The average charge fee on acquisitions declined by approximately 25 basis points year-over-year, driving the charge fee on the overall book down from approximately 79 basis points at the end of 2017 to approximately 75 basis points at the end of 2018.
This third transaction we completed in the quarter was an important tool for us to reduce capital requirements and reach our return hurdles despite the competitive environment. The Multifamily serious delinquency rate was at 6 basis points at the end of 2018.
While the population of the Multifamily substandard loans remains low, it increased in Q4 and was the primary driver of a slight increase in allowance. The increase is being driven by pressure in certain segments of the book in which properties backing our loans are experiencing slower or negative NOI growth.
Overall, however, the risk ratings and credit profile with a book remain very strong with near all-time lows in delinquency. Turning to our outlook, economic growth is projected to slow.
Some potential risk to economic and housing market expansion include; first higher interest rates have increased borrowing costs for households and businesses over the past year. Our forecast reflects one Fed rate increase in June.
Second, tax reform has weakened the mortgage subsidy with potential implications for regional housing price growth over time. We expect 2019 home price growth to be approximately 4% down from 5.6% in 2018, while the economy is slowing home price growth continues to be supported by a shortage of supply.
We expect total Single-Family refinance market originations in 2019 to be down by 8% versus 2018, while purchase mortgage originations are expected to increase modestly, resulting in a slight drop in the refinance share of the market originations to 26% in 2019. Our outlook for the Multifamily sector is that rent growth will be positive this year, but slightly lower than in 2018, and between 2% and 2.5% due to new supplies just as job growth slows resulting in fewer household formations and lower demand.
As it relates to our earnings, let me remind you of several things as you think about 2019. First, while the sale of re-performing and non-performing loans and the associated redesignation of these loans from house for investment or HFI, to held for sale or HFS has been a significant driver of income in recent periods.
We may see less benefit in 2019 to the extent the population of loans we are considering for sales decline. In the past year, redesignations and investment gains on sales of these loans from our retained portfolio were significant driver of earnings, contributing $2.3 billion on a pretax basis.
Second, we are unlikely to experience the same fair value gains as we did in 2018. Our fair value gains and losses are dependent on a number of factors including changes in interest rates, which are difficult to predict.
If rates were to decline, fair value gains could be much lower or turned to losses. Fair value gains drove positive $1.1 billion of pretax income in 2018.
Third, lower home price growth and a smaller allowance overall will likely further reduce credit related income in 2019, while higher rates are also a headwind. Actual and projected home price growth drove $1.2 billion of benefits for our pretax income in 2018.
Finally, I will turn to capital. At the end of 2018, our proposed capital requirement was $89 billion down $5 billion from the end of 2017.
Excluding the impact of DTA, which was included in the year end 2018 number, but not in the 2017 number. Our conservative capital requirement would have been down $11 billion.
The key driver of the decline of our theoretical capital requirement was 5.6% increase in home prices during the year, which drove an approximate $13 billion decline in our requirements and this was partially offset by other factors. The capital rule is very sensitive to home prices, when home price is go up, capital requirements go down, and as home prices decline, capital requirements increase.
This feature on the proposed capital framework is commonly referred to as procyclicality. We are committed to reducing the risk of the business in a prudent way and the reduced capital number also reflects our business actions.
The reduction in our retained portfolio down $52 billion during the year, due in part to aggressive sales, RPL and NPL loans and other factor was a meaningful contributor and reduce their capital requirements beyond the reduction driven by procyclicality. The reduction in capital from portfolio sales and procyclicality was partially offset by book growth associated with new acquisition.
To reduce the growth by our capital requirements on these new acquisitions, we continue to transfer risk across those businesses, including our highly successful DUS risk sharing program, which transferred almost a third of our risk for multifamily on day one and a back-end risk transfers we executed in Single-Family and Multifamily. We are proud of the advances we made on risk transfers this year, including: we transferred a portion of risk on over 90% of our recently acquired eligible Single-Family loans, using CRT transactions.
This population generally consists of non-refi plus 30-year fixed-rate mortgages with loan to value ratios between 60% and 97%. Through these programs, we transferred a small portion of our expected losses and a significant portion of the losses we expect would incur in a stress credit environment, such as the severe or prolonged downturn.
We also introduced a new CAS REMIC structure for Single-Family, which has attracted additional investors and better aligns the benefits of the risk transfer with GAAP accounting. As I mentioned, we continue to transfer approximately 30% of our front-end risk in the Multifamily business to our DUS program, which covers a portion of both expected and stress losses.
We also extended our Multifamily’s CIRT program, while exploring additional programs for transferring and Multifamily credit risk. In addition to the coverage we get through DUS, the two multifamily CIRT transactions we initiated in 2018 covered over one-third of our acquisitions or $22 billion of UPB.
This allowed us to transfer a significant portion of the losses we’d expect to experience on those loans in the stress environment. As we think about capital more broadly, we are focused on optimizing around the capital standard in place, considering the proposed will generally.
Key inputs to our analyses are; one, our mission requirement to provide liquidity in all markets; two, the DUS and availability of the risk transfer market. We are mindful of a GSE credit risk transfer markets are unproven and prolonged stress conditions.
