UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
Commission File No.: 0-50231
Federal National Mortgage Association
(Exact name of registrant as specified in its charter)
Fannie Mae
Federally chartered corporation | 52-0883107 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
3900 Wisconsin Avenue, NW Washington, DC (Address of principal executive offices) | 20016 (zip code) |
Registrant’s telephone number, including area code:
(800) 2FANNIE (800-232-6643)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange on Which Registered |
None | |
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, without par value
(Title of class)
8.25% Non-Cumulative Preferred Stock, Series T, stated value $25 per share
(Title of class)
8.75% Non-Cumulative Mandatory Convertible Preferred Stock, Series 2008-1, stated value $50 per share
(Title of class)
Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series S, stated value $25 per share
(Title of class)
7.625% Non-Cumulative Preferred Stock, Series R, stated value $25 per share
(Title of class)
6.75% Non-Cumulative Preferred Stock, Series Q, stated value $25 per share
(Title of class)
Variable Rate Non-Cumulative Preferred Stock, Series P, stated value $25 per share
(Title of class)
Variable Rate Non-Cumulative Preferred Stock, Series O, stated value $50 per share
(Title of class)
5.375% Non-Cumulative Convertible Series 2004-1 Preferred Stock, stated value $100,000 per share
(Title of class)
5.50% Non-Cumulative Preferred Stock, Series N, stated value $50 per share
(Title of class)
4.75% Non-Cumulative Preferred Stock, Series M, stated value $50 per share
(Title of class)
5.125% Non-Cumulative Preferred Stock, Series L, stated value $50 per share
(Title of class)
5.375% Non-Cumulative Preferred Stock, Series I, stated value $50 per share
(Title of class)
5.81% Non-Cumulative Preferred Stock, Series H, stated value $50 per share
(Title of class)
Variable Rate Non-Cumulative Preferred Stock, Series G, stated value $50 per share
(Title of class)
Variable Rate Non-Cumulative Preferred Stock, Series F, stated value $50 per share
(Title of class)
5.10% Non-Cumulative Preferred Stock, Series E, stated value $50 per share
(Title of class)
5.25% Non-Cumulative Preferred Stock, Series D, stated value $50 per share
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
The aggregate market value of the common stock held by non-affiliates of the registrant computed by reference to the last reported sale price of the common stock quoted on the OTC Bulletin Board on June 30, 2016 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $2.3 billion.
As of January 31, 2017, there were 1,158,082,750 shares of common stock of the registrant outstanding.
TABLE OF CONTENTS
Page | ||
Item 1. | ||
Legislation and Regulation | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
PART II | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Retained Mortgage Portfolio | ||
Mortgage Credit Book of Business | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
PART III | ||
Item 10. | ||
Fannie Mae 2016 Form 10-K | i | |
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
Item 15. | ||
Fannie Mae 2016 Form 10-K | ii | |
TABLE REFERENCE
Table | Description | Page |
1 | 2015 Housing Goals Performance | 27 |
2 | Summary of Consolidated Results of Operations | 60 |
3 | Analysis of Net Interest Income and Yield | 61 |
4 | Rate/Volume Analysis of Changes in Net Interest Income | 62 |
5 | Fair Value Losses, Net | 63 |
6 | Total Loss Reserves | 66 |
7 | Changes in Combined Loss Reserves | 67 |
8 | Troubled Debt Restructurings and Nonaccrual Loans | 69 |
9 | Credit Loss Performance Metrics | 70 |
10 | Credit Loss Concentration Analysis | 71 |
11 | Summary of Consolidated Balance Sheets | 72 |
12 | Summary of Mortgage-Related Securities at Fair Value | 73 |
13 | Retained Mortgage Portfolio | 74 |
14 | Retained Mortgage Portfolio Profile | 75 |
15 | Composition of Mortgage Credit Book of Business | 76 |
16 | Single-Family Housing and Mortgage Market Indicators | 80 |
17 | Single-Family Business Key Performance Data | 81 |
18 | Single-Family Business Financial Results | 82 |
19 | Representation and Warranty Status of Single-Family Conventional Loans Acquired in 2013-2016 | 87 |
20 | Credit Risk Transfer Transactions | 89 |
21 | Selected Credit Characteristics of Single-Family Conventional Guaranty Book of Business, by Acquisition Period | 91 |
22 | Risk Characteristics of Single-Family Conventional Business Volume and Guaranty Book of Business | 92 |
23 | Single-Family Adjustable-Rate Mortgage and Rate Reset Modifications by Year | 97 |
24 | Delinquency Status and Activity of Single-Family Conventional Loans | 98 |
25 | Single-Family Conventional Seriously Delinquent Loan Concentration Analysis | 99 |
26 | Statistics on Single-Family Loan Workouts | 101 |
27 | Single-Family Troubled Debt Restructuring Activity | 102 |
28 | Percentage of Single-Family Loan Modifications That Were Current or Paid Off at One and Two Years Post-Modification | 102 |
29 | Single-Family Foreclosed Properties | 103 |
30 | Single-Family Acquired Property Concentration Analysis | 104 |
31 | Multifamily Business Key Performance Data | 108 |
32 | Multifamily Business Financial Results | 109 |
33 | Multifamily Guaranty Book of Business Key Risk Characteristics | 110 |
34 | Activity in Debt of Fannie Mae | 114 |
35 | Outstanding Short-Term Borrowings and Long-Term Debt | 116 |
36 | Outstanding Short-Term Borrowings | 117 |
37 | Contractual Obligations | 118 |
38 | Cash and Other Investments Portfolio | 119 |
39 | Fannie Mae Credit Ratings | 119 |
Fannie Mae 2016 Form 10-K | iii | |
Table | Description | Page |
40 | Mortgage Insurance Coverage | 126 |
41 | Interest Rate Sensitivity of Net Portfolio to Changes in Interest Rate Level and Slope of Yield Curve | 134 |
42 | Derivative Impact on Interest Rate Risk (50 Basis Points) | 135 |
Fannie Mae 2016 Form 10-K | iv | |
Business | Introduction | ||
PART I
We have been under conservatorship, with the Federal Housing Finance Agency (“FHFA”) acting as conservator, since September 6, 2008. As conservator, FHFA succeeded to all rights, titles, powers and privileges of the company, and of any shareholder, officer or director of the company with respect to the company and its assets. The conservator has since delegated specified authorities to our Board of Directors and has delegated to management the authority to conduct our day-to-day operations. Our directors do not have any fiduciary duties to any person or entity except to the conservator and, accordingly, are not obligated to consider the interests of the company, the holders of our equity or debt securities or the holders of Fannie Mae MBS unless specifically directed to do so by the conservator. We describe the rights and powers of the conservator, key provisions of our agreements with the U.S. Department of the Treasury (“Treasury”), and their impact on shareholders in “Business—Conservatorship and Treasury Agreements.” | ||
This report contains forward-looking statements that are based on management’s current expectations and are subject to significant uncertainties and changes in circumstances. Please review “Business—Forward-Looking Statements” for more information on the forward-looking statements in this report. Our actual results may differ materially from those reflected in our forward-looking statements due to a variety of factors including, but not limited to, those discussed in “Risk Factors” and elsewhere in this report.
You can find a “Glossary of Terms Used in This Report” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations (‘MD&A’).”
Item 1. Business
Introduction | ||||
Fannie Mae is a government-sponsored enterprise (“GSE”) chartered by Congress. We serve as a stable source of liquidity for purchases of homes and financing of multifamily rental housing, as well as for refinancing existing mortgages. Our role in the market enables qualified borrowers to have reliable access to affordable mortgage credit, including a variety of conforming mortgage products such as the prepayable 30-year fixed-rate mortgage that protects homeowners from fluctuations in interest rates.
We operate in the secondary mortgage market. We support the liquidity and stability of the U.S. mortgage market primarily by securitizing mortgage loans originated by lenders into Fannie Mae mortgage-backed securities that we guarantee, which we refer to as Fannie Mae MBS. We also purchase mortgage loans and mortgage-related securities, primarily for securitization and sale at a later date. We use the term “acquire” in this report to refer to both our securitizations and our purchases of mortgage-related assets. We do not originate loans or lend money directly to consumers in the primary mortgage market.
We remain in conservatorship and our conservatorship has no specified termination date. We do not know when or how the conservatorship will terminate, what further changes to our business will be made during or following conservatorship, what form we will have and what ownership interest, if any, our current common and preferred stockholders will hold in us after the conservatorship is terminated or whether we will continue to exist following conservatorship. In addition, as a result of our agreements with Treasury and directives from our conservator, we are not permitted to retain our net worth (other than a limited amount that will decrease to zero in 2018), rebuild our capital position or pay dividends or other distributions to stockholders other than Treasury. Our senior preferred stock purchase agreement with Treasury also includes covenants that significantly restrict our business activities. Congress continues to consider options for reform of the housing finance system, including the GSEs. We cannot predict the prospects for the enactment, timing or final content of housing finance reform legislation or actions the Administration or FHFA may take with respect to housing finance reform. We provide additional information on the uncertainty of our future, the conservatorship, the provisions of our agreements with Treasury, and their impact on our business in “Conservatorship and Treasury Agreements” and “Risk Factors.” We describe recent actions and statements relating to housing finance reform by the Administration, Congress and FHFA in “Legislation and Regulation—Housing Finance Reform.”
Although Treasury owns our senior preferred stock and a warrant to purchase 79.9% of our common stock, and has made a commitment under a senior preferred stock purchase agreement to provide us with funds to maintain a positive net worth under specified conditions, the U.S. government does not guarantee our securities or other obligations.
Fannie Mae 2016 Form 10-K | 1 | |
Business | Introduction | ||
Our common stock is traded in the over-the-counter market and quoted on the OTC Bulletin Board under the symbol “FNMA.” Our debt securities are actively traded in the over-the-counter market.
Executive Summary | ||||
Please read this Executive Summary together with our MD&A and our consolidated financial statements as of December 31, 2016 and related notes to the consolidated financial statements.
Summary of Our Financial Performance
We recognized comprehensive income of $11.7 billion in 2016, consisting of net income of $12.3 billion, partially offset by other comprehensive loss of $648 million. In comparison, we recognized comprehensive income of $10.6 billion in 2015, consisting of net income of $11.0 billion, partially offset by other comprehensive loss of $326 million. The increase in our net income in 2016 was primarily driven by a shift from credit-related expense in 2015 to credit-related income in 2016 and lower fair value losses, partially offset by lower net revenues.
The table below highlights our key financial performance data and results for 2016 and 2015. See “MD&A—Consolidated Results of Operations” for more information on our financial results.
Key Performance Data and Results
2016 vs. 2015 | 2015 vs. 2014 |
Comprehensive income of $11.7 billion in 2016 increased 10% from 2015. | Comprehensive income of $10.6 billion in 2015 decreased 28% from 2014. |
Net income of $12.3 billion in 2016 increased 12% from 2015. | Net income of $11.0 billion in 2015 decreased 23% from 2014. |
Net revenues, which consist of net interest income and fee and other income, of $22.3 billion in 2016 decreased 2% from 2015. Net interest income of $21.3 billion in 2016 was primarily derived from guaranty fees from our guaranty book of business and remained relatively flat compared with 2015. | Net revenues of $22.8 billion in 2015 decreased 12% from 2014, driven by a decrease in fee and other income partially offset by an increase in net interest income. |
We recognized credit-related income of $1.5 billion in 2016, a shift from credit-related expense of $834 million in 2015. Credit-related income in 2016 was driven by a benefit for credit losses primarily resulting from an increase in home prices. | We recognized credit-related expense of $834 million in 2015, a shift from credit-related income of $3.8 billion in 2014. Credit related expense in 2015 was driven by foreclosed property expense on our single-family foreclosed properties. |
Net fair value losses of $1.1 billion in 2016 decreased 39% from 2015. We recognized fair value losses for 2016 primarily as a result of a decrease in the fair value of our risk management derivatives in the first half of 2016 due to declines in longer-term swap rates during the period. These losses were partially offset by an increase in the fair value of our risk management derivatives in the second half of 2016 due to an increase in longer-term swap rates during the period. | Net fair value losses of $1.8 billion in 2015 decreased 63% from 2014. We recognized fair value losses in 2015 primarily as a result of decreases in the fair value of our risk management derivatives due to declines in longer-term swap rates during the year. |
Our retained mortgage portfolio declined by 21% to $272.4 billion as of December 31, 2016. | Our retained mortgage portfolio declined by 17% to $345.1 billion as of December 31, 2015. |
Our single-family guaranty book of business was $2.8 trillion as of December 31, 2016. | Our single-family guaranty book of business was $2.8 trillion as of December 31, 2015. |
Our net worth increased to $6.1 billion as of December 31, 2016. | Our net worth increased to $4.1 billion as of December 31, 2015. |
The capital reserve amount applicable to our dividend payment for the first quarter of 2017 based on our net worth as of December 31, 2016 is $600 million. The capital reserve amount applicable to our dividends paid in 2016 was $1.2 billion. | The capital reserve amount applicable to our dividend payment for the first quarter of 2016 based on our net worth as of December 31, 2015 was $1.2 billion. The capital reserve amount applicable to our dividends paid in 2015 was $1.8 billion. |
We paid $9.6 billion in dividends to Treasury in 2016. | We paid $10.3 billion in dividends to Treasury in 2015. |
Fannie Mae 2016 Form 10-K | 2 | |
Business | Executive Summary | ||
We expect volatility from period to period in our financial results from a number of factors, particularly changes in market conditions that result in fluctuations in the estimated fair value of the financial instruments that we mark to market through our earnings. These instruments include derivatives and certain securities. The estimated fair value of our derivatives and securities may fluctuate substantially from period to period because of changes in interest rates, the yield curve, mortgage and credit spreads, and implied volatility, as well as activity related to these financial instruments. We use derivatives to manage the interest rate risk exposure of our net portfolio, which consists of our retained mortgage portfolio, cash and other investments portfolio, and outstanding debt of Fannie Mae. Some of these financial instruments in our net portfolio are not recorded at fair value in our consolidated financial statements, and as a result we may experience accounting gains or losses due to changes in interest rates or other market conditions that may not be indicative of the economic interest rate risk exposure of our net portfolio. See “MD&A—Risk Management—Market Risk Management, Including Interest Rate Risk Management” for more information. In addition, our credit-related income or expense can vary substantially from period to period based on a number of factors such as changes in actual and expected home prices, fluctuations in interest rates, borrower payment behavior, the types and volume of our loss mitigation activities, the volume of foreclosures completed, and redesignations of loans from held for investment (“HFI”) to held for sale (“HFS”).
Our Strategy and Business Objectives
Our vision is to be America’s most valued housing partner and to provide liquidity, access to credit and affordability in all U.S. housing markets at all times, while effectively managing and reducing risk to our business, taxpayers and the housing finance system. In support of this vision, we are focused on:
• | advancing a sustainable and reliable business model that reduces risk to the housing finance system and taxpayers; |
• | providing reliable, large-scale access to affordable mortgage credit for qualified borrowers and helping struggling homeowners; and |
• | serving customer needs by building a company that is efficient, innovative and continuously improving. |
Advancing a sustainable and reliable business model that reduces risk to the housing finance system and taxpayers
We have significantly changed our business model since we entered conservatorship in 2008 and our business continues to evolve. We have strengthened our underwriting and eligibility standards and transitioned from a portfolio-focused business to a guaranty-focused business. In addition, we are transferring an increasing portion of the credit risk on our guaranty book of business. These changes have transformed our business model and reduced certain risks of our business as compared with our business prior to entering conservatorship.
Our business also continues to evolve as a result of our many other efforts to build a safer and sustainable housing finance system and to pursue the strategic goals identified by our conservator. See “Legislation and Regulation—Housing Finance Reform—Conservator Developments and Strategic Goals” for a discussion of some of these efforts and FHFA’s strategic goals for our conservatorship.
Fannie Mae 2016 Form 10-K | 3 | |
Business | Executive Summary | ||
Stronger underwriting and eligibility standards
We strengthened our underwriting and eligibility standards for loans we acquired beginning in late 2008 and 2009. These changes have improved the credit quality of our single-family guaranty book of business and contributed to improvement in our credit performance. As of December 31, 2016, 88% of our single-family conventional guaranty book of business consisted of loans acquired since 2009. Our single-family serious delinquency rate has decreased each quarter since the first quarter of 2010.
__________
(1) | Calculated as of the end of each period based on the number of single-family conventional loans that are 90 days or more past due and loans that have been referred to foreclosure but not yet foreclosed upon, divided by the number of loans in our single-family conventional guaranty book of business. |
(2) | We have acquired HARP loans and other Refi Plus loans under our Refi PlusTM initiative since 2009. Our Refi Plus initiative offers refinancing flexibility to eligible borrowers who are current on their loans and whose loans are owned or guaranteed by us and meet certain additional criteria. HARP loans, which have loan-to-value (“LTV”) ratios at origination greater than 80%, refers to loans we have acquired pursuant to the Home Affordable Refinance Program® (“HARP®”). Other Refi Plus loans, which have LTV ratios at origination of 80% or less, refers to loans we have acquired under our Refi Plus initiative other than HARP loans. Loans we acquire under Refi Plus and HARP are refinancings of loans that were originated prior to June 2009. |
See “MD&A—Business Segments—Single-Family Business” for information on our recent single-family acquisitions and the credit performance of our single-family mortgage loans.
Transition to a guaranty-focused business
We have two primary sources of revenues: (1) the guaranty fees we receive for managing the credit risk on loans underlying Fannie Mae MBS held by third parties; and (2) the difference between interest income earned on the assets in our retained mortgage portfolio and the interest expense associated with the debt that funds those assets. Our retained mortgage portfolio refers to the mortgage-related assets we own (which excludes the portion of assets held by consolidated MBS trusts that back mortgage-related securities owned by third parties).
Fannie Mae 2016 Form 10-K | 4 | |
Business | Executive Summary | ||
As shown in the chart below, in recent years, an increasing portion of our net interest income has been derived from guaranty fees, rather than from our retained mortgage portfolio assets. This shift has been driven by both the guaranty fee increases we implemented in 2012 and the reduction of our retained mortgage portfolio in accordance with the requirements of our senior preferred stock purchase agreement with Treasury and direction from FHFA. More than two-thirds of our 2016 net interest income was derived from the loans underlying our Fannie Mae MBS in consolidated trusts, which primarily generate income through guaranty fees. We expect that guaranty fees will continue to account for an increasing portion of our net interest income.
Transferring a portion of the mortgage credit risk on our single-family book of business
In late 2013, we began entering into credit risk transfer transactions with the goal of transferring, to the extent economically sensible, a portion of the mortgage credit risk on some of the recently-acquired loans in our single-family book of business in order to reduce the economic risk to us and to taxpayers of future borrower defaults. Our primary method of achieving this objective has been through our Connecticut Avenue SecuritiesTM (“CAS”) and Credit Insurance Risk TransferTM (“CIRTTM”) transactions. In these transactions, we transfer to investors a portion of the mortgage credit risk associated with losses on a reference pool of mortgage loans and in exchange we pay investors a premium that effectively reduces the guaranty fee income we retain on the loans. As of December 31, 2016, $647.5 billion in outstanding unpaid principal balance of our single-family loans, or approximately 23% of the loans in our single-family conventional guaranty book of business measured by unpaid principal balance, were included in a reference pool for a credit risk transfer transaction. Over time, we expect that a larger portion of our single-family conventional guaranty book of business will be covered by credit risk transfer transactions.
Fannie Mae 2016 Form 10-K | 5 | |
Business | Executive Summary | ||
The chart below shows as of the dates specified the total outstanding unpaid principal balance of our single-family loans, as well as the percentage of our total single-family conventional guaranty book of business measured by unpaid principal balance, that were included in a reference pool for a credit risk transfer transaction.
For further discussion of our credit risk transfer transactions, including information on the portion of the credit risk of these loans we have transferred, see “MD&A—Business Segments—Single-Family Business—Single-Family Mortgage Credit Risk Management—Transfer of Mortgage Credit Risk—Credit Risk Transfer Transactions.”
Providing reliable, large-scale access to affordable mortgage credit for qualified borrowers and helping struggling homeowners
We continued to provide reliable, large-scale access to affordable mortgage credit to the U.S. housing market and to help struggling homeowners in 2016:
• | We provided approximately $637 billion in liquidity to the mortgage market in 2016 through our purchases of loans and guarantees of loans and securities. This liquidity enabled borrowers to complete approximately 1,401,000 mortgage refinancings and approximately 1,122,000 home purchases, and provided financing for approximately 724,000 units of multifamily housing. |
• | We provided approximately 103,500 loan workouts in 2016 to help homeowners stay in their homes or otherwise avoid foreclosure. Our loan workout efforts have helped to stabilize neighborhoods, home prices and the housing market. |
• | We helped borrowers refinance loans, including through our Refi PlusTM initiative, which offers refinancing flexibility to eligible borrowers who are current on their loans, whose loans are owned or guaranteed by us and who meet certain additional criteria. We acquired approximately 141,000 Refi Plus loans in 2016. Refinancings delivered to us through Refi Plus in the fourth quarter of 2016 reduced borrowers’ monthly mortgage payments by an average of $221. |
• | We support affordability in the multifamily rental market. Approximately 90% of the multifamily units we financed in 2016 were affordable to families earning at or below 120% of the median income in their area, providing support for both workforce housing and affordable housing. |
Serving customer needs by building a company that is efficient, innovative and continuously improving
We are committed to providing our lender customers with the products, services and tools they need to serve the housing market more effectively and efficiently, as well as continuing to improve our business processes. We have implemented a number of changes in recent years designed to help our customers originate mortgages with increased certainty, efficiency and lower costs, such as the following:
• | Introduced Innovative Tools. We have introduced a number of new, innovative tools that lenders can use to ensure the quality of the loans they deliver to us, such as our EarlyCheckTM loan verification tool and our Collateral Underwriter® appraisal review tool, which we make available to lenders at no cost. |
Fannie Mae 2016 Form 10-K | 6 | |
Business | Executive Summary | ||
• | Launched New Loan Delivery Platform. We launched a new loan delivery platform to help lenders deliver loans more efficiently and with greater transparency and certainty. |
• | Eliminated Technology Fees. We eliminated fees charged to customers for using our Desktop Underwriter® and Desktop Originator® underwriting systems. |
• | Reduced Repurchase Risk. We have significantly reduced lenders’ repurchase risk relating to loans they deliver to us by implementing a revised representation and warranty framework and other enhancements that clarify and limit lenders’ repurchase liability. As of December 31, 2016, over 3 million loans in our book of business had obtained relief from repurchases for breaches of certain representations and warranties pursuant to this revised framework, and over 5 million loans remained eligible for relief in the future. |
We continue to focus on improvements to our business processes and policies to better serve our customers and to promote stronger risk management and greater digitization of data and processes in the mortgage industry. In addition to providing value to our customers, we believe many of these improvements will increase access to mortgage credit by encouraging lenders to safely expand their lending to a wider range of qualified borrowers. New enhancements and innovations that we implemented in recent months or are currently working on include the following:
• | Trended Credit Data. We incorporated trended credit data into our Desktop Underwriter automated underwriting system in September 2016. Trended credit data refers to additional historical information on a borrower’s use of revolving credit accounts, including the balance, scheduled payments and actual payments made on these accounts. Incorporating trended credit data is expected to improve Desktop Underwriter’s credit risk assessment and benefit borrowers who regularly pay down their revolving debt. |
• | Day 1 Certainty. We introduced our new Day 1 CertaintyTM initiative in October 2016. As part of Day 1 Certainty, we began offering third-party validation of borrower income, asset and employment data through Desktop Underwriter in the fourth quarter of 2016. We also leveraged these new verification tools to expand the representation and warranty relief we provide to lenders. In the fourth quarter of 2016, we began providing lenders with additional representation and warranty relief with respect to borrower income, asset and employment data that has been validated through Desktop Underwriter and with respect to property value where the appraisal has received a qualifying risk score in our Collateral Underwriter appraisal review tool. See “MD&A—Business Segments—Single-Family Business—Single-Family Mortgage Credit Risk Management—Single-Family Acquisition and Servicing Policies and Underwriting and Servicing Standards—Representation and Warranty Relief” for further discussion of the actions we have taken to reduce and clarify lenders’ repurchase risk. |
• | eMortgages. We are investing in technology and resources to support the ability of lenders to deliver eMortgages to us. An eMortgage is an electronic mortgage submission where the loan documentation is created, executed, transferred and stored electronically. In 2016, we partnered with lenders, servicers and technology solution providers to implement eMortgage solutions and promote more entrants to the eMortgage marketplace. We plan to transition to a streamlined, less complex eNote format—MISMO SMART Doc® Version 3.0—to align the eNote format with Uniform Closing Dataset standards. We will continue to conduct educational outreach to industry and market stakeholders in 2017 to further drive eMortgage awareness and adoption. |
Treasury Draws and Dividend Payments
Treasury has made a commitment under a senior preferred stock purchase agreement to provide funding to us under certain circumstances if we have a net worth deficit. Pursuant to this agreement and the senior preferred stock we issued to Treasury in 2008, the Director of FHFA has directed us to pay dividends to Treasury on a quarterly basis since entering into conservatorship in 2008.
Fannie Mae 2016 Form 10-K | 7 | |
Business | Executive Summary | ||
The chart below shows the funds we have drawn from Treasury pursuant to the senior preferred stock purchase agreement, as well as the dividend payments we have made to Treasury on the senior preferred stock, since entering into conservatorship.
__________
(1) | Under the terms of the senior preferred stock purchase agreement, dividend payments we make to Treasury do not offset our prior draws of funds from Treasury, and we are not permitted to pay down draws we have made under the agreement except in limited circumstances. Accordingly, the current aggregate liquidation preference of the senior preferred stock is $117.1 billion, due to the initial $1.0 billion liquidation preference of the senior preferred stock (for which we did not receive cash proceeds) and the $116.1 billion we have drawn from Treasury. Amounts may not sum due to rounding. |
(2) | Treasury draws are shown in the period for which requested, not when the funds were received by us. We have not requested a draw for any period since 2012. |
We expect to pay Treasury a dividend of $5.5 billion for the first quarter of 2017 by March 31, 2017, calculated based on our net worth of $6.1 billion as of December 31, 2016, less the current capital reserve amount of $600 million. We expect to retain only a limited amount of any future net worth because we are required by the dividend provisions of the senior preferred stock and quarterly directives from our conservator to pay Treasury each quarter any dividends declared consisting of the amount, if any, by which our net worth as of the end of the immediately preceding fiscal quarter exceeds an applicable capital reserve amount. This capital reserve amount is $600 million for each quarter of 2017 and will decrease to zero in 2018. Those dividend payment provisions are referred to as “net worth sweep” dividend provisions.
