Loans have become harder to do,
and underwriters that I have spoken to keep telling me that every deal is
different. How many scenarios are there? Probably not as many as there are
atoms in the universe, or possible games of chess. The Shannon number, named
after Claude Shannon, is an estimated lower bound on the game-tree complexity
of chess. Put more simply, people throw that out there when they're talking
about the possible number of games of chess. I won't mire you down in the
complexity, permutations, and different opinions, but it is up around 10 to the
123rd power (10x10 one hundred and twenty three times). As a
comparison, the number of atoms in the observable universe, to which it is
often compared, is estimated to be "only" 10 to the 81st
power.
Congress returns to work this
week, and a certain amount of attention will be devoted to the Senate Banking
Committee. Chairman Tim Johnson (D-SD) and Ranking Member Mike Crapo (R-ID),
who are expected to unveil a GSE reform bill in the near future. But does
the government really want to dispose of its Golden Geese: Fannie &
Freddie?
Last week Fannie Mae not only
reported record earnings in 2013, but has paid back all of the bailout money
owed to the Treasury. The fourth quarter of 2013 was its eighth consecutive
profitable quarter for Fannie Mae, and the company posted net income for the
entire year of $84.0 billion and pre-tax income of $38.6 billion. In 2012 the
government sponsored enterprise (GSE) had both net income and pre-tax income of
$17.2 billion. The 2013 annual net income includes a one-time release of the
company's valuation allowance against its deferred tax assets. Fannie Mae
reported net income of $6.5 billion for the fourth quarter and pre-tax income
of $8.3 billion. Net income in the third quarter was $8.7 billion. The GSE will
pay a $7.2 billion dividend to the U.S. Treasury in March bringing the total
dividends in 2013 to $85.4 billion. Since the company was placed in
federal conservatorship in 2008 it has paid a total of $121.1 billion in dividends
against $114.1 billion in draw requests.
Are the earnings for real? Sure
they are: both Fannie and Freddie have been benefitting from a
recovering market that lifted home prices and kept a lid on loan defaults.
Their return to profitability also allowed them to reverse write-downs of
certain tax-related assets, which led to large one-time windfalls. Lastly, both
agencies have been the beneficiaries of various lawsuits and settlements with
mortgage aggregators, investment banks, and smaller lender who were, or are,
counterparties.
But what about 2014 and beyond?
There is a wide range of thinking on who, what, when, where, and how the
Agencies will transform - of even if they should. We are in yet another
election year, and Congress is notoriously slow in making possibly
controversial and difficult decisions in election years. Cynics are quick to
say that there is little political reason to turn a money making enterprise
over to private shareholders. There has been progress in the Senate Banking Committee
about proposals for Freddie & Fannie. But, thinking back to high school
civics, anything that comes out a committee has to go to the full Senate (or
House of Representatives). And the House is doing the same thing. And then the
bills are reconciled, voted on, and sent to the president. Many believe that in
an election year, this might be a near impossibility, in which case the work is
redone in 2015 based on the results of November's election. So even if a
bill is introduced, it will be a long path, and even if eventually signed by
the president, it will take years of hard work to affect change.
Lastly, the issues involved are
very complex. Not only are the Agencies' role in the primary markets very
important (standardized, pricing, uniform appraisal standards, documents, and
underwriting to name a few roles), but any changes could have a significantly
negative impact on the securities in the secondary markets. The MBA, SIFMA, and
other organizations are very involved in the discussions - no one wants to
spook the investor community.
Fannie Mae, for one, is
certainly doing more business with smaller and mid-sized lenders. And
that segment of the market is only too happy to sell the asset to the agencies,
and either try to keep the servicing or sell it on a flow basis to someone
other than an aggregator. The industry is abuzz about how the agencies are not
engaging in any kind of meaningful pre-funding review, and that it is
"easier" to sell to them. "Hey, they don't suspend our files
like Chase does!" is something I have repeatedly heard.
But industry vets agree that a)
Fannie and Freddie are not in the business of not reviewing files, and b) it is
only a matter of time until the Agencies come back to lenders to correct
deficiencies or for buybacks. Any back-up here or there will
be corrected, files will be thoroughly audited, and they can play hardball. But
yes, F&F have grabbed market share from the aggregators while the servicing
market has been in flux, and by sometimes offering better prices to smaller
lenders than to the aggregators. Bloomberg reports that Fannie's top 5
customers accounted for 42% of its volume in 2012, 60% in 2011, and I am sure
that the trend continued in 2013. Per the story, the decline in share from big
originators in recent years reflects exits from 3rd-party channels by several,
and large mortgage lenders leaving the business since 2006. Non-bank share is
also increasing, and although the trends show reducing the "significant
exposure concentration we have built up with a few large institutions" at
the same time smaller firms' "potentially lower financial strength,
liquidity and operational capacity" may raise counterparty & credit
risk. That will certainly prove true in 2014 - counterparty risk is the name of
the game.
There has not been much
volatility lately in interest rates - and no one minds. Congress returns this
week with a heavy focus on housing finance reform and flood insurance. The
House is expected to take up legislation similar to a recent Senate-passed bill
that would delay spikes in premiums under the National Flood Insurance Program.
But this week has plenty of
potentially market-moving news. There is zip today; tomorrow are some housing
price numbers as well as the S&P/Case-Shiller series, and Consumer
Confidence. On Wednesday will be New Home Sales, Thursday is Jobless Claims and
Durable Goods (always volatile, depending on if a big airplane or machinery
order came in), and Friday we'll see Pending Home Sales, the University of
Michigan Consumer Confidence number, the Chicago PMI, and revisions to the
fourth quarter GDP number. In addition, there will be Treasury auctions on Tuesday,
Wednesday, and Thursday. Looking at the numbers, the closing yield on Friday
of the risk-free 10-yr T-note was 2.73%, and this morning we're still there.
Agency MBS prices are also about unchanged.
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