In our 2018 defect severely adverse stress test, we assume that we would be unable to issue CRT. It’s worth noting that our DUS model has proven to be an effective risk sharing structure even in various stressed markets, while reducing risk to the tax payer by aligning incentives; Three, the ability of appropriately structured risk transfer to mute the impact of the allowance of stress test, and thus, reduce our stress losses; Four, the cost benefit of transferring risk more dynamically; Five, the Company’s cost structure; Six, the procyclicality of the proposed rule; Seven and finally, our ability to generate appropriate risk-adjusted return.
With that, I’ll turn it over to Tony, and Hugh and I will answer your questions.
Operator
Thank you, Celeste. [Operator Instructions] And we’re going to first [indiscernible] from Global Capital.
Unidentified Analyst
Hi, I didn’t dial in for a question, and I feel bad about asking anything, because I joined the call bit late. I had some problems connecting.
I guess maybe, and I’m sorry if you guys already touched on this, to what extent market volatility in the fourth quarter may be affected your ability to turn to capital markets for CRT financing? And look whether or not, you took a noted maybe portfolio loss just mark-to-market I mean you hold?
Thank you.
Celeste Mellet Brown
Good morning. Thanks for the question.
We – market volatility did not affect our ability to transfer risk in the fourth quarter. We continue to transfer risk in both the Single-Family and Multifamily business in a way that makes sense and is ROCC accretive.
As it relates to mark-to-market, we did have fair value losses in the quarter, driven primarily by the lower interest rates. But outside of that, there was nothing notable in terms of the market volatility.
Unidentified Analyst
Thank you.
Operator
[Operator Instructions] We’ll next move to the line of Bonnie Sinnock. Bonnie, please go ahead.
Bonnie Sinnock
Hi, thanks for taking my question. I wonder if you – I wanted to check when you’re talking about the captial and the procyclicality, maybe walk me through a little bit more.
And I wanted to double check, when you’re talking about, I think you said DTA, you meant like the deferred tax assets, correct?
Celeste Mellet Brown
Good morning, Bonnie. Yes, yes.
And your second question first, yes. We did mean the deferred tax asset.
The FHFA has changed what they would like us to include in terms of our capital requirement and the calculation of that. So as I said, it was not in the number at the end of 2017, but it was in the number at the end of 2018.
And can you remind me of your first question, I’m sorry.
Hugh Frater
Procyclicality.
Celeste Mellet Brown
Procyclicality, yes. So what happens is the capital rule is based on a set of grids that looks at when we issue a loan the cycle of loan and the loan-to-value of loan.
In those girds, what’s very contemplated is a 25% decline in home prices. So already – the grids already contemplate the fact that home prices could go down.
So what happens is, as home prices go up or down, the capital requirements for those loans go down or up. So if home prices go up, as they did during 2018, 5.6%, it leads to a decline in our capital requirement.
So while we are earning – we have strong earnings and things are good, our capital programs are actually going down. On the flip side, if home prices were to go down, our capital requirements were to go up – would go up.
So our ability – and our ability to generate capital because our earnings would be going down would be much more difficult. So as I mentioned, that’s what people refer to as procyclicality.
Bonnie Sinnock
Okay, thank you. And it sounds like that played a big role in what you thought, they’ve got a transferred the deferred tax assets.
But that played a – otherwise played a role in the difference between 2017, 2018?
Celeste Mellet Brown
That’s right. It was the biggest driver of our capital year-over-year, excluding the – inclusion in the deferred tax asset.
Actually even including the deferred tax asset, it was the biggest driver of our capital.
Bonnie Sinnock
Okay. So essentially it was a – sorry, [indiscernible] going to check if I could.
So what accounted for the difference in the home prices was there, you had the lower home price gains in the past year than the previous year.
Celeste Mellet Brown
But, Bonnie, home prices were up about the same amount in 2018 as 2017. The other drivers of capital in the quarter – so we mentioned – the procyclicality, we mentioned the deferred tax assets.
We did continue sell RPL and NPL loans and then, of course, every time we acquired new loan they’re capital associated with those and we were able to reduce the potential impact of that capital associated with the new loans without the risk transfer that we did.
Bonnie Sinnock
Okay. Is the procyclicality applied not equally to the two years?
Celeste Mellet Brown
The procyclicality would affect any period. We have not provided these numbers before this quarter.
So, I don’t have a comparable with me. I don’t have a comparable estimate, so what the impact would have been in 2017 over 2016.
Bonnie Sinnock
Okay. So you see the procyclicality in the 2018 numbers, but you don’t see in the 2017 numbers?
Celeste Mellet Brown
We would have seen an impact from procyclicality in the 2017 numbers, between 2016 and 2017, I just don’t have those numbers with me.
Bonnie Sinnock
Right, okay. It would be interesting to see.
Operator
All right, thank you. And at this time I’m not showing any further questions in our question queue.
So I’ll now turn the call back over to Fannie Mae Interim Chief Executive Officer, Hugh Frater.
Hugh Frater
Well, thank you, everybody for your time this morning. And thank you Tony, and we look forward to seeing you next time.
Operator
All right. And again, ladies and gentlemen, thank you so much for joining us today.
That does conclude our conference. You may now disconnect.