If we experience a net worth deficit in a future quarter, we will be required to draw additional funds from Treasury under the senior preferred stock purchase agreement in order to avoid being placed into receivership. As of the date of this filing, the maximum amount of remaining funding under the agreement is $117.6 billion. If we were to draw additional funds from Treasury under the agreement in a future period, the amount of remaining funding under the agreement would be reduced by the amount of our draw. Dividend payments we make to Treasury do not restore or increase the amount of funding available to us under the agreement. For a description of the terms of the senior preferred stock purchase agreement and the senior preferred stock, see “Conservatorship and Treasury Agreements—Treasury Agreements.” See “Risk Factors” for a discussion of the risks associated with our limited and declining capital reserves, and “Outlook” for our current expectations for our future financial results.
Fannie Mae 2016 Form 10-K | 8 | |
Business | Executive Summary | ||
As described in “Legal Proceedings” and “Note 18, Commitments and Contingencies,” several lawsuits have been filed by preferred and common stockholders of Fannie Mae and Freddie Mac against one or more of the United States, Treasury and FHFA challenging actions taken by the defendants relating to the senior preferred stock purchase agreements and the conservatorships of Fannie Mae and Freddie Mac, including challenges to the net worth sweep dividend provisions of the senior preferred stock. We are also a party to some of those lawsuits. We cannot predict the course or the outcome of these lawsuits, or the actions the U.S. government (including Treasury or FHFA) may take in response to any ruling or finding in any of these lawsuits.
2016 Market Share
We estimate that our single-family acquisition market share was 29% in 2016 and 27% in 2015. These amounts represent our single-family mortgage acquisitions for each year, excluding delinquent loans we purchased from our MBS trusts, as a percentage of the single-family first-lien mortgages we currently estimate were originated in the United States that year. Our estimate of mortgage originations in prior periods is subject to change as additional data become available; therefore, these market share estimates may change in the future, perhaps materially.
We were the largest issuer of single-family mortgage-related securities in the secondary market in 2016, with an estimated market share of new single-family mortgage-related securities issuances of 39%, compared with 37% in 2015. We estimate our market share of new single-family mortgage-related securities issuances was 41% in the fourth quarter of 2016, compared with 38% in the third quarter of 2016 and 36% in the fourth quarter of 2015. The chart below shows our market share of single-family mortgage-related securities issuances in 2016 compared with that of our primary competitors.
We remained a continuous source of liquidity in the multifamily market in 2016. We owned or guaranteed approximately 19% of the outstanding debt on multifamily properties as of September 30, 2016 (the latest date for which information is available) and approximately 18% as of December 31, 2015.
Outlook
In this section, we present a number of estimates and expectations regarding our future performance, as well as future housing market conditions. These estimates and expectations are forward-looking statements based on our current assumptions regarding numerous factors. See “Forward-Looking Statements” and “Risk Factors” for a discussion of factors that could cause actual results to differ materially from our current estimates and expectations. Due to the large size of our guaranty book of business, even small changes in these factors could have a significant impact on our financial results for a particular period.
Financial Results. Our financial results continued to be strong in 2016, with net income of $12.3 billion. We expect to remain profitable on an annual basis for the foreseeable future; however, certain factors, such as changes in interest rates or home prices, could result in significant volatility in our financial results from quarter to quarter or year to year. Our future financial results also will be affected by a number of other factors, including: our guaranty
Fannie Mae 2016 Form 10-K | 9 | |
Business | Executive Summary | ||
fee rates; the volume of single-family mortgage originations in the future; the size, composition and quality of our retained mortgage portfolio and guaranty book of business; and economic and housing market conditions. Although we expect to remain profitable on an annual basis for the foreseeable future, due to our limited and declining capital reserves (which decrease to zero in 2018) and the potential for significant volatility in our financial results, we could experience a net worth deficit in a future quarter. If we experience a net worth deficit in a future quarter, we will be required to draw additional funds from Treasury under the senior preferred stock purchase agreement in order to avoid being placed into receivership.
Our expectations for our future financial results do not take into account the impact on our business of potential future legislative or regulatory changes, which could have a material impact on our financial results, particularly the enactment of housing finance reform legislation, corporate income tax reform legislation and changes in accounting standards. For example, the current Administration proposes reducing the U.S. corporate income tax rate. Under applicable accounting standards, a significant reduction in the U.S. corporate income tax rate would require that we record a substantial reduction in the value of our deferred tax assets in the quarter in which the legislation is enacted. Thus, if legislation significantly lowering the U.S. corporate income tax rate is enacted, we expect to incur a significant net loss and net worth deficit for the quarter in which the legislation is enacted and we could potentially incur a net loss for that year. As noted above, if we experience a net worth deficit in a future quarter, we will be required to draw additional funds from Treasury under the senior preferred stock purchase agreement in order to avoid being placed into receivership.
See “Risk Factors” for a discussion of the risks associated with our limited and declining capital reserves and the potential impact of legislative and regulatory actions.
Revenues. We have two primary sources of revenues: (1) the guaranty fees we receive for managing the credit risk on loans underlying Fannie Mae MBS held by third parties; and (2) the difference between interest income earned on the assets in our retained mortgage portfolio and the interest expense associated with the debt that funds those assets.
Our guaranty fee revenues consist of two primary components: (1) the base guaranty fees that we receive over the life of the loan; and (2) upfront fees we receive at loan acquisition which are amortized over the contractual life of the loan. When mortgage loans prepay faster due to a lower interest rate environment, we typically have higher amortization income. Conversely, when mortgage loans prepay more slowly due to a higher interest rate environment, we typically have lower amortization income. Our guaranty fee revenues increased in 2015 and 2016 primarily driven by: (1) loans with higher base guaranty fees comprising a larger part of our guaranty book of business; and (2) an increase in amortization income as a lower interest rate environment during portions of these years increased prepayments on mortgage loans. We expect loans with lower guaranty fees to continue to liquidate from our book of business and be replaced with new loans that typically have higher guaranty fees, which will contribute to increasing guaranty fee revenues; however, the impact of this trend on our guaranty fee revenues could be offset by lower amortization income if interest rates remain at higher levels and result in lower prepayments on mortgage loans. Accordingly, our guaranty fee revenues may remain relatively flat in the near term.
We expect the size of our retained mortgage portfolio to continue to decrease, which will continue to negatively impact our net interest income and net revenues.
Factors that may affect our future revenues include: changes to guaranty fee pricing we may make in the future and their impact on our competitive environment and guaranty fee revenues; economic and housing market conditions, including changes in interest rates and home prices; the size, composition and quality of our guaranty book of business; the life of the loans in our guaranty book of business; the size, composition and quality of our retained mortgage portfolio; our market share; and legislative and regulatory changes.
Overall Market Conditions. While we expect the single-family serious delinquency rate for the overall mortgage market will continue to decline, we believe the rate of decline will be gradual. We expect the national single-family serious delinquency rate will remain high compared with pre-housing crisis levels because it will take some time for the remaining delinquent loans originated prior to 2009 to work their way through the foreclosure process.
We forecast that total originations in the U.S. single-family mortgage market in 2017 will decrease from 2016 levels by approximately 19% from an estimated $1.94 trillion in 2016 to $1.57 trillion in 2017, and that the amount of originations in the U.S. single-family mortgage market that are refinancings will decrease from an estimated $927 billion in 2016 to $510 billion in 2017.
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Business | Executive Summary | ||
Home Prices. Based on our home price index, we estimate that home prices on a national basis increased by 5.9% in 2016. We expect the rate of home price appreciation in 2017 to be slightly lower than the rate in 2016. We also expect significant regional variation in the timing and rate of home price growth.
Credit Losses. Our credit losses, which include our charge-offs, net of recoveries, reflect our realization of losses on our loans. Our credit losses were $3.7 billion in 2016, down from $10.7 billion in 2015. We expect our credit losses to be lower in 2017 than in 2016, absent further significant redesignations related to loan sales; however, we expect a significantly smaller decline in credit losses in 2017 as compared with the decline in 2016. See “MD&A—Consolidated Results of Operations—Credit-Related Income (Expense)” for a discussion of our credit losses for 2016 and 2015, including the impact on our 2015 credit losses of our adoption of FHFA’s Advisory Bulletin AB 2012-02, “Framework for Adversely Classifying Loans, Other Real Estate Owned, and Other Assets and Listing Assets for Special Mention” (the “Advisory Bulletin”) and a change in our accounting policy for nonaccrual loans, which collectively resulted in $3.6 billion in charge offs in 2015.
Loss Reserves. Our combined loss reserves were $23.8 billion as of December 31, 2016, down from $28.6 billion as of December 31, 2015. Our loss reserves have declined substantially from their peak and are expected to decline further in 2017; however, we expect a smaller decline in our loss reserves in 2017 as compared with the decline in 2016. For a discussion of the factors that contributed to the decline in our loss reserves in 2016, see “MD&A—Consolidated Results of Operations—Credit-Related Income (Expense)” and “MD&A—Consolidated Balance Sheet Analysis—Mortgage Loans and Allowance for Loan Losses.”
Residential Mortgage Market |
We conduct business in the U.S. residential mortgage market and the global securities market. According to the Federal Reserve, total U.S. residential mortgage debt outstanding was estimated to be approximately $11.4 trillion as of September 30, 2016 (the latest date for which information is available). We owned or guaranteed mortgage assets representing approximately 27% of total U.S. residential mortgage debt outstanding as of September 30, 2016.
We operate our business solely in the United States and its territories, and accordingly, we generate no revenue from and have no long-lived assets, other than financial instruments, in geographic locations other than the United States and its territories.
For a discussion of housing and mortgage market and economic conditions in the single-family U.S. residential housing market, see “MD&A—Business Segments—Single-Family Business—Single-Family Housing and Mortgage Market and Economic Conditions.” For a discussion of conditions in the multifamily U.S. residential housing market, see “MD&A—Business Segments—Multifamily Business—Multifamily Mortgage Market.”
Business Segments |
We have two reportable business segments: Single-Family and Multifamily. Our Single-Family and Multifamily businesses engage in business activities that provide liquidity to the mortgage market and increase the availability and affordability of housing in the United States. The Single-Family business operates in the secondary mortgage market relating to loans secured by properties containing four or fewer residential dwelling units, which are referred to as single-family mortgage loans. The Multifamily business operates in the secondary mortgage market relating primarily to loans secured by properties containing five or more residential units, which are referred to as multifamily mortgage loans.
Previously, we had a third reportable business segment—Capital Markets. In the fourth quarter of 2016, we realigned the composition of our reportable business segments to incorporate the activities of the Capital Markets group into the Single-Family or Multifamily segments. Throughout this filing, all segment information for the years ended December 31, 2015 and December 31, 2014 has been revised to conform to our new segment reporting presentation. For additional information on our change in segment reporting presentation, see “MD&A—Business Segments” and “Note 12, Segment Reporting.”
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Business | Business Segments | ||
The table below summarizes the primary business activities and the primary sources of revenue and expense for each of our business segments.
Primary Business Activities | Primary Drivers of Revenue | Primary Drivers of Expense |
Single-Family Business | ||
Mortgage securitizations: Works with our lender customers to acquire and securitize single-family mortgage loans delivered to us by lenders into Fannie Mae MBS. Also issues structured Fannie Mae MBS backed by single-family mortgage assets and provides other services to our lender customers. Credit risk management: Prices and manages the credit risk on loans in our single-family guaranty book of business. Also enters into transactions that transfer a portion of the credit risk on some of the loans in our single-family guaranty book of business. Credit loss management: Works to reduce costs of defaulted single-family loans through home retention solutions and foreclosure alternatives, management of foreclosures and our real estate owned (“REO”) inventory, selling nonperforming loans, and pursuing contractual remedies from lenders, servicers and providers of credit enhancement. | Net interest income: Single-family net interest income is generated from two primary sources: (1) guaranty fees received as compensation for assuming and managing the credit risk on single-family loans underlying Fannie Mae MBS held by third parties; and (2) the difference between the interest income earned on single-family mortgage assets in our retained mortgage portfolio and the interest expense associated with the debt funding those assets. Revenues from single-family guaranty fees include revenues generated by the 10 basis point increase in guaranty fees we implemented in 2012 pursuant to the Temporary Payroll Tax Cut Continuation Act of 2011 (“TCCA”). Fee and other income: Compensation received for engaging in structured transactions and providing other lender services. Also includes income resulting from settlement agreements resolving certain claims relating to PLS sold to us or that we have guaranteed. | Credit-related expense: Consists of the provision for single-family credit losses and foreclosed property expense on loans underlying our single-family guaranty book of business. Fair value gains and losses: Primarily consists of fair value gains and losses on risk management and mortgage commitment derivatives, trading securities, and other financial instruments associated with our single-family mortgage credit book of business. Investment gains and losses: Primarily consists of gains and losses on the sale of single-family mortgage assets. Administrative expenses: Consists of salaries and benefits, occupancy costs, professional services, and other expenses associated with our Single-Family business operations. TCCA fees: Consists of the portion of our single-family guaranty fees that is remitted to Treasury pursuant to the TCCA. |
Multifamily Business | ||
Mortgage securitizations: Works with our lender customers, primarily through our Delegated Underwriting and Servicing, or DUS®, program, to acquire and securitize multifamily mortgage loans delivered to us by lenders into Fannie Mae MBS. Also issues structured Fannie Mae MBS backed by multifamily mortgage assets and provides other services to our lender customers. Credit risk management: Prices and manages the credit risk on loans in our multifamily guaranty book of business. Lenders retain a portion of the credit risk in most multifamily transactions. Credit loss management: Works to reduce costs of defaulted multifamily loans through foreclosure alternatives, management of foreclosures and our REO inventory, and pursuing contractual remedies from lenders, servicers and providers of credit enhancement. | Net interest income: Multifamily net interest income is generated from two primary sources: (1) guaranty fees received as compensation for assuming and managing the credit risk on multifamily loans underlying Fannie Mae MBS held by third parties; and (2) the difference between the interest income earned on multifamily mortgage assets in our retained mortgage portfolio and the interest expense associated with the debt funding those assets. Fee and other income: Other fees associated with multifamily business activities, including yield maintenance income. | Credit-related expense: Consists of the provision for multifamily credit losses and foreclosed property expense on loans underlying our multifamily guaranty book of business. Fair value gains and losses: Primarily consists of fair value gains and losses on MBS commitment derivatives, trading securities, and other financial instruments associated with our multifamily mortgage credit book of business. Investment gains and losses: Primarily consists of (1) gains and losses on the sale of multifamily mortgage assets; and (2) gains and losses related to consolidation activities. Administrative expenses: Consists of salaries and benefits, occupancy costs, professional services, and other expenses associated with our Multifamily business operations. |
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Business | Business Segments | ||
The chart below displays the total net revenues for each of our business segments. Net revenues consist of net interest income and fee and other income.
For more information about the financial results and performance, and total assets, of each of our business segments, as well as more information about the activities of each segment, see “MD&A—Business Segments” and “Note 12, Segment Reporting.”
Mortgage Securitizations |
We support market liquidity by issuing Fannie Mae MBS that are readily traded in the capital markets. We create Fannie Mae MBS by placing mortgage loans in a trust and issuing securities that are backed by those mortgage loans. Monthly payments received on the loans are the primary source of payments passed through to Fannie Mae MBS holders. We guarantee to the MBS trust that we will supplement amounts received by the MBS trust as required to permit timely payment of principal and interest on the trust certificates. In return for this guaranty, we receive guaranty fees.
Below we discuss (1) three broad categories of securitization transactions: lender swaps, portfolio securitizations and structured securitizations; (2) features of our MBS trusts; (3) single-class and multi-class Fannie Mae MBS; and (4) circumstances under which we purchase loans from MBS trusts.
Lender Swaps, Portfolio Securitizations and Structured Securitizations
We currently securitize a substantial majority of the single-family and multifamily mortgage loans we acquire. Our securitization transactions primarily fall within three broad categories: lender swap transactions; portfolio securitizations; and structured securitizations.
Lender swaps. Our most common type of securitization transaction is our “lender swap transaction.” In a single-family lender swap transaction, a mortgage lender that operates in the primary mortgage market generally delivers a pool of mortgage loans to us in exchange for Fannie Mae MBS backed by these mortgage loans. A pool of mortgage loans is a group of mortgage loans with similar characteristics. After receiving the mortgage loans in a lender swap transaction, we place them in a trust for which we serve as trustee. This trust is established for the sole purpose of holding the mortgage loans separate and apart from our corporate assets. We deliver to the lender (or its designee) Fannie Mae MBS that are backed by the pool of mortgage loans in the trust and that represent an undivided beneficial ownership interest in each of the mortgage loans. We guarantee to each MBS trust that we will supplement amounts received by the MBS trust as required to permit timely payment of principal and interest on the related Fannie Mae MBS. We retain a portion of the interest payment as a fee for providing our guaranty. The mortgage servicer also retains a portion of the interest payment as a fee for servicing the loan. Then, on behalf of the trust, we make monthly distributions to the Fannie Mae MBS certificateholders from the principal and interest payments and other collections on the underlying mortgage loans.
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Business | Mortgage Securitizations | ||
Our Multifamily business generally creates multifamily Fannie Mae MBS in lender swap transactions in a manner similar to our Single-Family business. Our multifamily lender customers typically deliver only one mortgage loan to back each multifamily Fannie Mae MBS. The characteristics of each mortgage loan are used to establish guaranty fees on a risk-adjusted basis. Securitizing a single multifamily mortgage loan into a Fannie Mae MBS facilitates its sale into the secondary market.
Portfolio securitization transactions. In contrast to our lender swap securitizations, in which a mortgage lender delivers a pool of mortgage loans to us that we immediately place in a trust for securitization, our “portfolio securitization transactions” involve creating and issuing Fannie Mae MBS using mortgage loans and mortgage-related securities that we hold in our retained mortgage portfolio. Most of our portfolio securitization transactions are driven by our single-family whole loan conduit activities, pursuant to which we purchase single-family whole loans from a large group of lenders principally for the purpose of securitizing the loans into Fannie Mae MBS, which may then be sold to dealers and investors. We also securitize loans that have been held in our portfolio for a longer period of time, including reperforming loans, to hold or to sell, which provides more flexibility to manage our risk and reduce the size of our retained mortgage portfolio. Reperforming loans are mortgage loans on which the borrower had previously been delinquent but subsequently became current, either with or without a modification. We also have created portfolio securitization transactions backed by multifamily mortgage loans.
Structured securitizations. In a “structured securitization transaction,” we create structured Fannie Mae MBS, typically for our lender customers or securities dealer customers, in exchange for a transaction fee. In these transactions, the customer “swaps” a mortgage-related asset that it owns (typically a mortgage security) in exchange for a structured Fannie Mae MBS we issue. The process for issuing Fannie Mae MBS in a structured securitization is similar to the process involved in our lender swap securitizations described above.
We also issue structured transactions backed by multifamily Fannie Mae MBS through the Fannie Mae Guaranteed Multifamily Structures (“Fannie Mae GeMSTM”) program, which provides additional liquidity and stability to the multifamily market, while expanding the investor base for multifamily Fannie Mae MBS.
Features of Our MBS Trusts
Our MBS trusts hold either single-family or multifamily mortgage loans or mortgage-related securities. Each trust operates in accordance with a trust agreement or a trust indenture. Each MBS trust is also governed by an issue supplement documenting the formation of that MBS trust, the identification of its related assets and the issuance of the related Fannie Mae MBS. The trust agreement or the trust indenture, together with the issue supplement and any amendments, are considered the “trust documents” that govern an individual MBS trust.
Single-Class and Multi-Class Fannie Mae MBS
Fannie Mae MBS trusts may be single-class or multi-class. Single-class MBS are MBS in which the investors receive principal and interest payments on the mortgage loans backing the MBS directly in proportion to their percentage ownership of the MBS issuance. Multi-class MBS are MBS, including Real Estate Mortgage Investment Conduits (“REMICs”), in which the cash flows on the underlying mortgage assets are divided, creating several classes of securities, each of which represents a beneficial ownership interest in the assets of the related MBS trust and entitles the related holder to a specific portion and priority of cash flows. Terms to maturity of some multi-class Fannie Mae MBS, particularly REMIC classes, may match or be shorter than the maturity of the underlying mortgage loans and/or mortgage-related securities. After these classes mature, cash flows received on the underlying mortgage assets are allocated to the remaining classes in accordance with the payment terms of the securities. As a result, each of the classes in a multi-class MBS may have a different coupon rate, average life, repayment sensitivity or final maturity. Structured Fannie Mae MBS are either multi-class MBS or single-class MBS that are typically resecuritizations of other single-class Fannie Mae MBS. In a resecuritization, pools of MBS are collected and securitized.
Purchases of Loans from Our MBS Trusts
Under the terms of our MBS trust documents, we have the option or, in some instances, the obligation, to purchase mortgage loans that meet specific criteria from an MBS trust. Our acquisition cost for these loans is the unpaid principal balance of the loan plus accrued interest.
In deciding whether and when to exercise our option to purchase a loan from a single-family MBS trust, we consider a variety of factors, including: our legal ability to purchase loans under the terms of the trust documents; whether we have agreed to modify the loan; our mission and public policy; our loss mitigation strategies and the
Fannie Mae 2016 Form 10-K | 14 | |
Business | Mortgage Securitizations | ||
exposure to credit losses we face under our guaranty; our cost of funds; the impact on our results of operations; relevant market yields; the accounting impact; the administrative costs associated with purchasing and holding the loans; counterparty exposure to lenders that have agreed to cover losses associated with delinquent loans; and general market conditions. The weight we give to these factors changes depending on market circumstances and other factors.
The cost of purchasing most delinquent loans from single-family Fannie Mae MBS trusts and holding them in our retained mortgage portfolio is currently less than the cost of advancing delinquent payments to security holders. We generally purchase loans from single-family MBS trusts as they become four or more consecutive monthly payments delinquent. During 2016, we purchased delinquent loans with an unpaid principal balance of $11.1 billion from our single-family MBS trusts. We expect to continue purchasing loans from single-family MBS trusts as they become four or more consecutive monthly payments delinquent subject to market conditions, economic benefit, servicer capacity and other factors, including the limit on the amount of mortgage assets that we may own pursuant to the senior preferred stock purchase agreement and FHFA’s portfolio plan requirements.
For our multifamily MBS trusts, we typically exercise our option to purchase a loan from the trust if the loan is delinquent as to four or more consecutive monthly payments, whether those payments were missed in whole or in part.
Conservatorship and Treasury Agreements |
Conservatorship
On September 6, 2008, the Director of FHFA appointed FHFA as our conservator, pursuant to authority provided by the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, as amended, including by the Federal Housing Finance Regulatory Reform Act of 2008 (together, the “GSE Act”). The conservatorship is a statutory process designed to preserve and conserve our assets and property and put the company in a sound and solvent condition.
The conservatorship has no specified termination date and there continues to be significant uncertainty regarding the future of our company, including how long the company will continue to exist in its current form, the extent of our role in the market, how long we will be in conservatorship, what form we will have and what ownership interest, if any, our current common and preferred stockholders will hold in us after the conservatorship is terminated, and whether we will continue to exist following conservatorship. For more information on the risks to our business relating to the conservatorship and uncertainties regarding the future of our company and business, as well as the adverse effects of the conservatorship on the rights of holders of our common and preferred stock, see “Risk Factors.”
Our conservatorship could terminate through a receivership. For information on the circumstances under which FHFA is required or permitted to place us into receivership and the potential consequences of receivership, see “Legislation and Regulation—GSE Act and Other Regulation of Our Business—Receivership” and “Risk Factors.”
Management of the Company during Conservatorship
Upon its appointment, the conservator immediately succeeded to (1) all rights, titles, powers and privileges of Fannie Mae, and of any shareholder, officer or director of Fannie Mae with respect to Fannie Mae and its assets, and (2) title to the books, records and assets of any other legal custodian of Fannie Mae. The conservator subsequently delegated specified authorities to our Board of Directors and delegated to management the authority to conduct our day-to-day operations. In connection with its delegation of authority, FHFA has instructed the Board to oversee that management consults with and obtains the written approval of the conservator before taking action in any of the areas described in “Directors, Executive Officers and Corporate Governance—Corporate Governance—Conservatorship and Delegation of Authority to Board of Directors,” which includes matters that require the approval of or consultation with Treasury under the senior preferred stock purchase agreement. FHFA’s instructions also require the company to notify FHFA of planned changes in business processes or operations, so that FHFA may participate in decision-making as FHFA determines appropriate. The conservator retains the authority to amend or withdraw its delegations at any time.
Our directors serve on behalf of the conservator and exercise their authority as directed by and with the approval, where required, of the conservator. Our directors have no fiduciary duties to any person or entity except to the
Fannie Mae 2016 Form 10-K | 15 | |
Business | Conservatorship and Treasury Agreements | ||
conservator. Accordingly, our directors are not obligated to consider the interests of the company, the holders of our equity or debt securities or the holders of Fannie Mae MBS unless specifically directed to do so by the conservator.
Because we are in conservatorship, our common stockholders currently do not have the ability to elect directors or to vote on other matters. The conservator eliminated common and preferred stock dividends (other than dividends on the senior preferred stock issued to Treasury) during the conservatorship.
Powers of the Conservator under the GSE Act
FHFA has broad powers when acting as our conservator. As conservator, FHFA can direct us to enter into contracts or enter into contracts on our behalf. Further, FHFA may transfer or sell any of our assets or liabilities (subject to limitations and post-transfer notice provisions for transfers of certain types of financial contracts), without any approval, assignment of rights or consent of any party. The GSE Act provides, however, that mortgage loans and mortgage-related assets that have been transferred to a Fannie Mae MBS trust must be held by the conservator for the beneficial owners of the Fannie Mae MBS and cannot be used to satisfy the general creditors of the company. Neither the conservatorship nor the terms of our agreements with Treasury change our obligation to make required payments on our debt securities or perform under our mortgage guaranty obligations.
Treasury Agreements
On September 7, 2008, we, through FHFA, in its capacity as conservator, and Treasury entered into a senior preferred stock purchase agreement, which was amended and restated on September 26, 2008. The amended and restated agreement was subsequently amended on May 6, 2009, December 24, 2009 and August 17, 2012. Unless the context indicates otherwise, references in this report to the senior preferred stock purchase agreement refer to the agreement as amended through August 17, 2012. The terms of the senior preferred stock purchase agreement, senior preferred stock and the warrant discussed below continue to apply to us even if we are released from conservatorship. See “Risk Factors” for a description of the risks to our business relating to the Treasury agreements, as well as the adverse effects of the senior preferred stock and the warrant on the rights of holders of our common stock and other series of preferred stock.
Senior Preferred Stock Purchase Agreement and Related Issuance of Senior Preferred Stock and Common Stock Warrant
Senior Preferred Stock Purchase Agreement
Under the senior preferred stock purchase agreement, we issued to Treasury (a) one million shares of Variable Liquidation Preference Senior Preferred Stock, Series 2008-2, which we refer to as the “senior preferred stock,” and (b) a warrant to purchase, for a nominal price, shares of common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis at the time the warrant is exercised, which we refer to as the “warrant.”
