Fitch Places GSEs on ‘Rating Watch Negative’

Fitch Ratings has placed Fannie Mae's and Freddie Mac's 'AAA' Long-term Issuer Default Ratings (IDRs), 'F1+' Short-term IDRs, Government Support Ratings (GSRs) and debt ratings on Rating Watch Negative (RWN). These rating actions follow Fitch's placement of the United States' 'AAA' Long-term Foreign and Local Currency IDRs on RWN on May 24, 2023.

As the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac benefit from implicit government support. Fannie Mae's and Freddie Mac's Long-Term IDRs and GSRs are directly linked to the U.S. sovereign's Long-Term IDRs, based on Fitch's view of the U.S. government's direct financial support of the two housing GSEs.

The placement of the housing GSEs' ratings on RWN reflects the uncertainty surrounding the resolution of the RWN on the U.S. It is also unclear at this time what level of support the housing GSEs can expect if the U.S. rating were to drop to 'Restricted Default (RD)'. The rating linkages are further detailed in Fitch's report "GSE Rating Linkage to the U.S. Sovereign.”

If Fitch were to downgrade the U.S. sovereign to 'RD' due to debt ceiling challenges, it would not necessarily lead to an immediate downgrade of the housing GSEs' ratings to 'RD', provided the housing GSEs continued to perform on their respective obligations. Fitch notes that the repayment of the GSEs' obligations stems primarily from cash flows from operations, as opposed to direct reliance on the federal government.

The housing GSEs continue to benefit from meaningful financial support from the U.S. government. Fitch aligns the GSEs' ratings to the U.S. rating due to their mission critical function to the U.S. housing finance system and the U.S. Treasury's Senior Preferred Stock Purchase Agreement (SPSPA). Fitch believes Fannie Mae and Freddie Mac continue to execute on their mission to provide liquidity, stability, and affordability to the housing finance industry. Under the SPSPA, the U.S. Treasury is required to inject funds, up to the dollar amounts of the terms of the agreement into Fannie Mae and Freddie Mac to maintain positive net worth, so that each firm can avoid being considered technically insolvent by their conservator, the Federal Housing Finance Agency (FHFA). At March 31, 2023, Fannie Mae's net worth stood at $64 billion and Freddie Mac's stood at $39.1 billion. The current amended version of the SPSPA allows the GSEs to retain capital until they each meet minimum capital levels that would be required prior to exiting government control.

The Treasury and FHFA have the ability to amend the SPSPAs bilaterally, and following a Supreme Court decision in 2021, leadership at both the Treasury and FHFA serve at the President's will. In particular, changes to the SPSPAs that negatively affected the GSEs' ability to raise capital organically could strengthen the government's control over the GSEs by cutting off their ability to grow capital, which could create challenges for future administrations to release the GSEs from conservatorship.

Just last week, Fitch placed the U.S. “AAA” on RWN, signaling that it could downgrade U.S. debt if lawmakers did not agree on a bill that would have raised the Treasury’s debt limit.

In the future, if Fitch views government support as reduced, particularly through housing finance reform efforts, the ratings of the GSEs could be delinked from the sovereign and downgraded. Fitch believes this risk is well outside of the current rating horizon, and meaningful GSE reform is not likely for the foreseeable future.

The GSEs could be removed from RWN if the U.S. sovereign rating is removed from RWN.

Both Fannie Mae and Freddie Mac recently issued their earnings report for Q1 of 2023, with both GSEs showing quarter-over-quarter gains amid a volatile housing marketplace. Fannie Mae reported $3.8 billion in net income for Q1 of 2023, with net worth reaching $64 billion as of March 31, 2023. Fannie Mae reported its net income increased $2.3 billion in Q1 compared to Q4 of 2022, driven by a $3.2 billion decrease in provision for credit losses.

“We delivered strong first quarter results in a volatile market and remain committed to being a source of stability for the housing finance system throughout all economic cycles,” said Priscilla Almodovar, CEO of Fannie Mae. “We are able to do so because of the changes we've made to improve the resilience of our business, our focus on risk management, and strong liquidity. This allows us to continue to facilitate affordable, equitable, and sustainable access to homeownership and rental housing.”

Freddie Mac reported a net income of $2 billion in Q1 of 2023, yet a 47% year-over-year drop in the quarter, primarily driven by lower net revenues and a credit reserve build in the current period. Net revenues were $4.8 billion, down 17% year-over-year, as higher net interest income was offset by a decline in non-interest income. Net interest income was $4.5 billion, up 10% year-over-year, primarily driven by mortgage portfolio growth, higher average portfolio guarantee fee rates, and higher investments net interest income due to higher interest rates. These increases were partially offset by a decline in deferred fee income due to slower prepayments as a result of higher mortgage interest rates. Non-interest income was $0.3 billion, down 81% year-over-year, primarily driven by a decline in net investment gains in Single-Family from elevated levels in the prior year period.

“We had a solid quarter, earning $2 billion with no significant impact to our earnings or balance sheet from the recent banking industry disruption,” said Michael DeVito, Freddie Mac CEO during the GSEs’ earnings call. “Our earnings enabled us to transfer more than $250 million to Housing and Urban Development’s Housing Trust Fund and Treasury’s Capital Magnet Fund, to benefit lower-income borrowers and renters. Solid earnings also increased our net worth by more than $2 billion to $39.1 billion. Our performance during the quarter was partly the result of steps we’ve taken these past 15 years to focus on the safety and soundness of our enterprise, particularly with respect to credit risk. That’s enabled us to serve our mission and be a stabilizing force during the recent banking crisis and the pandemic before that. It’s also enabled us to be there for families when natural disasters struck across the country.”