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The Week Ahead: The GSEs and Their Dwindling Capital Buffer

Fannie-Freddie-logos-twoThe mortgage industry has been buzzing since mid-February when FHFA Director Mel Watt announced in a speech at the Bipartisan Center that there were risks that were certain to escalate the longer the GSEs remained in conservatorship, namely the requirement to lower the GSEs' capital buffer to zero by January 1, 2018.

With bad news all around in the Q1 earnings statements reported in the last two weeks, punctuated by a $111.2 million net loss for Ocwen, the mortgage industry is anxiously awaiting the first quarter financial results for Freddie Mac and Fannie Mae, which will be released on Tuesday, May 3, and Thursday, May 5, respectively.

The FHFA’s conservatorship of Fannie Mae and Freddie Mac remains a controversial topic due to the possibility of another draw on Treasury (i.e. another taxpayer-funded bailout). The GSEs returned to profitability in 2012, four years after they received a $187.5 billion bailout from taxpayers, but the ability of the GSEs to remain profitable has been questioned by lawmakers and other stakeholders. Last quarter, Freddie Mac answered the question—at least for now—by reporting a net income of $6.4 billion for the full-year 2015 in the Enterprise’s Q4 and full-year 2015 Earnings Report.

Though 2015 was Freddie Mac's fourth consecutive year of profitability, Freddie Mac's 2015 net income of $6.4 billion was a 17 percent decline from 2014 and an even larger decline from 2013's net income of $48.7 billion. The year 2015 was a volatile one for Freddie Mac's earnings—the net income for Q4 was $2.2 billion following a $475 million loss for Q3.

The loss in Q3 2015 for Freddie Mac—which was its first quarterly loss in nearly four years—was mostly due to losses on interest rate derivatives, which Freddie Mac uses as a hedge against changes in interest rates. The value of interest rate derivatives can fluctuate dramatically, however.

Fannie Mae, which relies more on issuance of longer-term debt in order to protect itself against interest rate changes, reported a net income of $2.5 billion for the fourth quarter and $11 billion for the full year of 2015. While Fannie Mae was profitable in 2015 for the fourth straight year, like with Freddie Mac, the profits have been steadily shrinking each year—the $11 billion net income was only a fraction of the $84 billion net income reported for 2013.

The Watt speech in February, the diminishing capital buffer for the GSEs, and the steady decline in GSE profits in the last three years has fueled conjecture that the GSEs will soon need another draw on Treasury. In fact, a blogpost on MarketWatch written by Andrea Riquier entitled “Freddie Mac May Need Another Taxpayer Bailout Next Week” examines the possibility. Riquier reported that Moody's Analytics Chief Economist Mark Zandi said the possibility of Freddie Mac taking a draw on Treasury during Q1 to be “less than 50-50.”

Key figures in the Obama Administration have said that the GSEs will not be recapitalized and released from conservatorship while Obama is president, but the possibility of GSE reform has been back on the minds of many since Watt's speech. The Urban Institute recently published a series of essays on housing finance reform written by economists and other analysts.

Employment Situation for April 2016—Friday, May 6, at 8:30 a.m. EST

All eyes will be on the Bureau of Labor Statistics' Employment Situation for April to see if the gains the labor market has experienced in the last few months will continue or if they will take a step back. Job gains bounced back in February and March after weak January numbers and have now averaged 209,000 per month in the last three months. In March, the unemployment rate ticked back up to 5.0 percent after a couple of sub-5 percent months.

The Fed will no doubt be watching the employment numbers closely in order to determine whether or not to raise the federal funds target rate in June. There will be one additional employment situation released before the next Federal Open Market Committee meeting, which will be June 14 and 15.

Tuesday, May 3, 2016
Freddie Mac Q1 2016 Financial Results, 7:30 a.m. EST

Thursday, May 5, 2016
Fannie Mae Q1 2016 Financial Results, 7:30 a.m. EST

Friday, May 6, 2016
BLS Employment Situation for April 2016, 8:30 a.m. EST

About Author: Brian Honea

Brian Honea's writing and editing career spans nearly two decades across many forms of media. He served as sports editor for two suburban newspaper chains in the DFW area and has freelanced for such publications as the Yahoo! Contributor Network, Dallas Home Improvement magazine, and the Dallas Morning News. He has written four non-fiction sports books, the latest of which, The Life of Coach Chuck Curtis, was published by the TCU Press in December 2014. A lifelong Texan, Brian received his master's degree from Amberton University in Garland.

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