The senior preferred stock and warrant were issued to Treasury as an initial commitment fee in consideration of the commitment from Treasury to provide funds to us under the terms and conditions set forth in the senior preferred stock purchase agreement. The senior preferred stock purchase agreement provides that, on a quarterly basis, we may draw funds up to the amount, if any, by which our total liabilities exceed our total assets, as reflected in our consolidated balance sheet, prepared in accordance with generally accepted accounting principles (“GAAP”), for the applicable fiscal quarter (referred to as the “deficiency amount”), up to the maximum amount of remaining funding under the agreement. As of the date of this filing, the maximum amount of remaining funding under the agreement is $117.6 billion. If we were to draw additional funds from Treasury under the agreement in a future period, the amount of remaining funding under the agreement would be reduced by the amount of our draw. Dividend payments we make to Treasury do not restore or increase the amount of funding available to us under the agreement. The senior preferred stock purchase agreement provides that the deficiency amount will be calculated differently if we become subject to receivership or other liquidation process.
The terms of the senior preferred stock purchase agreement provided for the payment of an unspecified quarterly commitment fee to Treasury; however, the August 2012 amendment to the agreement provided that this commitment fee will not be set, accrue or be payable, as long as the current dividend payment provisions of the senior preferred stock remain in effect.
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Business | Conservatorship and Treasury Agreements | ||
Treasury’s funding commitment under the senior preferred stock purchase agreement has no expiration date. The senior preferred stock purchase agreement provides that Treasury’s funding commitment will terminate under any of the following circumstances: (1) the completion of our liquidation and fulfillment of Treasury’s obligations under its funding commitment at that time; (2) the payment in full of, or reasonable provision for, all of our liabilities (whether or not contingent, including mortgage guaranty obligations); or (3) the funding by Treasury of the maximum amount that may be funded under the agreement. In addition, Treasury may terminate its funding commitment and declare the senior preferred stock purchase agreement null and void if a court vacates, modifies, amends, conditions, enjoins, stays or otherwise affects the appointment of the conservator or otherwise curtails the conservator’s powers. Treasury may not terminate its funding commitment under the agreement solely by reason of our being in conservatorship, receivership or other insolvency proceeding, or due to our financial condition or any adverse change in our financial condition.
The senior preferred stock purchase agreement provides that most provisions of the agreement may be waived or amended by mutual written agreement of the parties; however, no waiver or amendment of the agreement is permitted that would decrease Treasury’s aggregate funding commitment or add conditions to Treasury’s funding commitment if the waiver or amendment would adversely affect in any material respect the holders of our debt securities or guaranteed Fannie Mae MBS.
In the event of our default on payments with respect to our debt securities or guaranteed Fannie Mae MBS, if Treasury fails to perform its obligations under its funding commitment and if we and/or the conservator are not diligently pursuing remedies in respect of that failure, the holders of our debt securities or Fannie Mae MBS may file a claim in the United States Court of Federal Claims for relief requiring Treasury to fund to us the lesser of (1) the amount necessary to cure the payment defaults on our debt and Fannie Mae MBS and (2) the lesser of (a) the deficiency amount and (b) the maximum amount that may be funded under the agreement less the aggregate amount of funding previously provided under the commitment. Any payment that Treasury makes under those circumstances will be treated for all purposes as a draw under the senior preferred stock purchase agreement that will increase the liquidation preference of the senior preferred stock.
Senior Preferred Stock
Pursuant to the senior preferred stock purchase agreement, we issued one million shares of senior preferred stock to Treasury on September 8, 2008 with an aggregate initial liquidation preference of $1.0 billion. The stock’s liquidation preference is subject to adjustment. For any dividend period for which dividends are payable, to the extent that dividends are not paid in cash they will accrue and be added to the liquidation preference. In addition, any amounts Treasury pays to us pursuant to its funding commitment under the senior preferred stock purchase agreement and any quarterly commitment fees that are either not paid in cash to Treasury or not waived by Treasury will be added to the liquidation preference. Accordingly, the aggregate liquidation preference of the senior preferred stock was $117.1 billion as of December 31, 2016.
Treasury, as holder of the senior preferred stock, is entitled to receive, when, as and if declared, out of legally available funds, cumulative quarterly cash dividends. Pursuant to the August 2012 amendment to the agreement, beginning in 2013, the method for calculating the amount of dividends for each quarter was changed from an annual rate of 10% per year on the then-current liquidation preference of the senior preferred stock to an amount determined based on our net worth as of the end of the immediately preceding fiscal quarter. Our net worth as defined by the agreement is the amount, if any, by which our total assets (excluding Treasury’s funding commitment and any unfunded amounts related to the commitment) exceed our total liabilities (excluding any obligation in respect of capital stock), in each case as reflected on our balance sheet prepared in accordance with GAAP. For each dividend period from January 1, 2013 through and including December 31, 2017, the dividend amount will be the amount, if any, by which our net worth as of the end of the immediately preceding fiscal quarter exceeds an applicable capital reserve amount. The capital reserve amount was initially $3.0 billion for dividend periods in 2013 and decreases by $600 million each year until it reaches zero on January 1, 2018. Accordingly, the capital reserve amount was $1.2 billion for dividend periods in 2016 and decreased to $600 million for dividend periods in 2017. For each dividend period beginning in 2018, the dividend amount will be the entire amount of our net worth, if any, as of the end of the immediately preceding fiscal quarter. As a result of these dividend payment provisions and quarterly directives from our conservator, when we have quarterly earnings that result in a net worth greater than the applicable capital reserve amount, we will pay dividends to Treasury in the next quarter; but if our net worth does not exceed the applicable capital reserve amount as of the end of a quarter, then we will not be required to accrue or pay any dividends in the next quarter. See “Risk Factors” for a discussion
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of the risks relating to our limited and declining capital reserves and our dividend obligations to Treasury on the senior preferred stock.
The senior preferred stock ranks ahead of our common stock and all other outstanding series of our preferred stock, as well as any capital stock we issue in the future, as to both dividends and rights upon liquidation. The senior preferred stock provides that we may not, at any time, declare or pay dividends on, make distributions with respect to, or redeem, purchase or acquire, or make a liquidation payment with respect to, any common stock or other securities ranking junior to the senior preferred stock unless (1) full cumulative dividends on the outstanding senior preferred stock (including any unpaid dividends added to the liquidation preference) have been declared and paid in cash, and (2) all amounts required to be paid with the net proceeds of any issuance of capital stock for cash (as described in the following paragraph) have been paid in cash. Shares of the senior preferred stock are not convertible. Shares of the senior preferred stock have no general or special voting rights, other than those set forth in the certificate of designation for the senior preferred stock or otherwise required by law. The consent of holders of at least two-thirds of all outstanding shares of senior preferred stock is generally required to amend the terms of the senior preferred stock or to create any class or series of stock that ranks prior to or on parity with the senior preferred stock.
We are not permitted to redeem the senior preferred stock prior to the termination of Treasury’s funding commitment under the senior preferred stock purchase agreement. Moreover, we are not permitted to pay down the liquidation preference of the outstanding shares of senior preferred stock except to the extent of (1) accrued and unpaid dividends previously added to the liquidation preference and not previously paid down; and (2) quarterly commitment fees previously added to the liquidation preference and not previously paid down. In addition to these exceptions, if we issue any shares of capital stock for cash while the senior preferred stock is outstanding, the net proceeds of the issuance must be used to pay down the liquidation preference of the senior preferred stock; however, the liquidation preference of each share of senior preferred stock may not be paid down below $1,000 per share prior to the termination of Treasury’s funding commitment. Following the termination of Treasury’s funding commitment, we may pay down the liquidation preference of all outstanding shares of senior preferred stock at any time, in whole or in part.
In December 2015, as part of a funding bill, Congress enacted legislation prohibiting Treasury from disposing of its Fannie Mae and Freddie Mac senior preferred stock until January 1, 2018, unless legislation is enacted that includes specific instruction for its disposition.
Common Stock Warrant
Pursuant to the senior preferred stock purchase agreement, on September 7, 2008, we, through FHFA, in its capacity as conservator, issued a warrant to purchase common stock to Treasury. The warrant gives Treasury the right to purchase shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis on the date of exercise, for an exercise price of $0.00001 per share. The warrant may be exercised in whole or in part at any time on or before September 7, 2028.
Covenants under Treasury Agreements
The senior preferred stock purchase agreement and warrant contain covenants that significantly restrict our business activities and require the prior written consent of Treasury before we can take certain actions. As a result of these covenants, we can no longer obtain additional equity financing (other than pursuant to the senior preferred stock purchase agreement) and we are limited in the amount and type of debt financing we may obtain.
These covenants prohibit us from taking a number of actions, including:
• | paying dividends or other distributions on or repurchasing our equity securities (other than the senior preferred stock or warrant); |
• | issuing additional equity securities (except in limited instances); |
• | selling, transferring, leasing or otherwise disposing of any assets, except for dispositions for fair market value in limited circumstances including if (a) the transaction is in the ordinary course of business and consistent with past practice or (b) in one transaction or a series of related transactions if the assets have a fair market value individually or in the aggregate of less than $250 million; |
• | issuing subordinated debt; |
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• | entering into any new compensation arrangements or increasing amounts or benefits payable under existing compensation arrangements for any of our executive officers (as defined by Securities and Exchange Commission (“SEC”) rules) without the consent of the Director of FHFA, in consultation with the Secretary of the Treasury; and |
• | seeking or permitting the termination of our conservatorship, other than in connection with a receivership. |
We also are subject to limits, which are described below, on the amount of mortgage assets that we may own and the total amount of our indebtedness.
• | Mortgage Asset Limit. We are restricted in the amount of mortgage assets that we may own. Pursuant to the August 2012 amendment to the agreement, the maximum allowable amount of our mortgage assets was reduced to $650 billion on December 31, 2012 and, on each December 31 thereafter, we are required to reduce our mortgage assets to 85% of the maximum allowable amount that we were permitted to own as of December 31 of the immediately preceding calendar year, until the amount of our mortgage assets reaches $250 billion in 2018. Our mortgage asset limit under the agreement was $339.3 billion as of December 31, 2016 and will be $288.4 billion as of December 31, 2017. For purposes of the agreement, the definition of mortgage asset is based on the unpaid principal balance of such assets and does not reflect market valuation adjustments, allowance for loan losses, impairments, unamortized premiums and discounts and the impact of our consolidation of variable interest entities. Based on this definition, our mortgage assets were $272.4 billion as of December 31, 2016. We disclose the amount of our mortgage assets on a monthly basis under the caption “Gross Mortgage Portfolio” in our Monthly Summaries, which are available on our website and announced in a press release. |
In 2014, FHFA requested that we cap the portfolio each year at 90% of the annual limit under our senior preferred stock purchase agreement with Treasury. FHFA’s request noted that we may seek FHFA permission to increase this cap up to 95% of the annual limit under our senior preferred stock purchase agreement with Treasury upon written request and with a documented basis for exception, such as changed market conditions. To comply with FHFA’s request, we reduced our mortgage portfolio to $272.4 billion as of December 31, 2016, below the $305.4 billion cap requested by FHFA. See “MD&A—Retained Mortgage Portfolio” for more information about our retained mortgage portfolio.
• | Debt Limit. We are subject to a limit on the amount of our indebtedness. Our debt limit in 2016 was $479.0 billion and in 2017 is $407.2 billion. For every year thereafter, our debt cap will equal 120% of the amount of mortgage assets we are allowed to own under the senior preferred stock purchase agreement on December 31 of the immediately preceding calendar year. The definition of indebtedness for purposes of our debt cap is based on the par value of each applicable loan and does not reflect the impact of consolidation of variable interest entities. Under this definition, our indebtedness as of December 31, 2016 was $328.8 billion. We disclose the amount of our indebtedness on a monthly basis under the caption “Total Debt Outstanding” in our Monthly Summaries, which are available on our website and announced in a press release. |
Annual Risk Management Plan Covenant. We are required to provide an annual risk management plan to Treasury each year we remain in conservatorship. Each plan is required to set out our strategy for reducing our risk profile, describe the actions we will take to reduce the financial and operational risk associated with each of our business segments, and include an assessment of our performance against the planned actions described in the prior year’s plan. We submitted our most recent annual risk management plan to Treasury in December 2016.
Lawsuits Challenging the Senior Preferred Stock Purchase Agreements and Conservatorship
Several lawsuits have been filed by preferred and common stockholders of Fannie Mae and Freddie Mac against one or more of the United States, Treasury and FHFA challenging actions taken by the defendants relating to the senior preferred stock purchase agreements and the conservatorships of Fannie Mae and Freddie Mac. Some of these lawsuits also contain claims against Fannie Mae and Freddie Mac. For a description of these lawsuits, see “Legal Proceedings” and “Note 18, Commitments and Contingencies.”
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Housing Finance Reform
Policymakers and others have focused significant attention in recent years on how to reform the nation’s housing finance system, including what role, if any, the GSEs should play. We describe below recent actions and statements relating to housing finance reform from the Administration and Congress, as well as actions our conservator has been taking to further housing finance reform.
Administration Developments
The previous Administration endorsed the wind down of Fannie Mae and Freddie Mac through a responsible transition and the enactment of comprehensive housing finance reform legislation. The current Administration has not articulated a formal position on housing finance reform or the future of the GSEs; however, the Treasury Secretary indicated in his confirmation hearing that he is focused on housing finance reform and a solution to the current status of Fannie Mae and Freddie Mac.
Legislative Developments
Several bills were introduced and considered in the Senate and the House of Representatives in prior sessions of Congress relating to housing finance reform. The current session of Congress began in January 2017. The current Chairman of the Senate Committee on Banking, Housing and Urban Affairs and the current Chairman of the House Committee on Financial Services have both stated that passing comprehensive housing finance reform is a priority of their committees. Accordingly, we expect Congress to continue to consider housing finance reform legislation in the current congressional session that could result in significant changes in our structure and role in the future, including proposals that would result in Fannie Mae’s liquidation or dissolution. As a result, there continues to be significant uncertainty regarding the future of our company. See “Risk Factors” for a discussion of the risks to our business relating to the uncertain future of our company.
Conservator Developments and Strategic Goals
FHFA has taken a number of steps as conservator to further the reform of the housing finance system. FHFA’s current strategic goals for Fannie Mae and Freddie Mac’s conservatorships are to:
• | Maintain, in a safe and sound manner, credit availability and foreclosure prevention activities for new and refinanced mortgages to foster liquid, efficient, competitive and resilient national housing finance markets. |
• | Reduce taxpayer risk through increasing the role of private capital in the mortgage market. |
• | Build a new single-family infrastructure for use by Fannie Mae and Freddie Mac and adaptable for use by other participants in the secondary market in the future. |
Beginning in 2012, FHFA has released annual corporate performance objectives for Fannie Mae and Freddie Mac, referred to as the conservatorship scorecard. The conservatorship scorecard details the specific priorities each year for implementing FHFA’s strategic goals. Some of the actions we are taking pursuant to the mandates of the scorecards are helping to build the policies and infrastructure for a safer and sustainable housing finance system. FHFA’s conservatorship scorecards in recent years have included objectives relating to credit risk transfer transactions, development of a common securitization platform for Fannie Mae and Freddie Mac, development of a single mortgage-backed security for Fannie Mae and Freddie Mac, and mortgage data standardization initiatives.
For several years, FHFA’s conservatorship scorecards have included objectives relating to the development of a common securitization platform that can be used to perform certain aspects of the securitization process and the development of a single mortgage-backed security for Fannie Mae and Freddie Mac. FHFA’s 2017 conservatorship scorecard states that the common securitization platform and single security are significant, multi-year initiatives, and FHFA expects these inter-related projects to remain ongoing conservatorship priorities. More information on these initiatives is provided below.
Common Securitization Platform. In October 2013, at the direction of our conservator, Fannie Mae and Freddie Mac established Common Securitization Solutions, LLC (“CSS”), a jointly owned limited liability company formed to design, develop, build and ultimately operate a common securitization platform. The intended purpose of the common securitization platform is to replace certain elements of Fannie Mae’s and Freddie Mac’s respective
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proprietary systems for securitizing mortgages and performing associated back office and administrative functions. In addition, FHFA has specified that the design of the common securitization platform should allow for the integration of additional market participants in the future.
In 2014, Fannie Mae and Freddie Mac executed three agreements relating to the governance and operation of CSS, and appointed a chief executive officer and four members of the CSS Board of Managers, two each from Fannie Mae and Freddie Mac. CSS currently operates as a separate company from us and Freddie Mac, with funding and limited administrative support services and other resources provided to it by us and Freddie Mac. In November 2016, Fannie Mae, Freddie Mac and CSS entered into a Customer Services Agreement that sets forth the terms under which CSS will provide securitization services to us and Freddie Mac.
In November 2016, Freddie Mac began using the common securitization platform for some activities relating to the issuance of its current single-class fixed-rate mortgage-backed securities. We continue to work with FHFA, Freddie Mac and CSS on building and testing the common securitization platform, as well as on implementing required changes to our systems and operations to integrate with the common securitization platform. In addition, we continue to consult with an industry advisory group on the common securitization platform and single security.
Single Security. Since 2014, we, Freddie Mac and FHFA have been working on developing and implementing a single mortgage-backed security for Fannie Mae and Freddie Mac. FHFA has determined that the following features will apply to these single securities:
• | Fannie Mae and Freddie Mac will each issue and guarantee single securities directly backed by mortgage loans it has acquired, referred to as first-level securities, and will not cross-guarantee each other’s first-level securities; |
• | mortgage loans backing first-level single securities will be limited to fixed-rate mortgage loans now eligible for financing through the “To-Be-Announced” (“TBA”) market; |
• | Fannie Mae and Freddie Mac will each be able to issue second-level single securities, also referred to as resecuritizations, backed by first- or second-level securities issued by either company; |
• | the key features of the new single security will be the same as those of the current Fannie Mae MBS; |
• | the loan- and security-level disclosures for single securities will closely resemble those of Freddie Mac participation certificates (“Freddie Mac PCs”); and |
• | investors in Freddie Mac PCs will have the option to exchange legacy Freddie Mac PCs for comparable single securities backed by the same mortgage loans; there will not be an exchange option for legacy Fannie Mae MBS because FHFA expects investors to treat them as fungible with the single securities. |
In December 2016, FHFA announced that it expects to announce in the first quarter of 2017 a timeframe for implementation of the single security by Fannie Mae and Freddie Mac.
Historically, Fannie Mae MBS has had a trading advantage over comparable Freddie Mac PCs. One of FHFA’s stated objectives in developing a single security is to reduce the costs to Freddie Mac and taxpayers that result from differences in liquidity of Fannie Mae MBS and Freddie Mac PCs. As the implementation date of the single security approaches, some Fannie Mae MBS and comparable Freddie Mac PCs have traded closer to or at parity. See “Risk Factors” for a discussion of the risks to our business associated with a single security for Fannie Mae and Freddie Mac.
For more information on FHFA’s 2017 conservatorship scorecard objectives, see our Current Report on Form 8-K filed with the SEC on December 16, 2016. For information on actions we took in 2016 pursuant to FHFA’s 2016 conservatorship scorecard, see “Executive Compensation—Compensation Discussion and Analysis—Determination of 2016 Compensation—Assessment of Corporate Performance on 2016 Conservatorship Scorecard.”
Charter Act
Fannie Mae is a shareholder-owned corporation organized and existing under the Federal National Mortgage Association Charter Act, which we refer to as the Charter Act or our charter. We were initially established in 1938.
The Charter Act defines our mission of providing liquidity, increasing stability and promoting affordability in the residential mortgage market. Specifically, the Charter Act states that our purposes are to:
• | provide stability in the secondary market for residential mortgages; |
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• | respond appropriately to the private capital market; |
• | provide ongoing assistance to the secondary market for residential mortgages (including activities relating to mortgages on housing for low- and moderate-income families involving a reasonable economic return that may be less than the return earned on other activities) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing; and |
• | promote access to mortgage credit throughout the nation (including central cities, rural areas and underserved areas) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing. |
The Charter Act also sets forth the activities that we are permitted to conduct and describes our general corporate powers. We summarize these provisions of the Charter Act below.
• | Purchase and securitization of mortgage loans. Our charter permits us to purchase and securitize mortgage loans secured by single-family and multifamily properties. We are also authorized to service, sell, lend on the security of, and otherwise deal in mortgage loans. |
• | Principal balance limitations. Single-family conventional mortgage loans that we purchase or securitize are subject to maximum original principal balance limits, known as “conforming loan limits.” The conforming loan limits are established each year based on the average prices of one-family residences. FHFA set the national conforming loan limit for mortgages that finance one-family residences at $424,100 for 2017, with higher limits for mortgages secured by two-family to four-family residences and in four statutorily-designated states and territories (Alaska, Hawaii, Guam and the U.S. Virgin Islands). In addition, higher loan limits of up to 150% of the otherwise applicable loan limit apply in designated high-cost areas. FHFA provides Fannie Mae with the designated high-cost areas annually. For 2006 to 2016, the national conforming loan limit for one-family residences was set at $417,000. The Charter Act does not impose maximum original principal balance limits on loans we purchase or securitize that are insured by the Federal Housing Administration (“FHA”) or guaranteed by the Department of Veterans Affairs (“VA”) or on multifamily mortgage loans that we purchase or securitize. |
• | Credit enhancement requirements. The Charter Act generally requires credit enhancement on any single-family conventional mortgage loan that we purchase or securitize that has a loan-to-value (“LTV”) ratio over 80% at the time of purchase. The credit enhancement required by our charter may take the form of one or more of the following: (1) insurance or a guaranty by a qualified insurer on the portion of the unpaid principal balance of the mortgage that exceeds 80%; (2) a seller’s agreement to repurchase or replace the mortgage in the event of default; or (3) retention by the seller of at least a 10% participation interest in the mortgage. Regardless of LTV ratio, the Charter Act does not require us to obtain credit enhancement to purchase or securitize loans insured by FHA or guaranteed by the VA. |
• | Issuances of our securities. We are authorized, upon the approval of the Secretary of the Treasury, to issue debt obligations and mortgage-related securities. Neither the U.S. government nor any of its agencies guarantees, directly or indirectly, our debt or mortgage-related securities. |
• | Authority of Treasury to purchase our securities. At the discretion of the Secretary of the Treasury, Treasury may purchase our obligations up to a maximum of $2.25 billion outstanding at any one time. |
• | Exemptions for our securities. The Charter Act generally provides that our securities are exempt under the federal securities laws administered by the SEC. As a result, we are not required to file registration statements with the SEC under the Securities Act of 1933 with respect to offerings of any of our securities. Our non-equity securities are also exempt securities under the Securities Exchange Act of 1934 (the “Exchange Act”). However, our equity securities are not treated as exempt securities for purposes of Sections 12, 13, 14 or 16 of the Exchange Act. Consequently, we are required to file periodic and current reports with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. |
• | Exemption from specified taxes. Fannie Mae is exempt from taxation by states, territories, counties, municipalities and local taxing authorities, except for taxation by those authorities on our real property. We are not exempt from the payment of federal corporate income taxes. |
• | Limitations. We may not originate mortgage loans in the primary mortgage market. We also may not advance funds to a mortgage seller on an interim basis, using mortgage loans as collateral, pending the sale |
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of the mortgages in the secondary market. In addition, we may only purchase or securitize mortgages on properties located in the United States and its territories.
GSE Act and Other Regulation of Our Business
As a federally chartered corporation, we are subject to government regulation and oversight. FHFA is our primary regulator, and regulates our safety and soundness and our mission. FHFA is an independent agency of the federal government with general supervisory and regulatory authority over Fannie Mae, Freddie Mac and the Federal Home Loan Banks (“FHLBs”). The Department of Housing and Urban Development (“HUD”) is our regulator with respect to fair lending matters. Our regulators also include the SEC and Treasury.
The GSE Act provides FHFA with safety and soundness authority that is comparable to and in some respects broader than that of the federal banking agencies. We describe below regulations applicable to us pursuant to the GSE Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and other legislation. The current Administration and some members of Congress have indicated a desire to amend the Dodd-Frank Act. If the Dodd-Frank Act is amended, it could affect regulations currently applicable to us and our customers and counterparties.
Capital
We are required by the GSE Act to maintain sufficient capital to meet minimum and risk-based capital levels established by FHFA in order to be classified as “adequately capitalized.” However, because we are under conservatorship, FHFA has suspended our capital classifications and advised us that we will not be subject to corrective action requirements that would ordinarily result from our receiving a capital classification of “undercapitalized.” We continue to submit capital reports to FHFA and FHFA monitors our capital levels, but FHFA has stated that it does not intend to publish our risk-based capital level or our critical capital level during the conservatorship.
• | Minimum Capital. Under the GSE Act, we are required to maintain an amount of core capital that equals or exceeds our minimum capital requirement. The GSE Act defines core capital as the sum of the stated value of outstanding common stock (common stock less treasury stock), the stated value of outstanding non-cumulative perpetual preferred stock, paid-in capital, and retained earnings, as determined in accordance with GAAP. Our minimum capital requirement is generally equal to the sum of 2.50% of on-balance sheet assets and 0.45% of off-balance sheet obligations. For purposes of minimum capital, FHFA has directed us to continue reporting loans backing Fannie Mae MBS held by third parties based on 0.45% of the unpaid principal balance regardless of whether these loans have been consolidated pursuant to accounting rules. The GSE Act provides FHFA with broad authority to increase the level of our required minimum capital and to establish capital or reserve requirements for specific products and activities. |
• | Risk-Based Capital. The GSE Act requires FHFA to establish risk-based capital requirements for Fannie Mae and Freddie Mac, to ensure that we operate in a safe and sound manner. Existing risk-based capital regulation under the GSE Act ties our capital requirements to the risk in our book of business, as measured by a stress test model. FHFA has discontinued stress test simulations under the existing rule. We continue to submit detailed profiles of our books of business to FHFA to support FHFA’s monitoring of our business activity and their research into future risk-based capital rules. |
• | Critical Capital. The GSE Act also establishes a critical capital requirement, which is the amount of core capital below which we would be classified as “critically undercapitalized.” Under the GSE Act, such classification is a discretionary ground for appointing a conservator or receiver. Our critical capital requirement is generally equal to the sum of 1.25% of on-balance sheet assets and 0.25% of off-balance sheet obligations. FHFA has directed us, for purposes of critical capital, to continue reporting loans backing Fannie Mae MBS held by third parties based on 0.25% of the unpaid principal balance, notwithstanding our consolidation of substantially all of the loans backing these securities. |
Stress Testing
The Dodd-Frank Act requires certain financial companies to conduct annual stress tests to determine whether the companies have the capital necessary to absorb losses as a result of adverse economic conditions. Under FHFA regulations implementing this requirement, each year we are required to conduct a stress test using three different scenarios of financial conditions provided by FHFA: baseline, adverse and severely adverse. In conducting the stress test, we are required to calculate the impact of the scenario conditions on our capital levels and other
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specified measures of financial condition and performance over a period of at least nine quarters. In accordance with FHFA regulations, we submitted our most recent stress test results to FHFA and the Federal Reserve Board of Governors in May 2016 and published our most recent stress test results for the severely adverse scenario on our website in August 2016.
