Once a month federal regulators release a report that tells us how things are going with foreclosures at Fannie Mae and Freddie Mac. Judging from the numbers, things are going wonderfully well and in a strange way that’s something which should concern us all.
The latest reports shows that Fannie and Freddie owned 30.5 million mortgages at the end of September. Of those loans, 25.4 million were prime mortgages while 5.1 million were subprime financing.
Assuming we have about 50 million homes with mortgages in the U.S. — the estimate used by the Mortgage Bankers Association — then Fannie and Freddie plainly hold a huge and important chunk of the marketplace.
Okay, so what’s happened with all those Fannie and Freddie loans?
Here’s where we get to the good news: If we compare foreclosure starts to the number of Fannie Mae and Freddie Mac loans outstanding then federal figures for September look like this:
There were 22,495 foreclosures (.089 percent of 25.4 million loans) were started against prime borrowers.
There were 18,474 foreclosure actions (.36 percent of 5.1 million loans) started with subprime borrowers.
Not all foreclosure starts, of course, result in sales on the courthouse steps. In fact, government figures show that only about a third (32.7 percent) of all foreclosure starts with Fannie Mae and Freddie Mac actually result in the loss of a home.
“Fannie Mae and Freddie Mac are the largest buyers of U.S. mortgages so they’re crucially important to borrowers, lenders and investors nationwide,” says Jim Saccacio, chairman and CEO at RealtyTrac.com, the leading source of foreclosure listings and data. “For example, the recent winter-time foreclosure moratoriums started by Fannie Mae and Freddie Mac set a precedent that others in the mortgage field can easily copy.
“We associate Fannie Mae and Freddie Mac with conventional loan standards,” Saccacio continued. “One value of those benchmarks can be seen in the form of the relatively low foreclosure levels both companies enjoy at a very tough time in the marketplace.”
While the figures are not precisely comparable, the Mortgage Bankers Association says in the third quarter of 2008 that the non-seasonally adjusted foreclosure start rate for prime loans was 0.61 percent and 4.23 percent for subprime loans.
By any reasonable standard Fannie Mae and Freddie Mac are doing great. Despite difficult times they have substantially lower foreclosure rates than lenders in general.
Curiously, the Federal Housing Finance Agency (FHFA), the federal office which oversees Fannie Mae and Freddie Mac, has a different story to tell. Instead of looking at foreclosures and all the loans held by Fannie and Freddie, it has instead put out a news releaase which tells us the percentage of delinquent loans that have been converted into foreclosure starts.
“Loans for which foreclosure was started as a percent of loans 60+ days delinquent declined from 8.29 for the first quarter and 7.81 percent for the second quarter to 7.12 percent for the third quarter.”
If you’re a headline writer, 7.12 percent sure seems bigger — and more newsworthy — than the much smaller percentages which could be shown by looking at foreclosures and the total number of outstanding Fannie Mae and Freddie Mac loans.
Usually companies and federal agencies like to put out good news — say bigger profits or smaller losses — but that can’t be done at FHFA. If the agency explains how well Fannie and Freddie are doing it raises the question of why the two government-sponsored enterprises (GSEs) were taken over by the federal government in the first place.
The Take-Over
You’ll remember last July federal regulators said “the Enterprises’ $95 billion in total capital, their substantial cash and liquidity portfolios, and their experienced management serve as strong supports for the Enterprises’ continued operations.”
There’s no question that Fannie Mae and Freddie Mac have some percentage of failing loans within their portfolios but that’s hardly unusual — all lenders, in all markets, have some loans that don’t work out precisely because lending is not a risk-free business.
It’s equally true that both companies had massive reserves plus the ability to borrow more in mid-summer. Yet just a few weeks later they were taken over by the federal government in September because “as house prices, earnings and capital have continued to deteriorate, their ability to fulfill their mission has deteriorated. In particular, the capacity of their capital to absorb further losses while supporting new business activity is in doubt.”
How well the two companies are actually doing at year-end is unclear. About a month after they were placed under a federal control government regulators announced that “it is prudent and in the best interests of the market to suspend capital classifications of Fannie Mae and Freddie Mac during the conservatorship, in light of the United States Treasury’s Senior Preferred Stock Purchase Agreement.”
Prudent for whom? In who’s best interest? Certainly not the shareholders — they lost billions of dollars in equity during the past year as stock prices in the two companies fell to less than a buck.
In the first half of the year, Fannie Mac had a loss of $4.5 billion. In the third quarter the reported loss was $29 billion. At Freddie Mac the results were smaller but similar: During the first two quarters the company lost $972 million while in the third quarter it dropped $25.3 billion. In November the Treasury transferred $13.8 billion to Freddie Mac and the Federal Reserve announced that it would purchase mortgage-backed securities worth as much as $500 billion from Fannie Mae, Freddie Mac and Ginnie Mae.
Financial Flexibility
This is all routine stuff except for one notable curiosity: Fannie Mae and Freddie Mac are actually doing better than public reports suggest. Much better.
How can that be? Very simple. Financial reports allow for considerable latitude. Usually such flexibility is a license for companies to claim the largest possible quarterly profits, but there’s surely no rule which says corporate leaders cannot be more conservative.
For instance, Freddie Mac reported that for the third quarter “results were driven primarily by a non-cash charge of $14.3 billion related to the establishment of a partial valuation allowance against the company’s deferred tax assets, $9.1 billion in security impairments on available-for-sale securities and $6.0 billion in credit-related expenses arising from the dramatic deterioration in market conditions during the third quarter, including declining home prices, increasing unemployment, a significant decline in consumer spending and a considerable tightening of both consumer and business credit.”
In other words, not a nickel of the $14.3 billion, the $9.1 billion or the $6 billion — a total of $29.4 billion — was actually lost, instead the money was set aside just in case. Such beefed-up reserves were used to lower company earnings to produce that well-publicized $25.3 billion loss.
Meanwhile, Freddie’s cash and cash equivalents rose from $8.6 billion at the end of 2007 to $50.2 billion at the start of October 2008 — BEFORE the Treasury contribution.
Unlike Freddie Mac, Fannie Mae has received no federal money. Its third quarter loss of $29 billion is also the byproduct of financial flexibility, results “driven primarily by a $21.4 billion non-cash charge to establish a valuation allowance against deferred tax assets, as well as $9.2 billion in credit-related expenses arising from the ongoing deterioration in mortgage credit conditions and declining home prices.”
What do we see looking at Fannie Mae’s cash? You might expect the vault shelves to be dry but that’s not the case: cash and cash equivalents went from $3.9 billion at the end of 2007 to $36.3 billion at the end of September 2008.
The obvious question that arises is this: Why has it been necessary to nationalize two companies that have operated without fail, seen their cash hoards grow in the worst market since the 1930s and have lower foreclosure levels than most industry competitors?
What do you think? I would like to hear from my readers/clients. If you have any questions on foreclosures give me a call….239-596-1181
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