Portfolio
The GSE Act requires FHFA to establish standards governing our portfolio holdings, to ensure that they are backed by sufficient capital and consistent with our mission and safe and sound operations. FHFA is also required to monitor our portfolio and, in some circumstances, may require us to dispose of or acquire assets. In 2010, FHFA adopted, as the standard for our portfolio holdings, the portfolio limits specified in the senior preferred stock purchase agreement described under “Conservatorship and Treasury Agreements—Treasury Agreements—Covenants under Treasury Agreements,” as it may be amended from time to time. The rule is effective for as long as we remain subject to the terms and obligations of the senior preferred stock purchase agreement.
New Products and Activities
The GSE Act requires us to request FHFA’s approval before initially offering any new product, subject to certain exceptions. The GSE Act also requires us to provide FHFA with written notice before commencing any new activity. In July 2009, FHFA published an interim final rule implementing these provisions of the GSE Act. Subsequently, the then-Acting Director of FHFA concluded that permitting us to engage in new products was inconsistent with the goals of the conservatorship. FHFA therefore instructed us not to submit new product requests under the rule. In December 2016, FHFA published a final rule implementing our duty to serve three specified underserved markets, which is described below under “Duty to Serve Underserved Markets.” Among other things, the rule states that we may propose a new product for FHFA consideration if we determine that it would facilitate our duty to serve obligations and would be consistent with safety and soundness.
Prudential Management and Operations Standards
As required by the GSE Act, in June 2012, FHFA published a final rule establishing prudential standards relating to the management and operations of Fannie Mae, Freddie Mac and the FHLBs in ten areas: (1) internal controls and information systems; (2) independence and adequacy of internal audit systems; (3) management of market risk exposure; (4) management of market risk—measurement systems, risk limits, stress testing, and monitoring and reporting; (5) adequacy and maintenance of liquidity and reserves; (6) management of asset and investment portfolio growth; (7) investments and acquisitions of assets; (8) overall risk management processes; (9) management of credit and counterparty risk; and (10) maintenance of adequate records. The rule also includes provisions addressing the general responsibilities of boards of directors and senior management. In November 2015, FHFA amended these provisions and designated them as an additional prudential standard in order to clarify that they have the same effect and can be enforced in the same manner as the ten enumerated standards.
Affordable Housing Allocations
The GSE Act requires us to set aside in each fiscal year an amount equal to 4.2 basis points for each dollar of the unpaid principal balance of our total new business purchases and to pay this amount to specified HUD and Treasury funds. FHFA suspended this requirement in November 2008 and directed us to not set aside or allocate funds until further notice. In December 2014, FHFA terminated this suspension and directed us to begin making contributions to the funds. FHFA’s directive reinstating these contributions requires us to set aside amounts during each fiscal year beginning in fiscal year 2015, and to allocate or otherwise transfer the amounts set aside within 60 days after the end of each fiscal year, unless during such fiscal year we have made a draw from Treasury under the terms of the senior preferred stock purchase agreement or unless such allocation or transfer would cause us to have to make a draw from Treasury under the agreement, in which case we will make no allocation or transfer for that year and the amounts set aside for that year will be reversed. We are prohibited from redirecting or passing through the cost of these allocations to originators of mortgages that we purchase or securitize.
Executive Compensation
Fannie Mae’s Charter provides that the company has the power to pay compensation to our executives that the Board of Directors determines is reasonable and comparable with the compensation of executives performing similar duties in similar businesses, except that a significant portion of potential compensation must be based on
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our performance. The GSE Act directs FHFA to prohibit us from providing unreasonable or non-comparable compensation to our executive officers. FHFA may at any time review the reasonableness and comparability of an executive officer’s compensation and may require us to withhold any payment to the officer during such review. In addition, pursuant to the Stop Trading on Congressional Knowledge Act (the “STOCK Act”) and related regulations issued by FHFA, our senior executives are prohibited from receiving bonuses during any period of conservatorship on or after April 4, 2012.
FHFA is authorized by the GSE Act to prohibit or limit certain golden parachute and indemnification payments to directors, officers and certain other parties. FHFA regulation requires the approval of the Director of FHFA before we may enter into any agreement providing compensation in connection with the termination of an executive officer’s employment. FHFA regulation also generally prohibits us from making golden parachute payments to any current or former director, officer, employee, controlling stockholder or agent of the company during any period in which we are in conservatorship, receivership or other troubled condition unless either a specific exception applies or the Director of FHFA approves the payments.
In November 2015, the Equity in Government Compensation Act of 2015 was enacted. This law directs the Director of FHFA to suspend the compensation packages approved for 2015 for Fannie Mae’s and Freddie Mac’s chief executive officers and, in lieu of such packages, to establish the compensation and benefits that were in effect for such officers as of January 1, 2015. The law also provides that these officers’ compensation and benefits may not thereafter be increased and these restrictions on chief executive officer compensation are applicable as long as Fannie Mae and Freddie Mac are in conservatorship or receivership. In accordance with this law, on December 1, 2015, the Director of FHFA directed Fannie Mae to decrease the total target annual direct compensation of our chief executive officer to $600,000, effective November 25, 2015.
In April 2016, FHFA reissued its portion of a proposed rule under Section 956 of the Dodd-Frank Act relating to incentive compensation. Section 956 requires that FHFA and other financial regulators issue rules or guidelines: (1) prohibiting incentive-based payment arrangements that the regulators determine encourage inappropriate risks by providing excessive compensation or that could lead to material financial loss; and (2) requiring enhanced disclosure and reporting of incentive-based compensation arrangements. The proposed rule provides that, while we are in conservatorship, FHFA will determine how to best fulfill the requirements and purpose of Section 956, taking into consideration the possible duration of the conservatorship, the nature of our governance, the need to attract and retain management and other talent, limitations on the ability to employ equity-like instruments as incentive-based compensation, and any other circumstances FHFA deems relevant.
For more information on our executive compensation program and regulatory and other legal requirements affecting our executive compensation, see “Executive Compensation.”
Fair Lending
The GSE Act requires the Secretary of HUD to assure that the GSEs meet their fair lending obligations. Among other things, HUD periodically reviews and comments on our underwriting and appraisal guidelines to ensure consistency with the Fair Housing Act.
Guaranty Fees
In December 2011, Congress enacted the Temporary Payroll Tax Cut Continuation Act of 2011 (“TCCA”) under which, at the direction of FHFA, we increased the guaranty fee on all single-family residential mortgages delivered to us by 10 basis points effective April 1, 2012. The revenue generated by this fee increase is paid to Treasury and helps offset the cost of a two-month extension of the payroll tax cut from January 1, 2012 through February 29, 2012. FHFA and Treasury advised us to remit this fee increase to Treasury with respect to all loans acquired by us on or after April 1, 2012 and before January 1, 2022, and to continue to remit these amounts to Treasury on and after January 1, 2022 with respect to loans we acquired before this date until those loans are paid off or otherwise liquidated.
From time to time, FHFA establishes requirements for our guaranty fee pricing. In July 2016, FHFA advised us that, as a result of its recently completed comprehensive review of our guaranty fee levels for new acquisitions of single-family mortgages, FHFA, in its regulatory capacity, determined that it was necessary to set minimum base guaranty fees for us. FHFA’s objective is to ensure that guaranty fee reductions do not result in unsafe and unsound conditions. As a result, FHFA established minimum base guaranty fees that generally apply to our acquisitions of 30-year and 15-year fixed-rate loans in lender swap transactions. These new minimum base guaranty fees were implemented in November 2016.
Fannie Mae 2016 Form 10-K | 25 | |
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Housing Goals
We are subject to housing goals established by FHFA in accordance with the GSE Act. The housing goals establish specified requirements for our mortgage acquisitions relating to affordability or location. Our single-family performance is measured against the lower of benchmarks established by FHFA or goals-qualifying originations in the primary mortgage market. Multifamily goals are established as a number of units to be financed. We describe these goals and our 2015 performance against the goals below.
Single-Family Housing Goals
FHFA established the following single-family home purchase and refinance housing goal benchmarks for 2015 through 2017. A home purchase mortgage may be counted toward more than one home purchase benchmark.
• | Low-Income Families Home Purchase Benchmark: At least 24% of our acquisitions of single-family owner-occupied purchase money mortgage loans must be affordable to low-income families (defined as income equal to or less than 80% of area median income). |
• | Very Low-Income Families Home Purchase Benchmark: At least 6% of our acquisitions of single-family owner-occupied purchase money mortgage loans must be affordable to very low-income families (defined as income equal to or less than 50% of area median income). |
• | Low-Income Areas Home Purchase Goal Benchmark: The benchmark level for our acquisitions of single-family owner-occupied purchase money mortgage loans for families in low-income areas is set annually by notice from FHFA, based on the benchmark level for the low-income areas home purchase subgoal (below), plus an adjustment factor reflecting the additional incremental share of mortgages for moderate-income families (defined as income equal to or less than 100% of area median income) in designated disaster areas. FHFA set the overall low-income areas home purchase benchmark goal at 19% for 2015 and at 17% for 2016. |
• | Low-Income and High-Minority Areas Home Purchase Subgoal Benchmark: At least 14% of our acquisitions of single-family owner-occupied purchase money mortgage loans must be affordable to families in low-income census tracts or to moderate-income families in high-minority census tracts. |
• | Low-Income Families Refinancing Benchmark: At least 21% of our acquisitions of single-family owner-occupied refinance mortgage loans must be affordable to low-income families. |
Under the rule, not all of our single-family loan acquisitions that fall within these categories may be counted towards our housing goals. Certain types of loan acquisitions are excluded, such as single-family government loans and loans for single-family rental properties.
If we do not meet these benchmarks, we may still meet our goals. Our single-family housing goals performance is measured against both these benchmarks and against our share of goals-qualifying originations in the primary mortgage market after the release of data reported under the Home Mortgage Disclosure Act (“HMDA”), which is typically released each year in the fall. We are in compliance with the housing goals if we meet either the benchmarks or market share measures.
Multifamily Housing Goals
FHFA established the following multifamily goals and subgoals for 2015 through 2017.
• | Low-Income Families Goal: At least 300,000 multifamily units per year must be affordable to low-income families. |
• | Very Low-Income Families Subgoal: At least 60,000 multifamily units per year must be affordable to very low-income families. |
• | Small Affordable Multifamily Properties Subgoal: The subgoal for purchases of mortgages on small multifamily properties affordable to low-income families increases each year: 6,000 units in 2015; 8,000 units in 2016; and 10,000 units in 2017. |
There is no market-based alternative measurement for the multifamily goal or subgoals.
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Performance Against Housing Goals
In December 2016, FHFA determined that we met three of our five single-family housing goals and all of our multifamily housing goals for 2015. Table 1 displays our performance for 2015 against our single-family housing benchmarks and market share measures, as well as our multifamily housing goals, as validated by FHFA.
Table 1: 2015 Housing Goals Performance | ||||||||||
2015 | ||||||||||
Result | Benchmark | Single-Family Market Level | ||||||||
Single-family housing goals:(1) | ||||||||||
Low-income families home purchases | 23.5 | % | 24 | % | 23.6 | % | ||||
Very low-income families home purchases | 5.6 | 6 | 5.8 | |||||||
Low-income areas home purchases | 20.4 | 19 | 19.8 | |||||||
Low-income and high-minority areas home purchases | 15.6 | 14 | 15.2 | |||||||
Low-income families refinancing | 22.1 | 21 | 22.5 | |||||||
2015 | |||||||
Result | Goal | ||||||
(in units) | |||||||
Multifamily housing goals: | |||||||
Low-income families | 307,510 | 300,000 | |||||
Very low-income families | 69,078 | 60,000 | |||||
Small affordable multifamily properties | 6,731 | 6,000 | |||||
__________
(1) | Our single-family results and benchmarks are expressed as a percentage of the total number of eligible mortgages acquired during the period. |
As shown in Table 1, FHFA determined that we did not meet the single-family low-income families and very-low income families home purchase goals for 2015. FHFA notified us that it determined that achievement of these goals by us was feasible, based on the size and composition of the conventional conforming primary mortgage market for 2015. However, FHFA also determined that, because this was the first year since 2013 that we did not achieve these goals and we missed the goals by narrow amounts, FHFA will not require us to submit a formal housing plan under the GSE Act.
We will report our performance with respect to the 2016 housing goals in March 2017. FHFA will issue a final determination on our 2016 performance after the release of data reported under HMDA later this year.
As described in “Risk Factors,” actions we may take to meet our housing goals and duty to serve requirements described below may increase our credit losses and credit-related expense.
Duty to Serve Underserved Markets
The GSE Act requires that we serve very low-, low-, and moderate-income families in three specified underserved markets: manufactured housing, affordable housing preservation and rural areas. In December 2016, FHFA published a final rule implementing our duty to serve these underserved markets. Under the rule, we are required to adopt an underserved markets plan for each underserved market covering a three-year period that sets forth the activities and objectives we will undertake to meet our duty to serve that market. The development of these plans is subject to a public notice and comment process, and the plans will require FHFA’s “non-objection” before becoming final. Under the current timetable set forth by FHFA, we anticipate our first underserved markets plans will become effective in 2018.
The types of activities that are eligible for duty to serve credit in each underserved market are summarized below:
• | Manufactured housing market. For the manufactured housing market, duty to serve credit will be available for eligible activities relating to manufactured homes (whether titled as real property or personal property (known as chattel)) and loans for specified categories of manufactured housing communities. |
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• | Affordable housing preservation market. For the affordable housing preservation market, duty to serve credit will be available for eligible activities relating to preserving the affordability of housing for renters and buyers under specified programs enumerated in the GSE Act and other comparable affordable housing programs administered by state and local governments, subject to FHFA approval. Duty to serve credit will also be available for activities related to small (5 to 50 units) multifamily rental properties, energy efficiency improvements on existing multifamily rental and single-family first lien properties, certain shared equity homeownership programs, the purchase or rehabilitation of certain distressed properties, and activities under HUD’s Choice Neighborhoods Initiative and Rental Assistance Demonstration programs. |
• | Rural housing market. For the rural housing market, duty to serve credit will be available for eligible activities related to housing in rural areas, including activities related to housing in high-needs rural regions and for high-needs rural populations. |
FHFA could also approve duty to serve credit for additional activities identified in our underserved markets plans. Qualifying activities that promote residential economic diversity in one or more underserved markets could receive extra duty to serve credit. As provided under the rule, FHFA posted its proposed evaluation guidance in January 2017. The guidance communicates FHFA’s expectations regarding the development of the underserved markets plans and describes the annual process by which FHFA will evaluate our achievements under the underserved markets plans. Our performance results will be reported to Congress. If FHFA determines that we failed to meet the requirements of an underserved markets plan, it may result in the imposition of a housing plan.
Swap Transactions; Minimum Capital and Margin Requirements
The Dodd-Frank Act includes provisions requiring additional regulation of swap transactions. Because we are a user of interest rate swaps, the Dodd-Frank Act requires us, among other items, to submit new swap transactions for clearing to a derivatives clearing organization. Additionally, in October 2015, an inter-agency body of regulators issued a final rule under the Dodd-Frank Act governing margin and capital requirements applicable to entities that are subject to their oversight. The first phase of this rule becomes applicable on March 1, 2017 and requires us to collect and provide collateral in excess of the amounts we have historically collected or provided relative to our level of activity, and changes the types of collateral that can be posted. The second phase of this rule is expected to become applicable on September 1, 2020 and will require additional collateral from us and our counterparties, which will increase the costs associated with hedging our retained mortgage portfolio.
Ability to Repay
The Dodd-Frank Act amended the Truth in Lending Act (“TILA”) to require creditors to determine that borrowers have a “reasonable ability to repay” most mortgage loans prior to making such loans. In 2013, the Consumer Financial Protection Bureau (the “CFPB”) issued a final rule under Regulation Z that, among others things, requires creditors to determine a borrower’s “ability to repay” a mortgage loan. If a creditor fails to comply, a borrower may be able to offset a portion of the amount owed in a foreclosure proceeding or recoup monetary damages. The rule offers several options for complying with the ability to repay requirement, including making loans that meet certain terms and characteristics (referred to as “qualified mortgages”), which may provide creditors and their assignees with special protection from liability. Generally, a loan will be a qualified mortgage under the rule if, among other things, (1) the points and fees paid in connection with the loan do not exceed 3% of the total loan amount, (2) the loan term does not exceed 30 years, (3) the loan is fully amortizing with no negative amortization, interest-only or balloon features and (4) the debt-to-income ratio on the loan does not exceed 43% at origination. The CFPB also defined a special class of conventional mortgage loans that will be qualified mortgages if they (1) meet the points and fees, term and amortization requirements of qualified mortgages generally and (2) are eligible for sale to Fannie Mae or Freddie Mac. This class of qualified mortgages expires on the earlier of January 10, 2021 or when the GSEs cease to be in conservatorship or receivership.
Although TILA does not apply to us, as we do not originate loans in the primary mortgage market, these rules apply to the lenders from which we acquire single-family mortgage loans. In May 2013, FHFA directed Fannie Mae and Freddie Mac to limit our acquisition of single-family loans to those loans that meet the points and fees, term and amortization requirements for qualified mortgages, or to loans that are exempt from the ability-to-repay rule, such as loans made to investors. This limitation applies to loans with application dates on or after January 10, 2014, the effective date of the ability-to-repay rule.
Fannie Mae 2016 Form 10-K | 28 | |
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Risk Retention
The Dodd-Frank Act requires financial regulators to jointly prescribe regulations requiring securitizers to retain a portion of the credit risk in assets transferred, sold or conveyed through the issuance of asset-backed securities, with certain exceptions. In October 2014, an inter-agency body of regulators issued a final rule implementing this credit risk retention requirement. The final rule generally requires securitizers to retain at least 5% of the credit risk of the assets they securitize. The rule offers several compliance options, one of which is to have either Fannie Mae or Freddie Mac (so long as they are in conservatorship or receivership with capital support from the United States) securitize and fully guarantee the assets, in which case no further retention of credit risk is required. In addition, securities backed solely by mortgage loans meeting the definition of a “qualified residential mortgage” are exempt from the risk retention requirements of the rule. The rule defines “qualified residential mortgage” to have the same meaning as the term “qualified mortgage” as defined by the CFPB in connection with its ability-to-repay rule under Regulation Z discussed above. The final risk retention rule became effective on December 24, 2015 for single-family mortgage loans and on December 24, 2016 for multifamily mortgage loans.
TILA-RESPA Integrated Disclosure (“TRID”)
The Dodd-Frank Act required the CFPB to streamline and simplify the disclosures required under TILA and the Real Estate Settlement Procedures Act (“RESPA”). In October 2015, the CFPB’s final rule implementing these changes went into effect. Although this rule applies to mortgage originators and is not directly applicable to us, we could face potential liability for certain errors in the new required disclosures in connection with the loans we acquire from lenders. At this time, it is not yet clear what sorts of errors will give rise to liability. Also in October 2015, FHFA directed us and Freddie Mac not to conduct post-purchase loan file reviews for technical compliance with TRID. Consistent with FHFA’s directive, we currently do not intend to exercise our contractual remedies, including requiring the lender to repurchase the loan, for noncompliance with the newly applicable provisions of TRID, except in two limited circumstances: if the required form is not used; or if a particular practice would impair enforcement of the note or mortgage or would result in assignee liability, and a court of law, regulator or other authoritative body has determined that such practice violates TRID.
Receivership
Under the GSE Act, FHFA must place us into receivership if the Director of FHFA makes a written determination that our assets are less than our obligations (that is, we have a net worth deficit) or if we have not been paying our debts as they become due, in either case, for a period of 60 days. FHFA has notified us that the measurement period for any mandatory receivership determination with respect to our assets and liabilities would commence no earlier than the SEC public filing deadline for our quarterly or annual financial statements and would continue for 60 calendar days thereafter. FHFA has advised us that if, during that 60-day period, we receive funds from Treasury in an amount at least equal to the deficiency amount under the senior preferred stock purchase agreement, the Director of FHFA will not make a mandatory receivership determination.
In addition, we could be put into receivership at the discretion of the Director of FHFA at any time for other reasons set forth in the GSE Act. The statutory grounds for discretionary appointment of a receiver include: a substantial dissipation of assets or earnings due to unsafe or unsound practices; the existence of an unsafe or unsound condition to transact business; an inability to meet our obligations in the ordinary course of business; a weakening of our condition due to unsafe or unsound practices or conditions; critical undercapitalization; undercapitalization and no reasonable prospect of becoming adequately capitalized; the likelihood of losses that will deplete substantially all of our capital; or by consent.
The appointment of FHFA as receiver would immediately terminate the conservatorship. In the event of a receivership, the GSE Act requires FHFA, as the receiver, to organize a limited-life regulated entity with respect to Fannie Mae. Among other requirements, the GSE Act provides that this limited-life regulated entity:
• | would succeed to Fannie Mae’s charter and thereafter operate in accordance with and subject to such charter; |
• | would assume, acquire or succeed to our assets and liabilities to the extent that such assets and liabilities are transferred by FHFA to the entity; and |
• | would not be permitted to assume, acquire or succeed to any of our obligations to shareholders. |
Placement into receivership would likely have a material adverse effect on holders of our common stock and preferred stock, and could have a material adverse effect on holders of our debt securities and Fannie Mae MBS.
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Should we be placed into receivership, different assumptions would be required to determine the carrying value of our assets, which could lead to substantially different financial results. For more information on the risks to our business relating to receivership and uncertainties regarding the future of our business, see “Risk Factors.”
Our Customers |
Our principal customers are lenders that operate within the primary mortgage market where mortgage loans are originated and funds are loaned to borrowers. Our customers include mortgage banking companies, savings and loan associations, savings banks, commercial banks, credit unions, community banks, specialty servicers, insurance companies, and state and local housing finance agencies. Lenders originating mortgages in the primary mortgage market often sell them in the secondary mortgage market in the form of whole loans or in the form of mortgage-related securities.
We have a diversified funding base of domestic and international investors. Purchasers of Fannie Mae MBS or Fannie Mae debt securities include fund managers, commercial banks, pension funds, insurance companies, Treasury, foreign central banks, corporations, state and local governments, and other municipal authorities.
During 2016, approximately 1,200 lenders delivered single-family mortgage loans to us. We acquire a significant portion of our single-family mortgage loans from several large mortgage lenders. During 2016, our top five lender customers, in the aggregate, accounted for approximately 30% of our single-family business volume, compared with approximately 29% in 2015. Wells Fargo Bank, N.A., together with its affiliates, was the only customer that accounted for 10% or more of our single-family business volume in 2016, with approximately 14%.
Competition |
We compete to acquire mortgage assets in the secondary market. We also compete for the issuance of mortgage-related securities to investors. Competition in these areas is affected by many factors, including the number of residential mortgage loans offered for sale in the secondary market by loan originators and other market participants, the nature of the residential mortgage loans offered for sale (for example, whether the loans represent refinancings), the current demand for mortgage assets from mortgage investors, the interest rate risk investors are willing to assume and the yields they will require as a result, and the credit risk and prices associated with available mortgage investments.
Competition to acquire mortgage assets is significantly affected by both our and our competitors’ pricing and eligibility standards, as well as investor demand for our and our competitors’ mortgage-related securities. Our competitive environment also may be affected by many other factors, such as new legislation or regulations. See “Legislation and Regulation” and “Risk Factors” for information on matters that could affect our business and competitive environment.
Our competitors for the acquisition of single-family mortgage assets are financial institutions and government agencies that manage residential mortgage credit risk or invest in residential mortgage loans, including Freddie Mac, FHA, the VA, Ginnie Mae (which primarily guarantees securities backed by FHA-insured loans and VA-guaranteed loans), the FHLBs, U.S. banks and thrifts, securities dealers, insurance companies, pension funds, investment funds and other mortgage investors. Our primary competitors for the issuance of single-family mortgage-related securities are Freddie Mac and Ginnie Mae, as many private market competitors dramatically reduced or ceased their activities in the single-family secondary mortgage market following the 2008 housing crisis. For the acquisition of multifamily mortgage assets and the issuance of multifamily mortgage-related securities, we primarily compete with Freddie Mac, life insurers, U.S. banks and thrifts, other institutional investors, Ginnie Mae and private-label issuers of commercial mortgage-backed securities. See “Executive Summary—2016 Market Share” for a discussion of our market share compared with that of our competitors in 2016.
We also compete for low-cost debt funding with institutions that hold mortgage portfolios, including Freddie Mac and the FHLBs.
Fannie Mae 2016 Form 10-K | 30 | |
Business | Employees | ||
Employees |
As of January 31, 2017, we employed approximately 7,000 personnel, including full-time and part-time employees, term employees and employees on leave.
Where You Can Find Additional Information |
We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all other SEC reports and amendments to those reports as soon as reasonably practicable after we electronically file the material with, or furnish it to, the SEC. Our website address is www.fanniemae.com. Materials that we file with the SEC are also available from the SEC’s website, www.sec.gov. You may also request copies of any filing from us, at no cost, by calling the Fannie Mae Fixed-Income Securities Helpline at 1-800-2FANNIE (1-800-232-6643), Option 2, or by writing to Fannie Mae, Attention: Fixed-Income Securities, 3900 Wisconsin Avenue, NW, Area 2H-3N, Washington, DC 20016.
All references in this report to our website addresses or the website address of the SEC are provided solely for your information. Information appearing on our website or on the SEC’s website is not incorporated into this annual report on Form 10-K.
Forward-Looking Statements | ||||
This report includes statements that constitute forward-looking statements within the meaning of Section 21E of the Exchange Act. In addition, our senior management may from time to time make forward-looking statements orally to analysts, investors, the news media and others. Forward-looking statements often include words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” “forecast,” “project,” “would,” “should,” “could,” “likely,” “may,” “will” or similar words. Examples of forward-looking statements in this report include, but are not limited to, statements relating to our expectations regarding the following matters:
• | our profitability and financial results, and the factors that will affect our profitability and financial results; |
• | our revenues and the factors that will affect our revenues; |
• | our business plans and strategies and the impact of such plans and strategies; |
• | our capital reserves and our dividend payments to Treasury; |
• | our payments to HUD and Treasury funds under the GSE Act; |
• | the consequences of our conservatorship and possible receivership; |
• | the impact of legislation, regulation and accounting guidance on our business or financial results, including the impact of corporate income tax legislation and impairment accounting guidance; |
• | housing and mortgage market conditions, including home price appreciation, and the impact of such conditions on our financial results; |
• | the risks to our business; |
• | our credit losses and loss reserves; |
• | our serious delinquency rates and foreclosures; |
• | our engagement in credit risk transfer transactions and the effects of those transactions; |
• | factors that will affect or mitigate our credit risk exposure; |
• | the performance of the loans in our book of business and factors that will affect such performance; |
• | our single-family loan acquisitions and the credit risk profile of such acquisitions; and |
• | factors that will affect our liquidity and ability to meet our debt obligations and factors relating to our liquidity contingency plans. |
Forward-looking statements reflect our management’s expectations, forecasts or predictions of future conditions, events or results based on various assumptions and management’s estimates of trends and economic factors in
Fannie Mae 2016 Form 10-K | 31 | |
Business | Forward-Looking Statements | ||
the markets in which we are active, as well as our business plans. They are not guarantees of future performance. By their nature, forward-looking statements are subject to risks and uncertainties. Our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements.
There are a number of factors that could cause actual conditions, events or results to differ materially from those described in the forward-looking statements contained in this report, including, but not limited to, the following: the uncertainty of our future; future legislative and regulatory requirements or changes affecting us, such as the enactment of housing finance reform legislation or corporate income tax reform legislation; actions by FHFA, Treasury, HUD or other regulators that affect our business; the timing and level of, as well as regional variation in, home price changes; changes in interest rates, including negative interest rates; changes in unemployment rates and other macroeconomic and housing market variables; our future guaranty fee pricing and the impact of that pricing on our competitive environment and guaranty fee revenues; the size, composition and quality of our guaranty book of business and retained mortgage portfolio; our market share; the life of the loans in our guaranty book of business; challenges we face in retaining and hiring qualified executives and other employees; our future serious delinquency rates; the deteriorated credit performance of many loans in our guaranty book of business; the conservatorship and its effect on our business; the investment by Treasury and its effect on our business; adverse effects from activities we undertake to support the mortgage market and help borrowers; actions we may be required to take by FHFA, in its role as our conservator or as our regulator, such as changes in the type of business we do or implementation of a single security for Fannie Mae and Freddie Mac; limitations on our business imposed by FHFA, in its role as our conservator or as our regulator; our future objectives and activities in support of those objectives, including actions we may take to reach additional underserved creditworthy borrowers; a decrease in our credit ratings; limitations on our ability to access the debt capital markets; disruptions in the housing and credit markets; significant changes in modification and foreclosure activity; the volume and pace of future nonperforming loan sales and their impact on our results and serious delinquency rates; changes in borrower behavior; the effectiveness of our loss mitigation strategies, management of our REO inventory and pursuit of contractual remedies; defaults by one or more institutional counterparties; resolution or settlement agreements we may enter into with our counterparties; our need to rely on third parties to fully achieve some of our corporate objectives; our reliance on mortgage servicers; changes in GAAP; guidance by the Financial Accounting Standards Board (“FASB”); future changes to our accounting policies; changes in the fair value of our assets and liabilities; operational control weaknesses; our reliance on models; future updates to our models, including the assumptions used by these models; the level and volatility of interest rates and credit spreads; changes in the fiscal and monetary policies of the Federal Reserve, including any change in the Federal Reserve’s policy towards the reinvestment of principal payments of mortgage-backed securities or any future sales of such securities; changes in the structure and regulation of the financial services industry; credit availability; global political risks; natural disasters, environmental disasters, terrorist attacks, pandemics or other major disruptive events; information security breaches or threats; and those factors described in “Risk Factors.”
Readers are cautioned to place forward-looking statements in this report or that we make from time to time into proper context by carefully considering the factors discussed in this report. These forward-looking statements are representative only as of the date they are made, and we undertake no obligation to update any forward-looking statement as a result of new information, future events or otherwise, except as required under the federal securities laws.
Item 1A. Risk Factors
Refer to “MD&A—Risk Management” and “MD&A—Business Segments” for more detailed descriptions of the primary risks to our business and how we seek to manage those risks.
The risks we face could materially adversely affect our business, results of operations, financial condition, liquidity and net worth, and could cause our actual results to differ materially from our past results or the results contemplated by forward-looking statements contained in this report. However, these are not the only risks we face. In addition to the risks we discuss below, we face risks and uncertainties not currently known to us or that we currently believe are immaterial.
Fannie Mae 2016 Form 10-K | 32 | |
Risk Factors | ||
Risks Relating To Our Business | ||||
The future of our company is uncertain.
There continues to be significant uncertainty regarding the future of our company, including how long the company will continue to exist in its current form, the extent of our role in the market, how long we will be in conservatorship, what form we will have and what ownership interest, if any, our current common and preferred stockholders will hold in us after the conservatorship is terminated, and whether we will continue to exist following conservatorship. The conservatorship is indefinite in duration and the timing, conditions and likelihood of our emerging from conservatorship are uncertain. Our conservatorship could terminate through a receivership. Termination of the conservatorship, other than in connection with a receivership, requires Treasury’s consent under the senior preferred stock purchase agreement.
The previous Administration endorsed the wind down of Fannie Mae and Freddie Mac through a responsible transition and the enactment of comprehensive housing finance reform legislation. The current Administration has not articulated a formal position on housing finance reform or the future of the GSEs; however, the Treasury Secretary indicated in his confirmation hearing that he is focused on housing finance reform and a solution to the current status of Fannie Mae and Freddie Mac.
Last year, Congress continued to consider legislation that could materially affect our business if enacted. We expect that Congress will continue to consider legislation that could result in significant changes in our structure and role in the future, including proposals that would result in Fannie Mae’s liquidation or dissolution. Congress or FHFA may also consider legislation or regulation aimed at increasing the competition we face, reducing our market share, expanding our obligations to provide funds to Treasury or constraining our business operations. We cannot predict the prospects for the enactment, timing or final content of housing finance reform legislation or other legislation related to our activities.
We may not have sufficient capital reserves to avoid a net worth deficit if we experience a comprehensive loss in a future quarter. If we have a net worth deficit in a future quarter, we will be required to draw funds from Treasury in order to avoid being placed into receivership.
As a result of the dividend provisions of the senior preferred stock and quarterly directives from our conservator, we are obligated to pay Treasury each quarter any dividends declared consisting of the amount, if any, by which our net worth as of the end of the immediately preceding fiscal quarter exceeds an applicable capital reserve amount, which is $600 million for each quarter of 2017 and decreases to zero in 2018. Because we are permitted to retain only $600 million in capital reserves through 2017, we may not have sufficient reserves to avoid a net worth deficit if we experience a comprehensive loss in a future quarter. In addition, beginning in 2018, we are not permitted to retain any capital reserves against losses in subsequent quarters; therefore, if we have a comprehensive loss for a quarter we will also have a net worth deficit for that quarter.
We have experienced and expect to continue to experience volatility in our financial results from period to period due to a number of factors, particularly changes in market conditions that result in fluctuations in the estimated fair value of the financial instruments, such as derivatives and certain securities, that we mark to market through our earnings. Our credit-related income or expense also can vary substantially from period to period based on a number of factors such as changes in actual and expected home prices, fluctuations in interest rates, borrower payment behavior, the types and volume of our loss mitigation activities, the volume of foreclosures completed, and redesignations of loans from HFI to HFS. Accordingly, although we expect to remain profitable on an annual basis for the foreseeable future, the potential volatility in our financial results, which may be significant from quarter to quarter, could result in a net worth deficit in a future quarter.
In addition, other factors such as legislative actions or changes in accounting standards could result in a net worth deficit in a future quarter. For example:
• | The current Administration proposes reducing the U.S. corporate income tax rate. Under applicable accounting standards, a significant reduction in the U.S. corporate income tax rate would require that we record a substantial reduction in the value of our deferred tax assets in the quarter in which the legislation is enacted. Thus, if legislation significantly lowering the U.S. corporate income tax rate is enacted, we expect to incur a significant net loss and net worth deficit for the quarter in which the legislation is enacted and we could potentially incur a net loss for that year. |
Fannie Mae 2016 Form 10-K | 33 | |
Risk Factors | ||
• | In June 2016, the FASB issued guidance that changes the impairment model for most financial assets and certain other instruments, which will become effective January 1, 2020 with early adoption permitted on January 1, 2019. We are continuing to evaluate the impact of this guidance on our consolidated financial statements, including the timing of adoption. The adoption of this guidance will decrease, perhaps substantially, our retained earnings and increase our allowance for loan losses, which could result in a net worth deficit for the quarter in which we adopt the guidance. |
For any quarter for which we have a net worth deficit, we will be required to draw funds from Treasury under the senior preferred stock purchase agreement in order to avoid being placed into receivership. As of the date of this filing, the maximum amount of remaining funding under the agreement is $117.6 billion. If we were to draw additional funds from Treasury under the agreement in a future period, the amount of remaining funding under the agreement would be reduced by the amount of our draw. Dividend payments we make to Treasury do not restore or increase the amount of funding available to us under the agreement. Accordingly, if we experience multiple quarters of net worth deficits, the amount of remaining funding available under the senior preferred stock purchase agreement could be significantly reduced from its current level.
Our regulator is authorized or required to place us into receivership under specified conditions, which would result in the liquidation of our assets. Amounts recovered from the liquidation may not be sufficient to repay the liquidation preference of any series of our preferred stock or to provide any proceeds to common shareholders.
FHFA is required to place us into receivership if the Director of FHFA makes a written determination that our assets are less than our obligations for a period of 60 days after the filing deadline for our Form 10-K or Form 10-Q with the SEC. Although Treasury committed to providing us funds in accordance with the terms of the senior preferred stock purchase agreement, if we need funding from Treasury to avoid triggering FHFA’s obligation, Treasury may not be able to provide sufficient funds to us within the required 60 days if it has exhausted its borrowing authority, if there is a government shutdown, or if the funding we need exceeds the amount available to us under the agreement. In addition, we could be put into receivership at the discretion of the Director of FHFA at any time for other reasons set forth in the GSE Act, including if we are critically undercapitalized or if we are undercapitalized and have no reasonable prospect of becoming adequately capitalized.
A receivership would terminate the conservatorship. In addition to the powers FHFA has as our conservator, the appointment of FHFA as our receiver would terminate all rights and claims that our shareholders and creditors may have against our assets or under our charter arising from their status as shareholders or creditors, except for their right to payment, resolution or other satisfaction of their claims as permitted under the GSE Act. If we are placed into receivership and do not or cannot fulfill our guaranty to the holders of our Fannie Mae MBS, there may be significant delays of any payments to our MBS holders, and the MBS holders could become unsecured creditors of ours with respect to claims made under our guaranty to the extent the mortgage collateral underlying the Fannie Mae MBS is insufficient to satisfy the claims of the MBS holders.
In the event of a liquidation of our assets, only after payment of the administrative expenses of the receiver and the immediately preceding conservator, the secured and unsecured claims against the company (including repaying all outstanding debt obligations), and the liquidation preference of the senior preferred stock, would any liquidation proceeds be available to repay the liquidation preference on any other series of preferred stock. Finally, only after the liquidation preference on all series of preferred stock is repaid would any liquidation proceeds be available for distribution to the holders of our common stock. We believe that in the event of a liquidation of our assets it is unlikely that there would be sufficient proceeds to make any distribution to holders of our preferred stock or common stock, other than possibly to Treasury as a holder of our senior preferred stock.
Our business and results of operations may be materially adversely affected if we are unable to retain and recruit well-qualified senior executives and other employees. The conservatorship, the uncertainty of our future, limitations on our executive and employee compensation, and negative publicity concerning the GSEs put us at a disadvantage compared to many other companies in attracting and retaining these employees.
Our business processes are highly dependent on the talents and efforts of our senior executives and other employees. The conservatorship, the uncertainty of our future, limitations on executive and employee compensation, and negative publicity concerning the GSEs have had and are likely to continue to have an adverse effect on our ability to retain and recruit well-qualified executives and other employees. Our business is highly complex and we are currently undertaking critical work to help build a sustainable housing finance system;
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therefore, continuity of our current management team under the leadership of our Chief Executive Officer is important. Turnover in key management positions and challenges in integrating new management could harm our ability to manage our business effectively and successfully finalize the implementation of our and FHFA’s current strategic initiatives, and ultimately could adversely affect our financial performance.
Actions taken by Congress, FHFA and Treasury to date, or that may be taken by them or other government agencies in the future, have had, and may continue to have, an adverse effect on the retention and recruitment of senior executives and other employees. We are subject to significant restrictions on the amount and type of compensation we may pay our executives and other employees under conservatorship. In November 2015, the Equity in Government Compensation Act of 2015 was enacted. This law sets the annual direct compensation of our Chief Executive Officer at $600,000 while we are in conservatorship or receivership. We are also subject to the STOCK Act, which was enacted in April 2012 and includes a provision that prohibits our senior executives from receiving bonuses during any period of conservatorship on or after the date of enactment of the law. In addition, we are unable to offer equity-based compensation. As a result of these restrictions, we have not been able to incent and reward excellent performance with compensation structures that provide upside potential to our executives, which places us at a disadvantage compared to many other companies in attracting and retaining executives. In addition, the uncertainty of potential congressional action with respect to housing finance reform, which may result in the wind-down of the company, also negatively affects our ability to retain and recruit executives and other employees.
In many cases, the amount of compensation we pay our senior executives is significantly less than the compensation of executives in similar roles at many companies in our comparator group. Limitations on our ability to increase executive compensation to market levels for the foreseeable future puts us at greater risk of attrition, and also hampers our ability to recruit new executives. Moreover, limitations on our ability to offer market-based compensation makes succession planning difficult. In particular, the limit on the annual direct compensation of our Chief Executive Officer to $600,000 significantly elevates our risk that we will not be able to retain our Chief Executive Officer and negatively affects our succession planning and our ability to attract qualified candidates for this critical role.
We face competition from within the financial services industry and from businesses outside of the financial services industry for qualified executives and other employees. Additionally, with an improving economy, attractive opportunities have become available to our executives and other employees. Our competitors for talent are generally not subject to the same limitations on executive compensation. The constraints on our executive compensation could adversely affect our ability to attract and retain qualified candidates.
If we are unable to retain, promote and attract executives and other employees with the necessary skills and talent, we would face increased risks for operational failures. If there were several high-level departures at approximately the same time, our ability to conduct our business would likely be materially adversely affected, which could have a material adverse effect on our results of operations and financial condition.
Our business activities are significantly affected by the conservatorship and the senior preferred stock purchase agreement.
We are currently under the control of our conservator, FHFA, and we do not know when or how the conservatorship will terminate. As conservator, FHFA can direct us to enter into contracts or enter into contracts on our behalf, and generally has the power to transfer or sell any of our assets or liabilities. In addition, our directors do not have fiduciary duties to any person or entity except to the conservator. Accordingly, our directors are not obligated to consider the interests of the company, the holders of our equity or debt securities, or the holders of Fannie Mae MBS in making or approving a decision unless specifically directed to do so by the conservator.
We are subject to significant restrictions on our business activities during conservatorship. We may be prevented by our conservator from engaging in business activities or transactions that we believe would benefit our business and financial results. For example, because FHFA must approve changes to the national loan level price adjustments we charge and can direct us to make other changes to our guaranty fee pricing, our ability to address changing market conditions, pursue certain strategic objectives, or manage the mix of loans lenders choose to deliver to us is constrained. We publish national risk-based loan level price adjustment grids that specify the additional cash fees we charge at the time we acquire a loan based on the credit characteristics of the loan. These fees allow us to price appropriately for the credit risk we assume in providing our guaranty on the loans. We do not have the ability to implement changes to these pricing grids without the approval of FHFA. If the mix of
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our single-family loan acquisitions changes, and FHFA does not approve requested changes to our pricing grids in response to these changes, it could adversely affect our financial results and condition. In addition, if FHFA directs us to change our pricing in any manner—including increases or decreases in our base guaranty fees or our loan-level price adjustments—it could result in a decrease in our guaranty fee revenues in future periods, a decrease in our single-family business volume or a negative impact on the credit risk profile of our new single-family acquisitions, any of which could adversely affect our financial results and condition.
Because we are under the control of our conservator, our business objectives may not be consistent with the investment objectives of our investors. We may be required by our conservator to engage in activities that are operationally difficult, costly to implement or unprofitable, or that may adversely affect our financial results or the credit risk profile of our book of business. FHFA has changed our business objectives significantly since we entered conservatorship, and could make additional changes at any time. Actions we take to meet FHFA’s strategic goals and objectives for our conservatorship could adversely affect our financial results. For example, FHFA’s conservatorship scorecards in recent years have included objectives relating to the development of a single security for Fannie Mae and Freddie Mac. As the implementation date of the single security approaches, some Fannie Mae MBS and comparable Freddie Mac PCs have traded closer to or at parity. If our market share declines in the future due to this trend or other factors, it could adversely affect our financial results. In addition, FHFA’s conservatorship scorecards have included objectives relating to the sale of nonperforming loans in our book of business. These transactions could result in the sale of mortgage loans we hold at prices below the levels recorded in our financial statements or the sale of loans that may be more financially advantageous for us to hold. Moreover, we are devoting significant resources to meeting FHFA’s goals for our conservatorship and expect to continue to do so.
The senior preferred stock purchase agreement with Treasury includes a number of covenants that significantly restrict our business activities. We cannot, without the prior written consent of Treasury: pay dividends (except on the senior preferred stock); sell, issue, purchase or redeem Fannie Mae equity securities; sell, transfer, lease or otherwise dispose of assets in specified situations; engage in transactions with affiliates other than on arm’s-length terms or in the ordinary course of business; issue subordinated debt; or incur indebtedness that would result in our aggregate indebtedness exceeding 120% of the amount of mortgage assets we are allowed to own under the agreement. In deciding whether to consent to any request for approval it receives from us under the agreement, Treasury has the right to withhold its consent for any reason and is not required by the agreement to consider any particular factors, including whether or not management believes that the transaction would benefit the company. Pursuant to the senior preferred stock purchase agreement, the maximum allowable amount of mortgage assets we were permitted to own as of December 31, 2016 was $339.3 billion, and on each December 31 thereafter, our mortgage assets may not exceed 85% of the maximum allowable amount that we were permitted to own as of December 31 of the immediately preceding calendar year until the amount of our mortgage assets reaches $250 billion. In addition, FHFA has requested that we further cap our mortgage assets each year at 90% of the annual limit under our senior preferred stock purchase agreement with Treasury.
Actions taken by the conservator and the restrictions set forth in the senior preferred stock purchase agreement could adversely affect our business, results of operations, financial condition, liquidity and net worth.
A number of lawsuits have been filed against the U.S. government relating to the senior preferred stock purchase agreement and the conservatorship. See “Note 18, Commitments and Contingencies” and “Legal Proceedings” for a description of these lawsuits. We cannot predict the course or the outcome of these lawsuits, or the actions the U.S. government (including Treasury or FHFA) may take in response to any ruling or finding in any of these lawsuits. Accordingly, we cannot predict what impact, if any, these lawsuits will have on our business.
The conservatorship and agreements with Treasury have had, and will continue to have, a material adverse effect on our common and preferred shareholders.
We do not know when or how the conservatorship will terminate. Moreover, even if we are released from conservatorship, we remain subject to the terms of the senior preferred stock purchase agreement, senior preferred stock and warrant, which can only be canceled or modified with the consent of Treasury. The conservatorship and agreements with Treasury have had, and will continue to have, material adverse effects on our common and preferred shareholders, including the following:
No voting rights during conservatorship. The rights and powers of our shareholders are suspended during conservatorship. During conservatorship, our common shareholders do not have the ability to elect directors or to vote on other matters unless the conservator delegates this authority to them.
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No dividends to common or preferred shareholders, other than to Treasury. Our conservator announced in September 2008 that we would not pay any dividends on the common stock or on any series of preferred stock, other than the senior preferred stock, while we are in conservatorship. In addition, under the terms of the senior preferred stock purchase agreement, dividends may not be paid to common or preferred shareholders (other than on the senior preferred stock) without the prior written consent of Treasury, regardless of whether we are in conservatorship.
Our profits are distributed to Treasury. As described in a risk factor above, pursuant to the dividend provisions of the senior preferred stock and quarterly directives from our conservator, we are obligated to pay Treasury each quarter any dividends declared consisting of the amount, if any, by which our net worth as of the end of the immediately preceding fiscal quarter exceeds an applicable capital reserve amount, which will decrease to zero in 2018. As a result, our net income is not available to common shareholders or preferred shareholders other than Treasury as holder of the senior preferred stock.
Liquidation preference of senior preferred stock is high and could increase. The senior preferred stock ranks prior to our common stock and all other series of our preferred stock, as well as any capital stock we issue in the future, as to both dividends and distributions upon liquidation. Accordingly, if we are liquidated, the senior preferred stock is entitled to its then-current liquidation preference, plus any accrued but unpaid dividends, before any distribution is made to the holders of our common stock or other preferred stock. The liquidation preference on the senior preferred stock is currently $117.1 billion and would increase if we draw on Treasury’s funding commitment in any future quarters or if we do not pay dividends owed on the senior preferred stock. If we are liquidated, we believe it is unlikely that there would be sufficient funds remaining after payment of amounts to our creditors and to Treasury as holder of the senior preferred stock to make any distribution to holders of our common stock and other preferred stock.
Exercise of the Treasury warrant would substantially dilute investment of current shareholders. If Treasury exercises its warrant to purchase shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis, the ownership interest in the company of our then-existing common shareholders will be substantially diluted, and we would thereafter have a controlling shareholder.
No longer managed for the benefit of shareholders. Because we are in conservatorship, we are no longer managed with a strategy to maximize shareholder returns.
For additional description of the conservatorship and our agreements with Treasury, see “Business—Conservatorship and Treasury Agreements.”
We may incur significant credit losses and credit-related expenses on the loans in our mortgage credit book of business, which could materially adversely affect our earnings, financial condition and net worth.
We are exposed to a significant amount of mortgage credit risk on our $3.1 trillion mortgage credit book of business, which includes mortgage assets that back our guaranteed Fannie Mae MBS, mortgage assets in our retained mortgage portfolio and credit enhancements we provide. Borrowers of mortgage loans that we own or guaranty may fail to make required payments of principal and interest on their mortgage loans, exposing us to the risk of credit losses and credit-related expenses.
Although we strengthened our underwriting and eligibility standards in late 2008 and 2009, we continue to have loans in our book of business that were originated under our prior standards. As of December 31, 2016, 12% of our single-family conventional guaranty book of business consisted of loans acquired prior to 2009 and another 16% consisted of Refi Plus loans, which represent refinancings of loans that were originated prior to June 2009. Moreover, some of the loans we acquired prior to 2009 that remain in our single-family book of business as of December 31, 2016 have certain characteristics that expose us to greater credit risk than other types of mortgage loans, such as Alt-A loans (3% of our single-family conventional guaranty book), interest-only loans (2% of our single-family conventional guaranty book) and loans with FICO credit scores at origination of less than 620 (2% of our single-family conventional guaranty book). In addition, 16% of our single-family conventional guaranty book of business as of December 31, 2016 consisted of loans with original LTV ratios greater than 90%, which may pose a higher credit risk than loans with lower LTV ratios. We present detailed information about the risk characteristics of our single-family conventional guaranty book of business in “MD&A—Business Segments—Single-Family Business—Single-Family Mortgage Credit Risk Management,” and we present information on our 2016 credit-related expenses and credit losses in “MD&A—Consolidated Results of Operations—Credit-Related Income (Expense).” The credit performance of loans in our book of business could deteriorate in the future, particularly if we experience national or regional declines in home prices, weakening economic conditions or high
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unemployment, resulting in higher credit losses and credit-related expenses. Increases in our credit-related expenses would reduce our earnings and adversely affect our financial condition and net worth.
While we use certain credit enhancements to mitigate some of our potential future credit losses, these credit enhancements may provide less protection than we expect for a number of reasons. Some of the credit enhancements we use, such as mortgage insurance and credit insurance risk transfer transactions, are subject to the risk that the counterparties may not meet their obligations to us. Our credit risk transfer transactions have limited terms (typically 10 or 12.5 years), after which they provide limited or no further credit protection on the covered loans. Due to differences in accounting, there also could be a significant lag between the time when we recognize a provision for credit losses and when we recognize the related recovery from our CAS transactions. While a credit expense on a loan in a reference pool for a CAS transaction is recorded when it is probable that we have incurred a loss, for our CAS issued beginning in 2016, a recovery is recorded when an actual loss event occurs. In addition, it is uncertain if there will be adequate demand for our credit risk transfer transactions over the long term to meet our goals for these transactions. Moreover, our credit risk transfer transactions are not designed to shield us from all losses because we retain a portion of the risk of future losses on loans covered by these transactions, including all or a portion of the first loss risk in most transactions.
The processing of foreclosures of single-family loans continues to be slow in some states, which has negatively affected our foreclosure timelines and our single-family serious delinquency rate. We also believe the slow pace of foreclosures in certain states is contributing to a slower recovery of those housing markets.
A failure in our operational systems or infrastructure, or those of third parties, could materially adversely affect our business, impair our liquidity, cause financial losses and harm our reputation.
Shortcomings or failures in our internal processes, people, data management or systems could disrupt our business or have a material adverse effect on our risk management, liquidity, financial statement reliability, financial condition and results of operations. Such a failure could result in legislative or regulatory intervention or sanctions, liability to customers, financial losses, business disruptions and damage to our reputation. For example, our business is highly dependent on our ability to manage and process, on a daily basis, an extremely large number of transactions, many of which are highly complex, across numerous and diverse markets and in an environment in which we must adapt to changing external conditions. These transactions are subject to various legal, accounting and regulatory standards. Our financial, accounting, data processing or other operating systems and facilities may fail to operate properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially beyond our control, adversely affecting our ability to process these transactions or manage associated data with reliability and integrity. In addition, we rely on information provided by third parties in processing many of our transactions; that information may be incorrect or we may fail to properly manage or analyze it or properly monitor its data quality.
We rely upon business processes that are highly dependent on people, technology and equipment, data and the use of numerous complex systems and models to manage our business and produce books and records upon which our financial statements and risk reporting are prepared. This reliance increases the risk that we may be exposed to financial, reputational or other losses as a result of inadequately designed internal processes or data management architecture, inflexible technology or the failure of our systems. While we continue to enhance our technology, infrastructure, operational controls and organizational structure in order to reduce our operational risk, these actions may not be effective to manage these risks and may create additional operational risk as we execute these enhancements. In addition, our use of third-party service providers for some of our business functions increases the risk that an operational failure by a third party will adversely affect us.
Our ability to manage and aggregate data may be limited by the effectiveness of our policies, programs, processes, systems and practices that govern how data is acquired, validated, stored, protected, processed and shared. Failure to manage data effectively and to aggregate data in an accurate and timely manner may limit our ability to manage current and emerging risks, as well as to manage changing business needs.
We also face the risk of operational failure, termination or capacity constraints of any of the clearing agents, exchanges, clearinghouses or other financial intermediaries we use to facilitate our securities and derivatives transactions. In recent years, there has been significant consolidation among clearing agents, exchanges and clearing houses. This consolidation and interconnectivity increases the risk of operational failure, on both an individual basis and an industry-wide basis, as disparate complex systems need to be integrated, often on an accelerated basis. Any such failure, termination or constraint could adversely affect our ability to effect
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transactions or manage our exposure to risk, and could have a significant adverse impact on our business, liquidity, financial condition, net worth and results of operations.
Substantially all of our employees and business operations functions are consolidated in two metropolitan areas: Washington, DC and Dallas, Texas. As a result of this concentration of our employees and facilities, a catastrophic event at either location, such as a terrorist attack, natural disaster, extreme weather event or disease pandemic could impact our ability to operate notwithstanding the business continuity plans and facilities that we have in place. Although we have an out-of-region data center for disaster recovery, this data center will take several days to become operational in the event it becomes necessary as a result of the catastrophic loss of our in-region data center. Moreover, because of the concentration of our employees in the Washington, DC and Dallas metropolitan areas, if a regional disruption occurs in one of these areas, our employees may not be not able to occupy our facilities, work remotely, or communicate with or travel to other locations. Accordingly, we may not be able to successfully implement our contingency plans if a catastrophic event occurs, which could materially adversely affect our ability to conduct our business and lead to financial losses.
A breach of the security of our systems or facilities, or those of third parties with which we do business, including as a result of cyber attacks, could damage or disrupt our business or result in the disclosure or misuse of confidential information, which could damage our reputation, increase our costs and cause losses.
Our operations rely on the secure receipt, processing, storage and transmission of confidential and other information in our computer systems and networks and with our business partners, including proprietary, confidential or personal information that is subject to privacy laws, regulations or contractual obligations. Information security risks for large institutions like us have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct or automate financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including foreign state-sponsored actors. These actors may fraudulently entice users to provide unauthorized access to our systems, network and data. From time to time we have been, and likely will continue to be, the target of attempted cyber attacks, computer viruses, malicious code, phishing attacks, denial of service attacks and other information security threats. To date, we have not experienced any material losses relating to cyber attacks; however, we could suffer such losses in the future and we are not able to predict the severity of these attacks. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, the current global economic and political environment, our prominent size and scale and our role in the financial services industry, the outsourcing of some of our business operations, and the interconnectivity and interdependence of third parties to our systems.
Although we take measures to protect the security of our software and network-enabled computers and systems, our software, computers and systems may be vulnerable to cyber attacks, breaches, unauthorized access, misuse, computer viruses or other malicious code and other events that could have a security impact. The occurrence of such an event could jeopardize or result in the unauthorized disclosure, gathering, monitoring, misuse, corruption, loss or destruction of confidential and other information that belongs to us, our customers, our counterparties, third-party service providers or borrowers that is processed and stored in, and transmitted through, our computer systems and networks. The occurrence of such an event could also result in damage to our software, computers or systems, or otherwise cause interruptions or malfunctions in our, our customers’, our counterparties’ or third parties’ operations. This could result in significant losses, loss of customers and business opportunities, reputational damage, litigation, regulatory fines, penalties or intervention, reimbursement or other compensatory costs, or otherwise adversely affect our business, financial condition or results of operations. In addition, we may be required to expend significant additional resources to modify our protective measures and to investigate and remediate vulnerabilities or other exposures arising from operational and security risks. Although we maintain insurance coverage relating to cybersecurity risks, our insurance may not be sufficient to provide adequate loss coverage in all circumstances.
Third parties with which we do business may also be sources of cybersecurity or other technological risks. We outsource certain functions and these relationships allow for the external storage and processing of our information, as well as customer, counterparty and borrower information, including on cloud-based systems. While we engage in actions to mitigate our exposure resulting from outsourcing, ongoing threats may result in unauthorized access, loss or destruction of data or other cybersecurity incidents with increased costs and consequences to us such as those described above.
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Our concurrent implementation of multiple new initiatives may increase our operational risk and result in one or more significant deficiencies or material weaknesses in our internal control over financial reporting.
We are currently implementing a number of initiatives in furtherance of our goals to better serve our customers’ needs, improve our business efficiency and help to build a sustainable housing finance system, including initiatives implementing FHFA’s conservatorship scorecard objectives. The magnitude of the many new initiatives we are undertaking may increase our operational risk. Many of these initiatives involve significant changes to our business processes, systems and infrastructure, and present significant operational challenges for us. For example, we are working with FHFA and Freddie Mac on a multi-year effort to build a common securitization platform to eventually replace some of our current securitization infrastructure and to issue a single security on this platform. This initiative, in coordination with related internal infrastructure upgrades, is expected to result in significant changes to our current systems and operations, and involves a high degree of complexity. While implementation of each individual initiative creates operational challenges, implementing multiple initiatives during the same time period significantly increases these challenges. Due to the operational complexity associated with these changes and the limited time periods for implementing them, we believe there is a risk that implementing these changes could result in one or more significant deficiencies or material weaknesses in our internal control over financial reporting in a future period. If this were to occur, we could experience material errors in our reported financial results. In addition, FHFA, Treasury, other agencies of the U.S. government or Congress may require us to take actions in the future that could further increase our operational risk.
We may undertake efforts that adversely affect our business, results of operations, financial condition, liquidity and net worth.
In conservatorship our business is no longer managed with a strategy to maximize shareholder returns while fulfilling our mission. FHFA’s current strategic goals for our conservatorship are described in “Business—Legislation and Regulation—Housing Finance Reform—Conservator Developments and Strategic Goals.” In pursuit of the goals prescribed by our conservator, we are taking a variety of actions that could adversely affect our economic returns, possibly significantly, such as modifying loans to help struggling borrowers; expanding our underwriting and eligibility requirements to increase access to mortgage credit; increasing our use of credit risk transfer transactions, which effectively reduces the guaranty fee income we retain on the covered loans; and preparing to issue a single security. We may also be asked to take additional efforts in support of our conservator’s goals in the future that could adversely affect our economic returns. These activities may have short- and long-term adverse effects on our business, results of operations, financial condition, liquidity and net worth.
Other agencies of the U.S. government or Congress also may ask us to undertake significant efforts to support the housing and mortgage markets, as well as struggling homeowners. They may also ask us to take actions in support of other goals. These actions may adversely affect our financial results and condition. For example, in December 2011 Congress enacted the TCCA under which, at the direction of FHFA, we increased the guaranty fee on all single-family residential mortgages delivered to us by 10 basis points effective April 1, 2012. The revenue generated by this fee increase is paid to Treasury and helps offset the cost of a two-month extension of the payroll tax cut in 2012.
We are also required by the GSE Act to undertake efforts in support of the housing market that could adversely affect our financial results and condition. For example, we are subject to housing goals under the GSE Act that require that a portion of the mortgage loans we acquire must be for low- and very-low income families, families in low-income census tracts and moderate-income families in minority census tracts or designated disaster areas. FHFA’s 2015 to 2017 housing goals include higher benchmarks for most of the goals than those that were applicable in prior years. In addition, in December 2016, FHFA issued a final rule to implement our new duty to serve very low-, low- and moderate-income families in three underserved markets: manufactured housing, affordable housing preservation and rural areas. We will be required to make changes to our business and our acquisitions in the future to comply with our new duty to serve obligations. We may take actions to meet our housing goals and duty to serve obligations that could adversely affect our profitability. For example, we may acquire loans that offer lower expected returns on our investment than our other loan acquisitions and that may potentially increase our credit losses and credit-related expenses. If we do not meet our housing goals or duty to serve requirements, and FHFA finds that the goals or requirements were feasible, we may become subject to a housing plan that could require us to take additional steps that could have an adverse effect on our results of operations and financial condition. The potential penalties for failure to comply with housing plan requirements
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include a cease-and-desist order and civil money penalties. See “Business—Legislation and Regulation—GSE Act and Other Regulation of Our Business” for more information on our housing goals and duty to serve underserved markets.
Limitations on our ability to access the debt capital markets could have a material adverse effect on our ability to fund our operations.
Our ability to fund our business depends primarily on our ongoing access to the debt capital markets. Market concerns about matters such as the extent of government support for our business, the future of our business (including future profitability, future structure, regulatory actions and GSE status) and the creditworthiness of the U.S. government could cause a severe negative effect on our access to the unsecured debt markets, particularly for long-term debt. We believe that our ability in recent years to issue debt of varying maturities at attractive pricing resulted from federal government support of our business. As a result, we believe that our status as a GSE and continued federal government support is essential to maintaining our access to debt funding. Changes or perceived changes in federal government support of our business or our status as a GSE could materially and adversely affect our liquidity, financial condition and results of operations. There can be no assurance that the government will continue to support us, or that our current level of access to debt funding will continue. In addition, due to our reliance on the U.S. government’s support, our access to debt funding also could be materially adversely affected by a change or perceived change in the creditworthiness of the U.S. government.
Future changes or disruptions in the financial markets could significantly change the amount, mix and cost of funds we obtain, as well as our liquidity position. If we are unable to issue both short- and long-term debt securities at attractive rates and in amounts sufficient to operate our business and meet our obligations, it likely would interfere with the operation of our business and have a material adverse effect on our liquidity, results of operations, financial condition and net worth.
Our liquidity contingency plans may be difficult or impossible to execute during a liquidity crisis.
We believe that our liquidity contingency plans may be difficult or impossible to execute during a liquidity crisis. If we cannot access the unsecured debt markets, our ability to repay maturing indebtedness and fund our operations could be eliminated or significantly impaired. In this event, our alternative sources of liquidity—consisting of our cash and other investments portfolio and the unencumbered mortgage assets in our retained mortgage portfolio—may not be sufficient to meet our liquidity needs.
We believe that the amount of mortgage-related assets that we could successfully sell or borrow against in the event of a liquidity crisis or significant market disruption is substantially lower than the amount of mortgage-related assets we hold. Due to the current composition of our retained mortgage portfolio, including the significant amount of distressed assets in our portfolio, there would likely be insufficient market demand for large amounts of the mortgage-related assets in our portfolio over a prolonged period of time, which would limit our ability to borrow against or sell these assets. To the extent that we are able to obtain funding by pledging or selling mortgage-related securities as collateral, we anticipate that a discount would be applied that would reduce the value assigned to those securities. Depending on market conditions at the time, this discount could result in proceeds significantly lower than the current market value of these securities and could thereby reduce the amount of financing we obtain.
A decrease in the credit ratings on our senior unsecured debt could have an adverse effect on our ability to issue debt on reasonable terms, particularly if such a decrease were not based on a similar action on the credit ratings of the U.S. government. A decrease in our credit ratings also could trigger additional collateral requirements under our derivatives contracts.
A reduction in our credit ratings could materially adversely affect our liquidity, our ability to conduct our normal business operations, our financial condition and our results of operations. Credit ratings on our senior unsecured debt, as well as the credit ratings of the U.S. government, are primary factors that could affect our borrowing costs and our access to the debt capital markets. Credit ratings on our debt are subject to revision or withdrawal at any time by the rating agencies. Actions by governmental entities impacting the support we receive from Treasury could adversely affect the credit ratings on our senior unsecured debt. As of December 31, 2016, our long-term debt was rated “AA+” by Standard & Poor’s Ratings Services (“S&P”), “Aaa” by Moody’s Investors Services (“Moody’s”) and “AAA” by Fitch Ratings Limited (“Fitch”).
Because we rely on the U.S. government for capital support, in recent years, when a rating agency has taken an action relating to the U.S. government’s credit rating, they have taken a similar action relating to our ratings at
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approximately the same time. S&P, Moody’s and Fitch have all indicated that they would likely lower their ratings on the debt of Fannie Mae and certain other government-related entities if they were to lower their ratings on the U.S. government. We currently cannot predict whether one or more of these rating agencies will downgrade our debt ratings in the future, nor can we predict the potential impact.
A reduction in our credit ratings may also trigger additional collateral requirements under our derivative contracts because a majority of our over-the-counter (“OTC”) derivative contracts contain provisions that require our senior unsecured debt to maintain a minimum credit rating from S&P and Moody’s. If our senior unsecured debt credit ratings were downgraded to established thresholds in our OTC derivative contracts, which range from A+ to BBB+, we could be required to provide additional collateral to or terminate transactions with certain counterparties. The aggregate fair value of all OTC derivatives with credit-risk-related contingent features that were in a net liability position as of December 31, 2016 was $1.6 billion, for which we posted collateral of $1.4 billion in the normal course of business. If our senior unsecured debt had been downgraded to AA or Aa1, or even to AA- or Aa2, we would not have been required to post any additional collateral under these agreements as of December 31, 2016. If all of the credit-risk-related contingency features underlying these agreements had been triggered, an additional $258 million would have been required either to be posted as collateral or to immediately settle our positions based on the individual agreements and our fair value position as of December 31, 2016. A reduction in our credit ratings also could cause derivatives clearing organizations or their members to demand that we post additional collateral for our cleared derivative contracts. Our credit ratings and ratings outlook are included in “MD&A—Liquidity and Capital Management—Liquidity Management—Credit Ratings.”
One or more of our institutional counterparties may fail to fulfill their contractual obligations to us, resulting in financial losses, business disruption and decreased ability to manage risk.
We routinely enter into a high volume of transactions with counterparties in the financial services industry. We face the risk that one or more of our institutional counterparties may fail to fulfill their contractual obligations to us. Our primary exposures to institutional counterparty risk are with mortgage servicers that service the loans we hold in our retained mortgage portfolio or that back our Fannie Mae MBS; mortgage sellers and servicers that are obligated to repurchase loans from us or reimburse us for losses in certain circumstances; credit guarantors that provide credit enhancements on the mortgage assets that we hold in our retained mortgage portfolio or that back our Fannie Mae MBS, including mortgage insurers, credit insurance risk transfer counterparties, financial guarantors and multifamily lenders with risk sharing arrangements; custodial depository institutions that hold principal and interest payments for loans in our retained mortgage portfolio and for MBS certificateholders, as well as collateral posted by derivatives counterparties, mortgage sellers and mortgage servicers; the financial institutions that issue the investments held in our cash and other investments portfolio; and derivatives counterparties.
We may have multiple exposures to one counterparty as many of our counterparties provide several types of services to us. For example, our lender customers or their affiliates may also act as derivatives counterparties, mortgage servicers, custodial depository institutions or document custodians. Accordingly, if one of these counterparties were to become insolvent or otherwise default on its obligations to us, it could harm our business and financial results in a variety of ways.
An institutional counterparty may default in its obligations to us for a number of reasons, such as changes in financial condition that affect its credit rating, changes in its servicer rating, a reduction in liquidity, operational failures or insolvency. Counterparty defaults or limitations on their ability to do business with us could result in significant financial losses or hamper our ability to do business or manage the risks to our business, which could materially adversely affect our business, results of operations, financial condition, liquidity and net worth.
We depend on our ability to enter into derivatives transactions in order to manage the duration and prepayment risk of our retained mortgage portfolio. If we lose access to our derivatives counterparties, it could adversely affect our ability to manage these risks, which could have a material adverse effect on our business, results of operations, financial condition and liquidity.
Our financial condition or results of operations may be adversely affected if mortgage servicers fail to perform their obligations to us.
We delegate the servicing of the mortgage loans in our guaranty book of business to mortgage servicers; we do not have our own servicing function. Functions performed by mortgage servicers on our behalf include collecting and delivering principal and interest payments, administering escrow accounts, monitoring and reporting
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delinquencies, performing default prevention activities and other functions. The inability of a mortgage servicer to perform these functions due to financial, operational, regulatory or other issues could negatively affect our ability to manage our book of business, delay or prevent our collection of amounts due to us or otherwise result in the failure to perform other servicing duties, resulting in financial losses.
Our servicers also have an active role in our loss mitigation efforts. Our ability to actively manage the troubled loans that we own or guarantee, and to implement our homeownership assistance and foreclosure prevention efforts quickly and effectively, is limited by our reliance on our mortgage servicers. A decline in servicer performance on loss mitigation could adversely affect our credit performance, which could have a material adverse effect on our business, results of operations and financial condition.
A large portion of our single-family guaranty book is serviced by non-depository servicers. The potentially lower financial strength, liquidity and operational capacity of non-depository mortgage sellers and servicers compared with depository mortgage sellers and servicers may negatively affect their ability to satisfy their repurchase or compensatory fee obligations or to service the loans on our behalf. In addition, regulatory bodies have been reviewing the activities of some of our largest non-depository servicers.
If we replace a mortgage servicer, we likely would incur costs and potential increases in servicing fees and could also face operational risks. If a mortgage servicer counterparty fails, it could result in a temporary disruption in servicing and loss mitigation activities relating to the loans serviced by that mortgage servicer, particularly if there is a loss of experienced servicing personnel. We may also face challenges in transferring a large servicing portfolio.
Multifamily mortgage servicing is typically performed by the lenders who sell the mortgages to us. We are exposed to the risk that multifamily servicers could come under financial pressure, which could potentially result in a decline in the quality of the servicing they provide us.
We may incur losses as a result of claims under our mortgage insurance policies not being paid in full or at all.
We rely heavily on mortgage insurers to provide insurance against borrower defaults on single-family conventional mortgage loans with LTV ratios over 80% at the time of acquisition. Although the financial condition of our primary mortgage insurer counterparties currently approved to write new business has improved in recent years, there is still a risk that these counterparties may fail to fulfill their obligations to pay our claims under insurance policies.
In addition, three of our mortgage insurer counterparties who are currently not approved to write new business—PMI Mortgage Insurance Co. (“PMI”), Triad Guaranty Insurance Corporation (“Triad”) and Republic Mortgage Insurance Company (“RMIC”)—are currently under various forms of supervised control by their state regulators and are in run-off. A mortgage insurer that is in run-off continues to collect renewal premiums and process claims on its existing insurance business, but no longer writes new insurance, which increases the risk that the mortgage insurer will pay claims only in part or fail to pay claims at all under existing insurance policies. Entering run-off may close off a source of profits and liquidity that may have otherwise assisted a mortgage insurer in paying claims under insurance policies, and could also cause the quality and speed of its claims processing to deteriorate. PMI and Triad have been paying only a portion of policyholder claims and deferring the remaining portion. PMI is currently paying 71.5% of claims under its mortgage insurance policies in cash and is deferring the remaining 28.5%, and Triad is currently paying 75% of claims in cash and deferring the remaining 25%. It is uncertain whether PMI or Triad will be permitted in the future to pay their deferred policyholder claims and/or increase or decrease the amount of cash they pay on claims. RMIC is no longer deferring payments on policyholder claims and has paid us its previously outstanding deferred payment obligations; however, RMIC has not paid us interest on its deferred payment obligations and remains in run-off and under the supervisory control of its state regulator. PMI, Triad and RMIC provided a combined $8.0 billion, or 6%, of our risk in force mortgage insurance coverage of our single-family guaranty book of business as of December 31, 2016.
On at least a quarterly basis, we assess our mortgage insurer counterparties’ respective abilities to fulfill their obligations to us, and our loss reserves take into account this assessment. If our assessment indicates their ability to pay claims has deteriorated significantly or if our projected claim amounts have increased, it could result in an increase in our loss reserves and our credit losses.
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Challenges to the MERS® company, system and processes could pose operational, reputational and legal risks for us.
MERSCORP Holdings, Inc. (“MERSCORP”) is a privately held company that maintains an electronic registry (the “MERS System”) that tracks servicing rights and ownership of loans in the United States. Mortgage Electronic Registration Systems, Inc. (“MERS”), a wholly owned subsidiary of MERSCORP, can serve as a nominee for the owner of a mortgage loan and, in that role, become the mortgagee of record for the loan in local land records. Fannie Mae sellers and servicers may choose to use MERS as a nominee; however, we have prohibited servicers from initiating foreclosures on Fannie Mae loans in MERS’s name. A large portion of the loans we own or guarantee are registered in MERS’s name and the related servicing rights are tracked in the MERS System. The MERS System is widely used by participants in the mortgage finance industry. Along with a number of other organizations in the mortgage finance industry, we are a shareholder of MERSCORP. In 2016, Intercontinental Exchange, Inc. acquired a majority equity position in MERSCORP.
Numerous legal challenges have been made disputing MERS’s ability to initiate foreclosures, act as nominee in local land records, and/or assign mortgages or take other action on behalf of the loan owner. These challenges seek judicial relief ranging from money damages, fines and penalties to injunctive/declaratory relief seeking the prevention of mortgage assignments by MERS and/or the voiding of completed foreclosures in which MERS appeared in the chain of title. These challenges have focused public attention on MERS and on how loans are recorded in local land records. As a result, these challenges could negatively affect MERS’s ability to serve as the mortgagee of record in some jurisdictions, which could cause additional costs and time in the recordation process and could negatively impact our interest in the loans. These challenges also could result in court decisions that substantially delay new or pending foreclosures, or void completed foreclosures in certain jurisdictions, which would require that we re-foreclose on the affected properties, thereby increasing our costs and lengthening the time it takes for us to foreclose on and dispose of the properties.
In addition, where MERS is the mortgagee of record, it must execute assignments of mortgages, affidavits and other legal documents in connection with foreclosure proceedings. In April 2011, federal banking regulators and FHFA announced a consent order with MERS and MERSCORP to address significant weaknesses in, among other things, oversight, management supervision and corporate governance at MERS and MERSCORP that were uncovered as part of the regulators’ review of mortgage servicers’ foreclosure processing. Failures by MERS or MERSCORP to apply prudent and effective process controls and to comply with legal and other requirements could pose counterparty, operational, reputational and legal risks for us. If investigations or new regulation or legislation restricts servicers’ use of MERS, our counterparties may be required to record all mortgage transfers in land records, incurring additional costs and time in the recordation process. The legal challenges against MERS and MERSCORP remain ongoing. The outcome of these legal challenges could adversely affect our business, results of operations or financial condition.
Changes in accounting standards and policies can be difficult to predict and can materially impact how we record and report our financial results.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the FASB or the SEC changes the financial accounting and reporting standards or the policies that govern the preparation of our financial statements. In addition, FHFA provides guidance that affects our adoption or implementation of financial accounting or reporting standards. These changes can be difficult to predict and expensive to implement, and can materially impact how we record and report our financial condition and results of operations. We could be required to apply new or revised guidance retrospectively, which may result in the revision of prior period financial statements by material amounts. The implementation of new or revised accounting guidance, such as the new impairment guidance issued in June 2016 described above and in “Note 1, Summary of Significant Accounting Policies—New Accounting Guidance,” could have a material adverse effect on our financial results or net worth and result in or contribute to the need for additional draws from Treasury under the senior preferred stock purchase agreement.
Material weaknesses in our internal control over financial reporting could result in errors in our reported results or disclosures that are not complete or accurate.
Management has determined that, as of the date of this filing, we have ineffective disclosure controls and procedures that result in a material weakness in our internal control over financial reporting. In addition, our independent registered public accounting firm, Deloitte & Touche LLP, has expressed an adverse opinion on our internal control over financial reporting because of the material weakness. Our ineffective disclosure controls and
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procedures and material weakness could result in errors in our reported results or disclosures that are not complete or accurate, which could have a material adverse effect on our business and operations.
Our material weakness relates specifically to the impact of the conservatorship on our disclosure controls and procedures. Because we are under the control of FHFA, some of the information that we may need to meet our disclosure obligations may be solely within the knowledge of FHFA. As our conservator, FHFA has the power to take actions without our knowledge that could be material to our shareholders and other stakeholders, and could significantly affect our financial performance or our continued existence as an ongoing business. Because FHFA currently functions as both our regulator and our conservator, there are inherent structural limitations on our ability to design, implement, test or operate effective disclosure controls and procedures relating to information known to FHFA. As a result, we have not been able to update our disclosure controls and procedures in a manner that adequately ensures the accumulation and communication to management of information known to FHFA that is needed to meet our disclosure obligations under the federal securities laws, including disclosures affecting our financial statements. Given the structural nature of this material weakness, we do not expect to remediate this weakness while we are under conservatorship. See “Controls and Procedures” for further discussion of management’s conclusions on our disclosure controls and procedures and internal control over financial reporting.
In many cases, our accounting policies and methods, which are fundamental to how we report our financial condition and results of operations, require management to make judgments and estimates about matters that are inherently uncertain. Management also relies on models in making these estimates.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in applying many of these accounting policies and methods so that these policies and methods comply with GAAP and reflect management’s judgment of the most appropriate manner to report our financial condition and results of operations. In some cases, management must select the appropriate accounting policy or method from two or more alternatives, any of which might be reasonable under the circumstances but might affect the amounts of assets, liabilities, revenues and expenses that we report. See “Note 1, Summary of Significant Accounting Policies” for a description of our significant accounting policies.
We have identified two of our accounting policies as being critical to the presentation of our financial condition and results of operations. These accounting policies are described in “MD&A—Critical Accounting Policies and Estimates.” We believe these policies are critical because they require management to make particularly subjective or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions.
Because our financial statements involve estimates for amounts that are very large, even a small change in the estimate can have a significant impact for the reporting period. For example, because our total loss reserves are so large, even a change that has a small impact relative to the size of our loss reserves can have a meaningful impact on our results for the quarter in which we make the change.
Many of our accounting methods involve substantial use of models. Models are inherently imperfect predictors of actual results because they are based on assumptions, including assumptions about future events. Our actual results could differ significantly from those generated by our models. As a result, the estimates that we use to prepare our financial statements, as well as our estimates of our future results of operations, may be inaccurate, perhaps significantly.
Failure of our models to produce reliable results may adversely affect our ability to manage risk and make effective business decisions.
We make significant use of quantitative models to measure and monitor our risk exposures and to manage our business. For example, we use models to measure and monitor our exposures to interest rate, credit and market risks, and to forecast credit losses. The information provided by these models is used in making business decisions relating to strategies, initiatives, transactions, pricing and products.
Models are inherently imperfect predictors of actual results because they are based on historical data and assumptions regarding factors such as future loan demand, borrower behavior, creditworthiness and home price trends. Other potential sources of inaccurate or inappropriate model results include errors in computer code, bad data, misuse of data, or use of a model for a purpose outside the scope of the model’s design. Modeling often
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assumes that historical data or experience can be relied upon as a basis for forecasting future events, an assumption that may be especially tenuous in the face of unprecedented events.
Given the challenges of predicting future behavior, management judgment is used at every stage of the modeling process, from model design decisions regarding core underlying assumptions, to interpreting and applying final model output. To control for these inherent imperfections, our models are validated by an independent model risk management team within our Enterprise Risk Division and are subject to control requirements set by our model risk policies.
When market conditions change quickly and in unforeseen ways, there is an increased risk that the model assumptions and data inputs for our models are not representative of the most recent market conditions. Under such circumstances, we must rely on management judgment to make adjustments or overrides to our models. A formal model update is typically an extensive process that involves basic research, testing, independent validation and production implementation. In a rapidly changing environment, it may not be possible to update existing models quickly enough to properly account for the most recently available data and events. Management adjustments to modeled results are applied within the confines of the governance structure provided by a combination of our model risk management team and our finance and risk committees.
If our models fail to produce reliable results on an ongoing basis, we may not make appropriate risk management decisions, including decisions affecting loan purchases, management of credit losses, guaranty fee pricing, and asset and liability management. Any of these decisions could adversely affect our business, results of operations, liquidity, net worth and financial condition. Furthermore, strategies we employ to manage and govern the risks associated with our use of models may not be effective or fully reliable.
Changes in interest rates or our loss of the ability to manage interest rate risk successfully could adversely affect our financial results and condition, and increase interest rate risk.
We fund our operations primarily through the issuance of debt and invest our funds primarily in mortgage-related assets that permit mortgage borrowers to prepay their mortgages at any time. These business activities expose us to market risk, which is the risk of loss resulting from adverse changes in the value of financial instruments caused by changes in market conditions. Market risk includes interest rate risk, which is the risk of loss from adverse changes in the value of our assets or liabilities or our future earnings due to changes in interest rates. We describe these risks in more detail in “MD&A—Risk Management—Market Risk Management, Including Interest Rate Risk Management.” Changes in interest rates affect both the value of our mortgage assets and prepayment rates on our mortgage loans.
Changes in interest rates could have a material adverse effect on our business, results of operations, financial condition, liquidity and net worth. Our ability to manage interest rate risk depends on our ability to issue debt instruments with a range of maturities and other features, including call provisions, at attractive rates and to engage in derivatives transactions. We must exercise judgment in selecting the amount, type and mix of debt and derivative instruments that will most effectively manage our interest rate risk. The amount, type and mix of financial instruments that are available to us may not offset possible future changes in the spread between our borrowing costs and the interest we earn on our mortgage assets.
We mark to market changes in the estimated fair value of our derivatives through our earnings on a quarterly basis, but we do not similarly mark to market changes in some of the financial instruments that generate our interest rate risk exposures. As a result, changes in interest rates, particularly significant changes, can have a significant adverse effect on our earnings and net worth for the quarter in which the changes occur, depending on the nature of the changes and the derivatives we hold at that time. We have experienced significant fair value losses in some periods due to changes in interest rates, and we expect to continue to experience volatility from period to period in our financial results as a result of fair value losses or gains on our derivatives.
Changes in interest rates also can affect our credit losses. When interest rates increase, our credit losses from loans with adjustable payment terms may increase as borrower payments increase at their reset dates, which increases the borrower’s risk of default, particularly for adjustable-rate loans with interest-only features. Rising interest rates may also reduce the opportunity for these borrowers to refinance into a fixed-rate loan. Similarly, many borrowers may have additional debt obligations, such as home equity lines of credit and second liens, that also have adjustable payment terms. If a borrower’s payment on his or her other debt obligations increases due to rising interest rates or a change in amortization, it increases the risk that the borrower may default on a loan we own or guarantee. In addition to increasing the risk of future borrower defaults, rising interest rates reduce
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expected future loan prepayments, which lengthens the expected life of our individually impaired loans and therefore increases our impairment related to concessions we have provided on those loans.
While we have not experienced negative interest rates in the United States, some central banks in Europe and Asia have cut interest rates below zero. If U.S. interest rates were to fall below zero, it could negatively impact our financial results and increase our operational risk.
Changes in spreads could materially impact our results of operations, net worth and the fair value of our net assets.
Spread risk or basis risk is the resulting impact of changes in the spread between our mortgage assets and our debt and derivatives we use to hedge our position. Changes in market conditions, including changes in interest rates, liquidity, prepayment and default expectations, and the level of uncertainty in the market for a particular asset class may cause fluctuations in spreads. Changes in mortgage spreads have contributed to significant volatility in our financial results in certain periods, due to fluctuations in the estimated fair value of the financial instruments that we mark to market through our earnings, and this could occur again in a future period. A widening of mortgage spreads could cause significant fair value losses, and could adversely affect our near-term financial results and net worth. We do not actively manage or hedge our spread risk after we purchase mortgage assets, other than through asset monitoring and disposition.
Our business is subject to laws and regulations that restrict our activities and operations, which limit our ability to diversify our business and may prohibit us from undertaking activities that management believes would benefit our business.
As a federally chartered corporation, we are subject to the limitations imposed by the Charter Act, extensive regulation, supervision and examination by FHFA and regulation by other federal agencies, including Treasury, HUD and the SEC. As a company under conservatorship, our primary regulator has management authority over us in its role as our conservator. We are also subject to other laws and regulations that affect our business, including those regarding taxation and privacy.
The Charter Act defines our permissible business activities. For example, we may not originate mortgage loans or purchase single-family loans in excess of the conforming loan limits, and our business is limited to the U.S. housing finance sector. In addition, as described in a previous risk factor, our business activities are subject to significant restrictions as a result of the conservatorship and the senior preferred stock purchase agreement. As a result of these limitations on our ability to diversify our operations, our financial condition and results of operations depend almost entirely on conditions in a single sector of the U.S. economy, specifically, the U.S. housing market. Weak or unstable conditions in the housing market can therefore have a significant adverse effect on our results of operations, financial condition and net worth.
Our business and financial results could be materially adversely affected by legal or regulatory proceedings.
We are a party to various claims and other legal proceedings. We also have been, and in the future may be, involved in government investigations. We may be required to establish accruals and to make substantial payments in the event of adverse judgments or settlements of any such claims, investigations or proceedings, which could have a material adverse effect on our business, results of operations, financial condition, liquidity and net worth. Any legal proceeding or governmental investigation, even if resolved in our favor, could result in negative publicity or cause us to incur significant legal and other expenses.
Developments in, outcomes of, impacts of, and costs, expenses, settlements and judgments related to these legal proceedings and governmental investigations may differ from our expectations and exceed any amounts for which we have accrued or require adjustments to such accruals. In addition, responding to these matters could divert significant internal resources away from managing our business.
An active trading market in our equity securities may cease to exist, which would adversely affect the market price and liquidity of our common and preferred stock.
Our common stock and preferred stock are now traded exclusively in the over-the-counter market. We cannot predict the actions of market makers, investors or other market participants, and can offer no assurances that the market for our securities will be stable. If there is no active trading market in our equity securities, the market price and liquidity of the securities will be adversely affected.
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Mortgage fraud could result in significant financial losses and harm to our reputation.
We use a process of delegated underwriting in which lenders make specific representations and warranties about the characteristics of the mortgage loans we purchase and securitize. As a result, we do not independently verify most borrower information that is provided to us. This exposes us to the risk that one or more of the parties involved in a transaction (the borrower, seller, broker, appraiser, title agent, lender or servicer) will engage in fraud by misrepresenting facts about a mortgage loan. Similarly, we rely on delegated servicing of loans and use of a variety of external resources to manage our REO. We have experienced financial losses resulting from mortgage fraud, including institutional fraud perpetrated by counterparties. In the future, we may experience additional financial losses or reputational damage as a result of mortgage fraud.
Risks Relating To Our Industry | ||||
Our business and financial results are affected by general economic conditions, particularly home prices and employment trends, and a deterioration of economic conditions or the financial markets may materially adversely affect our results of operations, net worth and financial condition.
Our business is significantly affected by the status of the U.S. economy, particularly home prices and employment trends. A prolonged period of slow growth in the U.S. economy or any deterioration in general economic conditions or the financial markets could materially adversely affect our results of operations, net worth and financial condition. For example, if home prices decrease or the unemployment rate increases, it could result in significantly higher levels of credit losses and credit-related expense.
Global economic conditions can also adversely affect our business and financial results. Changes or volatility in market conditions resulting from deterioration in or uncertainty regarding global economic conditions can adversely affect the value of our assets, which could materially adversely affect our results of operations, net worth and financial condition. For example, concerns about the impact of Brexit contributed to a decline in interest rates in the second quarter of 2016. This decline in interest rates contributed to the fair value losses on our derivatives in the second quarter of 2016. Global economic conditions also could negatively affect the credit performance of the loans in our book of business.
Volatility or uncertainty in global political conditions also can significantly affect economic conditions and the financial markets. We describe above the risks to our business posed by changes in interest rates and changes in spreads. In addition, as described above, future changes or disruptions in the financial markets could significantly change the amount, mix and cost of funds we obtain, as well as our liquidity position.
A decline in activity in the U.S. housing market or increasing interest rates could lower our business volumes.
Our business volume is affected by the rate of growth in total U.S. residential mortgage debt outstanding and the size of the U.S. residential mortgage market. A decline in mortgage debt outstanding reduces the unpaid principal balance of mortgage loans available for us to acquire, which in turn could reduce our net interest income. Even if we were able to increase our share of the secondary mortgage market, it may not be sufficient to make up for a decline in the rate of growth in mortgage originations.
Mortgage interest rates also affect our business volume. Rising interest rates generally result in fewer mortgage originations, particularly for refinances. An increase in interest rates, particularly if the increase is sudden and steep, could significantly reduce our business volume. Significant reductions in our business volume could adversely affect our results of operations and financial condition. In December 2016, the Federal Reserve raised the target range for the federal funds rate and stated that it expects economic conditions to evolve in a manner that will warrant only gradual increases in the federal funds rate. The Federal Reserve may increase rates at a faster rate than it is currently expecting. Moreover, the Federal Reserve’s federal funds rate path is not the only factor that affects long-term interest rates. Accordingly, our business remains subject to the risk of sudden and steep interest rate increases.
A reduction or end to the Federal Reserve’s acquisition of agency mortgage-backed securities could adversely affect our business, results of operations, financial condition, liquidity and net worth.
In recent years, the Federal Reserve has purchased a significant amount of mortgage-backed securities issued by us, Freddie Mac and Ginnie Mae. The Federal Reserve began to taper these purchases in January 2014 and
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concluded its asset purchase program in October 2014. Since concluding its asset purchase program, the Federal Reserve has maintained its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities; therefore, it has continued to purchase a significant amount of agency mortgage-backed securities. In a statement issued in February 2017, the Federal Reserve indicated that it anticipates maintaining its current reinvestment policy “until normalization of the level of the federal funds rate is well under way.” Any change in the Federal Reserve’s policy towards the reinvestment of principal payments of mortgage-backed securities, or possible future sales of mortgage-backed securities by the Federal Reserve, could result in increases in mortgage interest rates, adversely affect our business volume and reduce demand for Fannie Mae MBS, which could adversely affect our business, results of operations, financial condition, liquidity and net worth.
Changing regulations applicable to U.S. banks could materially adversely affect demand by banks for our debt securities and Fannie Mae MBS in the future.
U.S. banking regulators have issued a number of new regulations in recent years, including regulations relating to capital requirements, liquidity requirements, stress testing and other matters. These new requirements could materially adversely affect demand by U.S. banks for our debt securities and Fannie Mae MBS in the future and could limit the ability of banks to create markets for our debt securities and Fannie Mae MBS, which could adversely affect the price of those securities and could have a material adverse effect on our business, results of operations, financial condition, liquidity and net worth. For example, U.S. banking regulators issued a regulation that became effective January 1, 2015 setting minimum liquidity standards for large U.S. banks generally in accordance with Basel III standards. Under the rule, U.S. banks subject to the standards are required to hold a minimum level of high-quality liquid assets based on projections of their short-term cash needs. The debt and mortgage-related securities of Fannie Mae and Freddie Mac are permitted to count toward only up to 40% of the banks’ high-quality liquid asset requirement, and then only after applying a 15% discount to the market value of those securities. U.S. banks currently hold large amounts of our outstanding debt and MBS securities, and prior U.S. banking regulations did not limit the amount of these securities that banks were permitted to count toward their liquidity requirements. Accordingly, this rule could materially adversely affect demand by banks for Fannie Mae debt securities and Fannie Mae MBS in the future and could limit the ability of banks to create markets for our debt securities and Fannie Mae MBS.
The Dodd-Frank Act and regulatory changes in the financial services industry may negatively impact our business.
The Dodd-Frank Act has significantly changed the regulation of the financial services industry. This legislation is affecting and is expected to continue to affect many aspects of our business and could affect us in substantial and unforeseeable ways. The Dodd-Frank Act and related regulatory changes have required us to change certain business practices, limit the types of products we offer and incur additional costs. Additionally, implementation of this legislation has resulted in and is expected to continue to result in increased supervision and more comprehensive regulation of our customers and counterparties in the financial services industry, which may have a significant impact on the business practices of our customers and counterparties, as well as on our counterparty credit risk. The Dodd-Frank Act’s impact on our customers’ and counterparties’ business practices could indirectly adversely affect our business. For example, if our customers reduce the amount of their mortgage originations, it would adversely affect the number of mortgages available for us to purchase or guarantee.
Examples of aspects of the Dodd-Frank Act and related regulatory changes that have affected us or may affect us in the future include: rules requiring the clearing of certain derivatives transactions and margin and capital rules for uncleared derivative trades, which impose additional costs on us; the CFPB’s “ability-to-repay” rule, which has limited the types of products we offer and could impact the volume of loans sold to us in the future; and the development of single-counterparty credit limit regulations, which could cause our customers to change their business practices.
The Dodd-Frank Act also established the Financial Stability Oversight Council to ensure that all financial companies—not just banks—whose failure could pose a threat to the financial stability of the United States will be subject to strong oversight. Under the Dodd-Frank Act, the Financial Stability Oversight Council is responsible for designating systemically important nonbank financial companies. It is possible that we could be designated as a systemically important nonbank financial company by the Financial Stability Oversight Council, although we have not received any notification of possible designation. If this were to occur, we would become subject to regulation by the Federal Reserve Board, which could impose stricter prudential standards on us.
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The current Administration and some members of Congress have indicated a desire to amend the Dodd-Frank Act. If the Dodd-Frank Act is amended, it could affect regulations currently applicable to us and our customers and counterparties. We cannot predict the prospects for the enactment of amendments to the Dodd-Frank Act or how they might impact our business or our customers and counterparties.
In addition, the actions of Treasury, the Commodity Futures Trading Commission, the SEC, the FDIC, the Federal Reserve and international central banking authorities directly or indirectly impact financial institutions’ cost of funds for lending, capital-raising and investment activities, which could increase our borrowing costs or make borrowing more difficult for us. Changes in monetary policy are beyond our control and difficult to anticipate.
Overall, these legislative and regulatory changes could affect us in substantial and unforeseeable ways and could have a material adverse effect on our business, results of operations, financial condition, liquidity and net worth.
Legislative, regulatory or judicial actions could negatively impact our business, results of operations, financial condition or net worth.
Legislative, regulatory or judicial actions at the federal, state or local level could negatively impact our business, results of operations, financial condition or net worth. Legislative, regulatory or judicial actions could affect us in a number of ways, including by imposing significant additional costs on us and diverting management attention or other resources. For example, we could be affected by legislative or regulatory changes that expand our or our servicers’ responsibility and liability for securing, maintaining or otherwise overseeing vacant properties prior to foreclosure, which could increase our costs. We also could be affected by state laws and court decisions granting new or expanded priority rights to homeowners associations over our mortgages, which could adversely affect our ability to recover our losses on affected loans. In addition, as described above, our business could be materially adversely affected by legislative and regulatory actions relating to housing finance reform, corporate income tax reform or the financial services industry, or by legal or regulatory proceedings.
The occurrence of a major natural or other disaster in the United States could negatively impact our credit losses and credit-related expenses.
We conduct our business in the residential and multifamily mortgage markets and own or guarantee the performance of mortgage loans throughout the United States. The occurrence of a major natural or environmental disaster, terrorist attack, cyber attack, pandemic, or similar event (a “major disruptive event”) in a regional geographic area of the United States could negatively impact our credit losses and credit-related expenses in the affected area or, depending on the nature of the event, nationally.
The occurrence of a major disruptive event could negatively impact a geographic area in a number of different ways, depending on the nature of the event. A major disruptive event that either damages or destroys residential or multifamily real estate securing mortgage loans in our book of business or negatively impacts the ability of borrowers to continue to make principal and interest payments on mortgage loans in our book of business could increase our delinquency rates, default rates and average loan loss severity of our book of business in the affected region or regions, which could have a material adverse effect on our business, results of operations, financial condition, liquidity and net worth. While we attempt to create a geographically diverse mortgage credit book of business, there can be no assurance that a major disruptive event, depending on its magnitude, scope and nature, will not generate significant credit losses and credit-related expenses.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We own or lease ten office facilities in the Washington, DC area with a total square footage of approximately 2,161,000 square feet.
In January 2015, we entered into a lease for a future principal office in a building to be built at 1100 15th Street, NW, Washington, DC. Accordingly, we sold our current principal office located at 3900 Wisconsin Ave, NW, Washington, DC, as well as two other Washington, DC office facilities, in November 2016. We currently occupy these three facilities pursuant to lease arrangements.
We also maintain approximately 680,000 square feet of office space in leased premises in Dallas, Texas and other locations in the United States.
Fannie Mae 2016 Form 10-K | 50 | |
Legal Proceedings | ||
Item 3. Legal Proceedings
This item describes our material legal proceedings. We describe additional material legal proceedings in “Note 18, Commitments and Contingencies,” which is incorporated herein by reference. In addition to the matters specifically described or incorporated by reference in this item, we are involved in a number of legal and regulatory proceedings that arise in the ordinary course of business that do not have a material impact on our business. Litigation claims and proceedings of all types are subject to many factors that generally cannot be predicted accurately.
We record accruals for legal claims when losses associated with those claims become probable and the amounts can be reasonably estimated. The actual costs of resolving legal claims may be substantially higher or lower than the amounts accrued for those claims. For matters where the likelihood or extent of a loss is not probable or cannot be reasonably estimated, we do not recognize in our consolidated financial statements the potential liability that may result from these matters. We presently cannot determine the ultimate resolution of the matters described below or incorporated by reference into this item. If certain of these matters are determined against us, FHFA or Treasury it could have a material adverse effect on our results of operations, liquidity and financial condition, including our net worth.
FHFA Private-Label Mortgage-Related Securities Litigation
In the third quarter of 2011, FHFA, as conservator, filed 16 lawsuits on behalf of both Fannie Mae and Freddie Mac against various financial institutions, their officers and affiliated and unaffiliated underwriters that were responsible for marketing and selling private-label mortgage-related securities to us. Fourteen of these lawsuits were resolved during 2013 and 2014, and two remain pending.
These two remaining lawsuits, which were both filed on September 2, 2011, seek to recover losses we and Freddie Mac incurred on the private-label mortgage-related securities the defendants sold to us and Freddie Mac. The lawsuits allege that the defendants violated federal and state securities laws by making material misstatements and omissions regarding the characteristics of the loans underlying the securities in the offering documents for the securities that were sold to Fannie Mae and Freddie Mac. The complaints seek, among other things, rescission and recovery of consideration paid for the securities at issue in the lawsuits and interest.
One of the remaining lawsuits is against Nomura Holding America Inc., RBS Securities Inc. and certain related entities and individuals. On May 15, 2015, the U.S. District Court for the Southern District of New York entered a final judgment in the Nomura action, holding the defendants liable for claims brought under state and federal securities laws. On June 10, 2015, defendants in the Nomura action appealed this judgment to the U.S. Court of Appeals for the Second Circuit, which heard oral argument on November 18, 2016. The judgment, if affirmed in full, requires defendants to pay Fannie Mae $27 million and Freddie Mac $779 million, and requires Fannie Mae and Freddie Mac to deliver the securities at issue in the complaint to the defendants. In addition, if the judgment is affirmed in full, defendants are required to pay $33 million to cover attorneys’ fees and costs for both us and Freddie Mac.
The other remaining lawsuit is against The Royal Bank of Scotland Group PLC and certain related entities and individuals, and is pending in the U.S. District Court for the District of Connecticut.
Senior Preferred Stock Purchase Agreements Litigation
Between June 2013 and October 2016, several lawsuits were filed by preferred and common stockholders of Fannie Mae and Freddie Mac in the U.S. Court of Federal Claims, the U.S. District Court for the District of Columbia, the U.S. District Court for the Southern District of Iowa, the U.S. District Court for the Northern District of Iowa, the U.S. District Court for the District of Delaware, the U.S. District Court for the Eastern District of Kentucky, the U.S. District Court for the Northern District of Illinois, the U.S. District Court for the Western District of Texas and the U.S. District Court for the Southern District of Texas against one or more of the United States, Treasury and FHFA, challenging actions taken by the defendants relating to the senior preferred stock purchase agreements and the conservatorships of Fannie Mae and Freddie Mac. Some of these lawsuits also contain claims against Fannie Mae and Freddie Mac. The legal claims being advanced by one or more of these lawsuits include challenges to the net worth sweep dividend provisions of the senior preferred stock that were implemented pursuant to the August 2012 amendments to the agreements, the payment of dividends to Treasury under the net worth sweep dividend provisions, and FHFA’s decision to require Fannie Mae and Freddie Mac to draw funds from Treasury in order to pay dividends to Treasury prior to the August 2012 amendments. The
Fannie Mae 2016 Form 10-K | 51 | |
Legal Proceedings | ||
plaintiffs seek various forms of equitable and injunctive relief, including rescission of the August 2012 amendments, as well as damages.
On September 30, 2014, the U.S. District Court for the District of Columbia dismissed all but one of the cases then pending before that court. The plaintiffs in each of the dismissed cases filed a notice of appeal and on October 27, 2014, the U.S. Court of Appeals for the D.C. Circuit consolidated these appeals. The plaintiffs in the case that was not dismissed by the court voluntarily dismissed their lawsuit on October 31, 2014. On February 3, 2015, the U.S. District Court for the Southern District of Iowa dismissed the case pending before it. On April 15, 2016, the U.S. Court of Appeals for the D.C. Circuit heard oral argument on the consolidated appeals. On September 9, 2016, the U.S. District Court for the Eastern District of Kentucky dismissed the case pending before it. The plaintiff in that case filed a notice of appeal and the appeal was docketed on November 17, 2016. A case filed in the U.S. District Court for the District of Columbia in June 2016, after the dismissal of the initial set of cases filed in that court, was dismissed on December 19, 2016. The matters where Fannie Mae is a named defendant are described below or in “Note 18, Commitments and Contingencies.”
Fannie Mae is a nominal defendant in two actions filed against the United States in the U.S. Court of Federal Claims: Fisher v. United States of America, filed on December 2, 2013, and Rafter v. United States of America, filed on August 14, 2014. Plaintiffs in these cases allege that the net worth sweep dividend provisions of the senior preferred stock that were implemented pursuant to the August 2012 amendment to the senior preferred stock purchase agreement constitute a taking of Fannie Mae’s property without just compensation in violation of the U.S. Constitution. The Fisher plaintiffs are pursuing this claim derivatively on behalf of Fannie Mae, while the Rafter plaintiffs are pursing the claim directly against the United States. Plaintiffs in Rafter also allege a derivative claim that the government breached an implied contract with Fannie Mae’s Board of Directors by implementing the net worth sweep dividend provisions. Plaintiffs in Fisher request just compensation to Fannie Mae in an unspecified amount. Plaintiffs in Rafter seek just compensation for themselves on their constitutional claim and payment of damages to Fannie Mae on their derivative claim for breach of an implied contract. The United States filed a motion to dismiss the Fisher case on January 23, 2014; however, the court has stayed proceedings in this case until discovery in a related case, Fairholme Funds v. United States, is complete and the court sets a date for the Fairholme Funds plaintiffs to respond to the government’s motion to dismiss filed in that case. In the Rafter case, the court has ordered the government to file a response to the complaint within sixty days after discovery is complete in the Fairholme Funds case.
Fannie Mae is also a nominal defendant in a case filed against FHFA and Treasury in the U.S. District Court for the District of Delaware: Jacobs v. FHFA, filed on August 17, 2015. The plaintiffs allege that the net worth sweep dividend provisions of the senior preferred stock that were implemented pursuant to the August 2012 amendments to the agreements violate Delaware law. The plaintiffs are pursuing this claim derivatively on behalf of Fannie Mae and directly against the government. The plaintiffs have also alleged direct breach of contract claims and breach of fiduciary duty claims against the government. The government filed motions to dismiss the case on November 13, 2015.
On March 14, 2016, Timothy Pagliara filed a lawsuit against Fannie Mae in the Delaware Court of Chancery: Pagliara v. Federal National Mortgage Association. The plaintiff owns Fannie Mae preferred stock and seeks access to Fannie Mae’s books and records under a provision of Delaware state law. The plaintiff alleges that he is entitled to inspect Fannie Mae’s books and records in order to investigate potential breaches of duties to stockholders related to the net worth sweep dividend provisions of the senior preferred stock that were implemented pursuant to the August 2012 amendment to the senior preferred stock purchase agreement, as well as Fannie Mae’s involvement in the common securitization platform, Common Securitization Solutions, LLC, and the single security. On March 25, 2016, Fannie Mae and FHFA removed the case to the U.S. District Court for the District of Delaware. On July 18, 2016, FHFA filed a motion to substitute itself for the plaintiff.
LIBOR Lawsuit
On October 31, 2013, Fannie Mae filed a lawsuit in the U.S. District Court for the Southern District of New York against Barclays Bank PLC, UBS AG, The Royal Bank of Scotland Group PLC, The Royal Bank of Scotland PLC, Deutsche Bank AG, Credit Suisse Group AG, Credit Suisse International, Bank of America Corp., Bank of America, N.A., Citigroup Inc., Citibank, N.A., J.P. Morgan Chase & Co., J.P. Morgan Chase Bank, N.A., Coöperative Centrale Raiffeisen-Boerenleenbank B.A., the British Bankers Association (the “BBA”) and BBA LIBOR Ltd. alleging they manipulated LIBOR. On October 6, 2014, Fannie Mae filed an amended complaint alleging, among other things, that the banks submitted false borrowing costs to the BBA in order to suppress
Fannie Mae 2016 Form 10-K | 52 | |
Legal Proceedings | ||
LIBOR. The amended complaint seeks compensatory and punitive damages based on claims for breach of contract, breach of the implied duty of good faith and fair dealing, unjust enrichment, fraud and conspiracy to commit fraud. The defendants filed motions to dismiss the lawsuit on November 5, 2014. On August 4, 2015, the court decided defendants’ motions to dismiss, granting in part and denying in part the relief sought. The court ruled that Fannie Mae had adequately pled its fraud, breach of contract and unjust enrichment claims against the defendants, but that the applicable statute of limitations periods precluded some of our contract and unjust enrichment claims against the defendants from proceeding. In addition, the court dismissed the BBA and Credit Suisse Group AG from the lawsuit.
Item 4. Mine Safety Disclosures
None.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded in the over-the-counter market and quoted on the OTC Bulletin Board under the ticker symbol “FNMA.” The transfer agent and registrar for our common stock is Computershare Trust Company, N.A., P.O. Box 30170, College Station, TX 77842-3170.
Common Stock Data
The following table displays, for the periods indicated, the high and low prices per share of our common stock as reported in the Bloomberg Financial Markets service. These prices represent high and low trade prices. No dividends were declared on shares of our common stock during the periods indicated.
Quarter | High | Low | |||||
2015 | |||||||
First Quarter | $ | 3.51 | $ | 2.05 | |||
Second Quarter | 2.96 | 2.27 | |||||
Third Quarter | 2.72 | 2.00 | |||||
Fourth Quarter | 2.70 | 1.58 | |||||
2016 | |||||||
First Quarter | $ | 1.83 | $ | 0.98 | |||
Second Quarter | 2.48 | 1.26 | |||||
Third Quarter | 2.08 | 1.57 | |||||
Fourth Quarter | 5.00 | 1.61 | |||||
Dividends
Our payment of dividends is subject to the following restrictions:
Restrictions Relating to Conservatorship. Our conservator announced on September 7, 2008 that we would not pay any dividends on the common stock or on any series of preferred stock, other than the senior preferred stock. In addition, FHFA’s regulations relating to conservatorship and receivership operations prohibit us from paying any dividends while in conservatorship unless authorized by the Director of FHFA. The Director of FHFA has directed us to make dividend payments on the senior preferred stock on a quarterly basis.
Restrictions Under Senior Preferred Stock Purchase Agreement. The senior preferred stock purchase agreement prohibits us from declaring or paying any dividends on Fannie Mae equity securities (other than the senior preferred stock) without the prior written consent of Treasury. In addition, in 2012 the terms of the senior preferred stock purchase agreement and the senior preferred stock were amended to require that we pay Treasury each quarter any dividends declared consisting of the amount, if any, by which our net worth as of the end of the immediately preceding fiscal quarter exceeds an applicable capital reserve amount, which will decrease to zero in 2018. As a result, our net income is not available to common stockholders. For more information on the terms of the senior preferred stock purchase agreement and senior preferred stock, see “Business—Conservatorship and
Fannie Mae 2016 Form 10-K | 53 | |
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | ||
Treasury Agreements—Treasury Agreements—Senior Preferred Stock Purchase Agreement and Related Issuance of Senior Preferred Stock and Common Stock Warrant.”
Additional Restrictions Relating to Preferred Stock. Payment of dividends on our common stock is also subject to the prior payment of dividends on our preferred stock and our senior preferred stock. Payment of dividends on all outstanding preferred stock, other than the senior preferred stock, is also subject to the prior payment of dividends on the senior preferred stock.
Statutory Restrictions. Under the GSE Act, FHFA has authority to prohibit capital distributions, including payment of dividends, if we fail to meet our capital requirements. If FHFA classifies us as significantly undercapitalized, approval of the Director of FHFA is required for any dividend payment. Under the Charter Act and the GSE Act, we are not permitted to make a capital distribution if, after making the distribution, we would be undercapitalized. The Director of FHFA, however, may permit us to repurchase shares if the repurchase is made in connection with the issuance of additional shares or obligations in at least an equivalent amount and will reduce our financial obligations or otherwise improve our financial condition.
Holders
As of January 31, 2017, we had approximately 12,000 registered holders of record of our common stock. In addition, as of January 31, 2017, Treasury held a warrant giving it the right to purchase shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis on the date of exercise.
Recent Sales of Unregistered Securities
Under the terms of our senior preferred stock purchase agreement with Treasury, we are prohibited from selling or issuing our equity interests, other than as required by (and pursuant to) the terms of a binding agreement in effect on September 7, 2008, without the prior written consent of Treasury. During the quarter ended December 31, 2016, we did not issue any equity securities.
Information about Certain Securities Issuances by Fannie Mae
Pursuant to SEC regulations, public companies are required to disclose certain information when they incur a material direct financial obligation or become directly or contingently liable for a material obligation under an off-balance sheet arrangement. The disclosure must be made in a current report on Form 8-K under Item 2.03 or, if the obligation is incurred in connection with certain types of securities offerings, in prospectuses for that offering that are filed with the SEC.
Because the securities we issue are exempted securities under the Securities Act of 1933, we do not file registration statements or prospectuses with the SEC with respect to our securities offerings. To comply with the disclosure requirements of Form 8-K relating to the incurrence of material financial obligations, we report our incurrence of these types of obligations either in offering circulars or prospectuses (or supplements thereto) that we post on our website or in a current report on Form 8-K that we file with the SEC, in accordance with a “no-action” letter we received from the SEC staff in 2004. In cases where the information is disclosed in a prospectus or offering circular posted on our website, the document will be posted on our website within the same time period that a prospectus for a non-exempt securities offering would be required to be filed with the SEC.
The website address for disclosure about our debt securities is www.fanniemae.com/debtsearch. From this address, investors can access the offering circular and related supplements for debt securities offerings under Fannie Mae’s universal debt facility, including pricing supplements for individual issuances of debt securities.
Disclosure about our obligations pursuant to some of the MBS we issue, some of which may be off-balance sheet obligations, can be found at www.fanniemae.com/mbsdisclosure. From this address, investors can access information and documents about our MBS, including prospectuses and related prospectus supplements.
We are providing our website address solely for your information. Information appearing on our website is not incorporated into this report.
Our Purchases of Equity Securities
We did not repurchase any of our equity securities during the fourth quarter of 2016.
Fannie Mae 2016 Form 10-K | 54 | |
Selected Financial Data | ||
Item 6. Selected Financial Data
The selected consolidated financial data displayed below are summarized from our results of operations for the five-year period ended December 31, 2016, as well as selected consolidated balance sheet data as of the end of each year within this five-year period. This data should be reviewed in conjunction with the audited consolidated financial statements and related notes and with the MD&A included in this annual report on Form 10-K.
For the Year Ended December 31, | ||||||||||||||||||||
2016 | 2015 | 2014 | 2013 | 2012 | ||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||
Statement of operations data: | ||||||||||||||||||||
Net revenues(1) | $ | 22,261 | $ | 22,757 | $ | 25,855 | $ | 26,334 | $ | 22,988 | ||||||||||
Net income attributable to Fannie Mae | 12,313 | 10,954 | 14,208 | 83,963 | 17,224 | |||||||||||||||
New business purchase data: | ||||||||||||||||||||
New business purchases(2) | $ | 637,425 | $ | 515,541 | $ | 409,834 | $ | 759,535 | $ | 867,387 | ||||||||||
Performance ratios: | ||||||||||||||||||||
Net interest yield(3) | 0.67 | % | 0.68 | % | 0.63 | % | 0.70 | % | 0.68 | % | ||||||||||
Credit loss ratio (in basis points)(4) | 12.0 | bps | 35.0 | bps | 19.4 | bps | 14.7 | bps | 48.2 | bps | ||||||||||
As of December 31, | |||||||||||||||||||
2016 | 2015 | 2014 | 2013 | 2012 | |||||||||||||||
(Dollars in millions) | |||||||||||||||||||
Balance sheet data: | |||||||||||||||||||
Investments in securities | $ | 48,925 | $ | 60,138 | $ | 62,158 | $ | 68,939 | $ | 103,876 | |||||||||
Mortgage loans, net of allowance(5) | 3,079,753 | 3,019,644 | 3,019,494 | 3,026,240 | 2,949,406 | ||||||||||||||
Total assets | 3,287,968 | 3,221,917 | 3,248,176 | 3,270,108 | 3,222,422 | ||||||||||||||
Short-term debt | 35,579 | 71,950 | 106,572 | 74,449 | 108,716 | ||||||||||||||
Long-term debt | 3,226,737 | 3,125,721 | 3,115,583 | 3,160,074 | 3,080,801 | ||||||||||||||
Total liabilities | 3,281,897 | 3,217,858 | 3,244,456 | 3,260,517 | 3,215,198 | ||||||||||||||
Senior preferred stock | 117,149 | 117,149 | 117,149 | 117,149 | 117,149 | ||||||||||||||
Preferred stock | 19,130 | 19,130 | 19,130 | 19,130 | 19,130 | ||||||||||||||
Total Fannie Mae stockholders’ equity | 6,071 | 4,030 | 3,680 | 9,541 | 7,183 | ||||||||||||||
Net worth surplus | 6,071 | 4,059 | 3,720 | 9,591 | 7,224 | ||||||||||||||
Fannie Mae 2016 Form 10-K | 55 | |
Selected Financial Data | ||
As of December 31, | ||||||||||||||||||||
2016 | 2015 | 2014 | 2013 | 2012 | ||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||
Book of business data: | ||||||||||||||||||||
Mortgage credit book of business(6) | $ | 3,102,503 | $ | 3,065,955 | $ | 3,091,102 | $ | 3,136,765 | $ | 3,116,842 | ||||||||||
Guaranty book of business(7) | 3,092,271 | 3,043,141 | 3,056,219 | 3,090,538 | 3,039,457 | |||||||||||||||
Credit quality: | ||||||||||||||||||||
Total troubled debt restructurings on accrual status | $ | 127,494 | $ | 140,964 | $ | 145,294 | $ | 141,227 | $ | 136,064 | ||||||||||
Total nonaccrual loans(8) | 44,450 | 49,412 | 64,959 | 83,606 | 114,833 | |||||||||||||||
Total loss reserves | 23,929 | 28,774 | 38,173 | 47,290 | 62,629 | |||||||||||||||
Total loss reserves as a percentage of total guaranty book of business | 0.77 | % | 0.95 | % | 1.25 | % | 1.53 | % | 2.06 | % | ||||||||||
Total loss reserves as a percentage of total nonaccrual loans | 53.83 | 58.23 | 58.76 | 56.56 | 54.54 | |||||||||||||||
__________
(1) | Consists of net interest income and fee and other income. |
(2) | New business purchases consist of single-family and multifamily whole mortgage loans purchased during the period and single-family and multifamily mortgage loans underlying Fannie Mae MBS issued during the period pursuant to lender swaps. |
(3) | Calculated based on net interest income for the period divided by the average balance of total interest-earning assets during the period, expressed as a percentage. |
(4) | Consists of (a) charge-offs, net of recoveries and (b) foreclosed property expense (income) for the reporting period (adjusted to exclude the impact of fair value losses resulting from credit-impaired loans acquired from MBS trusts) divided by the average guaranty book of business during the period, expressed in basis points. See “MD&A—Consolidated Results of Operations—Credit-Related Income (Expense)—Credit Loss Performance Metrics” for a discussion of how our credit loss metrics are calculated. Our credit loss ratio in 2015 was impacted by charge-offs of (1) $1.8 billion in loans held for investment and $724 million in preforeclosure property taxes and insurance receivable that we recognized on January 1, 2015 upon our adoption of the Advisory Bulletin and (2) $1.1 billion in accrued interest receivable that we recognized on January 1, 2015 upon our adoption of a change in accounting policy related to loans placed on nonaccrual status. See “Note 1, Summary of Significant Accounting Policies” for additional information. |
(5) | Mortgage loans consist solely of domestic residential real-estate mortgages. |
(6) | Refers to the sum of the unpaid principal balance of: (a) mortgage loans of Fannie Mae; (b) mortgage loans underlying Fannie Mae MBS; (c) non-Fannie Mae mortgage-related securities held in our retained mortgage portfolio; and (d) other credit enhancements that we provide on mortgage assets. |
(7) | Reflects mortgage credit book of business less non-Fannie Mae mortgage-related securities held in our retained mortgage portfolio for which we do not provide a guaranty. |
(8) | We generally classify single-family loans as nonaccrual when the payment of principal or interest on the loan is 60 days or more past due. Multifamily loans are placed on nonaccrual status when the loan becomes 90 days or more past due according to its contractual terms or is deemed individually impaired. See “Note 1, Summary of Significant Accounting Policies” for more information about our policies on nonaccrual loans. |
Fannie Mae 2016 Form 10-K | 56 | |
MD&A | Critical Accounting Policies and Estimates | ||
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read this MD&A in conjunction with our consolidated financial statements as of December 31, 2016 and related notes to the consolidated financial statements, and with “Business—Executive Summary.” Please also see “Glossary of Terms Used in This Report.”
Critical Accounting Policies and Estimates | ||||
The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We describe our most significant accounting policies in “Note 1, Summary of Significant Accounting Policies.”
We evaluate our critical accounting estimates and judgments required by our policies on an ongoing basis and update them as necessary based on changing conditions. Management has discussed any significant changes in judgments and assumptions in applying our critical accounting policies with the Audit Committee of our Board of Directors. See “Risk Factors” for a discussion of the risks associated with the need for management to make judgments and estimates in applying our accounting policies and methods. We have identified two of our accounting policies as critical because they involve significant judgments and assumptions about highly complex and inherently uncertain matters, and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition: fair value measurement and combined loss reserves.
Fair Value Measurement
The use of fair value to measure our assets and liabilities is fundamental to our financial statements and our fair value measurement is a critical accounting estimate because we account for and record a portion of our assets and liabilities at fair value. In determining fair value, we use various valuation techniques. We describe the valuation techniques and inputs used to determine the fair value of our assets and liabilities and disclose their carrying value and fair value in “Note 17, Fair Value.”
The fair value accounting rules provide a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Each asset or liability is assigned to a level based on the lowest level of any input that is significant to its fair value measurement. The three levels of the fair value hierarchy are described below:
Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Observable market-based inputs, other than quoted prices in active markets for identical assets or liabilities.
Level 3: Unobservable inputs.
The majority of the financial instruments that we report at fair value in our consolidated financial statements fall within the Level 2 category and are valued primarily utilizing inputs and assumptions that are observable in the marketplace, that can be derived from observable market data or that can be corroborated by recent trading activity of similar instruments with similar characteristics. For example, we generally request non-binding prices from at least three independent pricing services to estimate the fair value of our trading and available-for-sale securities at an individual security level. We use the average of these prices to determine the fair value.
In the absence of such information or if we are not able to corroborate these prices by other available, relevant market information, we estimate their fair values based on single source quotations from brokers or dealers or by using internal calculations or discounted cash flow techniques that incorporate inputs, such as prepayment rates, discount rates and delinquency, default and cumulative loss expectations, that are implied by market prices for similar securities and collateral structure types. Because these valuation techniques rely on significant unobservable inputs, the fair value estimation is classified as Level 3. The process for determining fair value using unobservable inputs is generally more subjective and involves a high degree of management judgment and assumptions. These assumptions may have a significant effect on our estimates of fair value, and the use of
Fannie Mae 2016 Form 10-K | 57 | |
MD&A | Critical Accounting Policies and Estimates | ||
different assumptions as well as changes in market conditions could have a material effect on our results of operations or financial condition.
Fair Value Hierarchy—Level 3 Assets and Liabilities
The assets and liabilities that we have classified as Level 3 consist primarily of financial instruments for which there is limited market activity and therefore little or no price transparency. As a result, the valuation techniques that we use to estimate the fair value of Level 3 instruments involve significant unobservable inputs, which generally are more subjective and involve a high degree of management judgment and assumptions. Our Level 3 assets and liabilities consist of certain mortgage-backed securities and residual interests, certain mortgage loans, acquired property, certain long-term debt arrangements and certain highly structured, complex derivative instruments. We provide a detailed discussion of our Level 3 assets and liabilities, including the valuation techniques and significant unobservable inputs used to measure the fair value of these instruments, in “Note 17, Fair Value.”
Valuation Control Processes
We have control processes that are designed to ensure that our fair value measurements are appropriate and reliable, that they are based on observable inputs wherever possible and that our valuation approaches are consistently applied and the assumptions used are reasonable. Our control processes consist of a framework that provides for a segregation of duties and oversight of our fair value methodologies and valuations, as well as validation procedures. We provide a detailed discussion of our valuation control processes in “Note 17, Fair Value.”
Combined Loss Reserves
Our combined loss reserves consist of the following components:
• | Allowance for loan losses |
• | Reserve for guaranty losses |
These components can be further allocated into our single-family and multifamily loss reserves.
We maintain an allowance for loan losses for loans classified as held for investment, including both loans we hold in our portfolio and loans held in consolidated Fannie Mae MBS trusts. We maintain a reserve for guaranty losses for loans held in unconsolidated Fannie Mae MBS trusts we guarantee and loans we have guaranteed under long-term standby commitments and other credit enhancements we have provided. These amounts, which we collectively refer to as our combined loss reserves, represent probable losses incurred related to loans in our guaranty book of business, including concessions granted to borrowers upon modifications of their loans, as of the balance sheet date.
The allowance for loan losses is a valuation allowance that reflects an estimate of incurred credit losses related to our loans held for investment. The reserve for guaranty losses is a liability account in our consolidated balance sheets that reflects an estimate of incurred credit losses related to our guaranty to each unconsolidated Fannie Mae MBS trust that we will supplement amounts received by the Fannie Mae MBS trust as required to permit timely payments of principal and interest on the related Fannie Mae MBS. As a result, the guaranty reserve considers not only the principal and interest due on the loan at the current balance sheet date, but also an estimate of any additional interest payments due to the trust from the current balance sheet date until the point of loan acquisition or foreclosure. Our loss reserves consist of a specific loss reserve for individually impaired loans and a collective loss reserve for all other loans.
We have an established process, using analytical tools, benchmarks and management judgment, to determine our loss reserves. Our process for determining our loss reserves is complex and involves significant management judgment. Although our loss reserve process benefits from extensive historical loan performance data, this process is subject to risks and uncertainties, including a reliance on historical loss information that may not be representative of current conditions. We continually monitor prepayment, delinquency, modification, default and loss severity trends and periodically make changes in our historically developed assumptions and estimates as necessary to better reflect present conditions, including current trends in borrower risk, general economic trends, changes in risk management practices, and changes in public policy and the regulatory environment. We also consider the recoveries that we expect to receive on mortgage insurance and other loan-specific credit
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MD&A | Critical Accounting Policies and Estimates | ||
enhancements entered into contemporaneously with and in contemplation of a guaranty or loan purchase transaction, as such recoveries reduce the severity of the loss associated with defaulted loans.
We provide more detailed information on our accounting for the allowance for loan losses in “Note 1, Summary of Significant Accounting Policies.”
Single-Family Loss Reserves
We establish a specific single-family loss reserve for individually impaired loans, which includes loans we restructure in troubled debt restructurings (“TDRs”), certain nonperforming loans in MBS trusts and acquired credit-impaired loans that have been further impaired subsequent to acquisition. The single-family loss reserve for individually impaired loans represents the majority of our single-family loss reserves due to the high volume of restructured loans. We typically measure impairment based on the difference between our recorded investment in the loan and the present value of the estimated cash flows we expect to receive, which we calculate using the effective interest rate of the original loan or the effective interest rate at acquisition for an acquired credit-impaired loan. However, when foreclosure is probable on an individually impaired loan, we measure impairment based on the difference between our recorded investment in the loan and the fair value of the underlying property, adjusted for the estimated discounted costs to sell the property and estimated insurance or other proceeds we expect to receive. When a loan has been restructured or modified, we measure impairment using a cash flow analysis discounted at the loan’s original effective interest rate.
We establish a collective single-family loss reserve for all other single-family loans in our single-family guaranty book of business using a model that estimates the probability of default of loans to derive a loss reserve estimate given multiple factors such as: origination year, mark-to-market LTV ratio, delinquency status and loan product type. The loss severity estimates we use in determining our loss reserves reflect current available information on actual events and conditions as of each balance sheet date, including current home prices. Our loss severity estimates do not incorporate assumptions about future changes in home prices. We do, however, use recent regional historical sales and appraisal information, including the sales of our own foreclosed properties, to develop our loss severity estimates for all loan categories.
Multifamily Loss Reserves
We establish a collective multifamily loss reserve for all loans in our multifamily guaranty book of business that are not individually impaired using an internal model that applies loss factors to loans in similar risk categories. Our loss factors are developed based on our historical default and loss severity experience. Management may also apply judgment to adjust the loss factors derived from our models, taking into consideration model imprecision and specific, known events, such as current credit conditions, that may affect the credit quality of our multifamily loan portfolio but are not yet reflected in our model-generated loss factors.
We establish a specific multifamily loss reserve for multifamily loans that we determine are individually impaired. We identify multifamily loans for evaluation for impairment through a credit risk assessment process. As part of this assessment process, we stratify multifamily loans into different internal risk categories based on the credit risk inherent in each individual loan and management judgment. We categorize loan credit risk, taking into consideration available operating statements and expected cash flows from the underlying property, the estimated value of the property, the historical loan payment experience and current relevant market conditions that may impact credit quality. If we conclude that a multifamily loan is impaired, we measure the impairment based on the difference between our recorded investment in the loan and the fair value of the underlying property less the estimated discounted costs to sell the property and any lender loss sharing or other proceeds we expect to receive. When a multifamily loan is deemed individually impaired because we have modified it, we measure the impairment based on the difference between our recorded investment in the loan and the present value of expected cash flows discounted at the loan’s original interest rate unless foreclosure is probable, at which time we measure impairment the same way we measure it for other individually impaired multifamily loans.
Consolidated Results of Operations | ||||
This section provides a discussion of our consolidated results of operations for the periods indicated and should be read together with our consolidated financial statements, including the accompanying notes.
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MD&A | Consolidated Results of Operations | ||
Table 2: Summary of Consolidated Results of Operations | |||||||||||||||||||||||
For the Year Ended December 31, | Variance | ||||||||||||||||||||||
2016 | 2015 | 2014 | 2016 vs. 2015 | 2015 vs. 2014 | |||||||||||||||||||
(Dollars in millions) | |||||||||||||||||||||||
Net interest income | $ | 21,295 | $ | 21,409 | $ | 19,968 | $ | (114 | ) | $ | 1,441 | ||||||||||||
Fee and other income | 966 | 1,348 | 5,887 | (382 | ) | (4,539 | ) | ||||||||||||||||
Net revenues | 22,261 | 22,757 | 25,855 | (496 | ) | (3,098 | ) | ||||||||||||||||
Investment gains, net | 1,256 | 1,336 | 936 | (80 | ) | 400 | |||||||||||||||||
Fair value losses, net | (1,081 | ) | (1,767 | ) | (4,833 | ) | 686 | 3,066 | |||||||||||||||
Administrative expenses | (2,741 | ) | (3,050 | ) | (2,777 | ) | 309 | (273 | ) | ||||||||||||||
Credit-related income (expense): | |||||||||||||||||||||||
Benefit for credit losses | 2,155 | 795 | 3,964 | 1,360 | (3,169 | ) | |||||||||||||||||
Foreclosed property expense | (644 | ) | (1,629 | ) | (142 | ) | 985 | (1,487 | ) | ||||||||||||||
Total credit-related income (expense) | 1,511 | (834 | ) | 3,822 | 2,345 | (4,656 | ) | ||||||||||||||||
TCCA fees | (1,845 | ) | (1,621 | ) | (1,375 | ) | (224 | ) | (246 | ) | |||||||||||||
Other expenses, net | (1,028 | ) | (613 | ) | (478 | ) | (415 | ) | (135 | ) | |||||||||||||
Income before federal income taxes | 18,333 | 16,208 | 21,150 | 2,125 | (4,942 | ) | |||||||||||||||||
Provision for federal income taxes | (6,020 | ) | (5,253 | ) | (6,941 | ) | (767 | ) | 1,688 | ||||||||||||||
Net income | 12,313 | 10,955 | 14,209 | 1,358 | (3,254 | ) | |||||||||||||||||
Less: Net income attributable to noncontrolling interest | — | (1 | ) | (1 | ) | 1 | — | ||||||||||||||||
Net income attributable to Fannie Mae | $ | 12,313 | $ | 10,954 | $ | 14,208 | $ | 1,359 | $ | (3,254 | ) | ||||||||||||
Total comprehensive income attributable to Fannie Mae | $ | 11,665 | $ | 10,628 | $ | 14,738 | $ | 1,037 | $ | (4,110 | ) | ||||||||||||
Net Interest Income
We have two primary sources of net interest income: (1) the guaranty fees we receive for managing the credit risk on loans underlying Fannie Mae MBS held by third parties; and (2) the difference between interest income earned on the assets in our retained mortgage portfolio and the interest expense associated with the debt that funds those assets.
Guaranty fees consist of two primary components: (1) base guaranty fees that we receive over the life of the loan; and (2) upfront fees that we receive at the time of loan acquisition primarily related to single-family loan level pricing adjustments and other fees we receive from lenders, which are amortized over the contractual life of the loan. We recognize almost all of our guaranty fee revenue in net interest income due to the consolidation of the substantial majority of loans underlying our Fannie Mae MBS in consolidated trusts on our balance sheet. Those guaranty fees are the primary component of the difference between the interest income on loans in consolidated trusts and the interest expense on the debt of consolidated trusts.
Table 3 displays an analysis of our net interest income, average balances, and related yields earned on assets and incurred on liabilities for the periods indicated. For most components of the average balances, we use a daily weighted average of amortized cost. When daily average balance information is not available, such as for mortgage loans, we use monthly averages. Table 4 displays the change in our net interest income between periods and the extent to which that variance is attributable to: (1) changes in the volume of our interest-earning assets and interest-bearing liabilities or (2) changes in the interest rates of these assets and liabilities.
Fannie Mae 2016 Form 10-K | 60 | |
MD&A | Consolidated Results of Operations | ||
Table 3: Analysis of Net Interest Income and Yield | ||||||||||||||||||||||||||||||||
For the Year Ended December 31, | ||||||||||||||||||||||||||||||||
2016 | 2015 | 2014 | ||||||||||||||||||||||||||||||
Average Balance | Interest Income/ Expense | Average Rates Earned/Paid | Average Balance | Interest Income/ Expense | Average Rates Earned/Paid | Average Balance | Interest Income/ Expense | Average Rates Earned/Paid | ||||||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||||||||||
Mortgage loans of Fannie Mae | $ | 228,786 | $ | 9,376 | 4.10 | % | $ | 257,870 | $ | 9,728 | 3.77 | % | $ | 286,042 | $ | 10,285 | 3.60 | % | ||||||||||||||
Mortgage loans of consolidated trusts | 2,838,453 | 95,266 | 3.36 | 2,794,050 | 97,971 | 3.51 | 2,769,418 | 101,835 | 3.68 | |||||||||||||||||||||||
Total mortgage loans(1) | 3,067,239 | 104,642 | 3.41 | 3,051,920 | 107,699 | 3.53 | 3,055,460 | 112,120 | 3.67 | |||||||||||||||||||||||
Mortgage-related securities | 69,561 | 2,743 | 3.94 | 109,749 | 4,880 | 4.45 | 143,934 | 6,713 | 4.66 | |||||||||||||||||||||||
Elimination of Fannie Mae MBS held in retained mortgage portfolio | (48,131 | ) | (1,868 | ) | ||||||||||||||||||||||||||||