Barclays is out with a new note regarding the Senate banking committee proposal to wind-down Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC), below is an excerpt from the report.
Following our note this morning, the Senate Banking Committee announced that it has reached a deal in principle on Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) GSE reform. Our conversations with investors lead us to believe there continues to be significant skepticism about GSE reform (see figure below from Barclays Housing Symposium on 2/26/2014), but we now believe this is an issue that investors should be following closely. Over the coming days and weeks, we expect additional details on the bill to emerge, but at first blush, it appears that much of what we anticipated has came to fruition in this release. In line with our view, the principles of the bill are heavily based on Corker-Warner, seek to wind down Fannie and Freddie, and require 10% private capital up front to protect U.S. taxpayers. Overall, we see this issue as a potential negative for the housing stocks due to the likelihood that there will be upward pressure on rates if the bill gains momentum.
What do you think is the likelihood of GSE reform occurring in the next two years?
Source: Barclays Housing Symposium poll February 26, 2014; ARS Data Systems
Following this morning’s release, we offer the following takeaways:
· Heavily based on Corker-Warner: As expected, the principles of the bill are modeled after the Corker-Warner bill and provide a plan for the wind-down and elimination of Fannie Mae and Freddie and provide a smooth and stable transition from the old system to the new system.
· “Wind-down” and “eliminate” Fannie Mae and Freddie Mac: The ultimate goal of the principles introduced today is to wind down and eliminate Fannie Mae and Freddie in order to bring private capital back into the market. We note that Corker-Warner outlines a timeframe of five years and we believe investors need to realize that this is the aspect of Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) reform that is the least controversial.
· Private capital will be required: One of the overarching principles of the release is ensuring that U.S. tax payers won’t be put on the hook for bailing out Fannie Mae and Freddie again. As such, the bill mandates 10% private capital, up front, and will create a mortgage insurance fund for the system to protect taxpayers against future bailouts. We believe this has been the most controversial aspect of Corker-Warner, as many believe the 10% figure is too high, citing the private market’s inability to actually raise that much capital. We expect the subject of how much private capital is needed as a backstop to remain a point of extensive debate, even once a bill is revealed.
· Slightly more conservative underwriting standards: The bill requires that loans backed by the government need to meet the “qualified mortgage (QM)” definition as well as have a 5% down payment (3.5% for first-time home buyers).
· The left presents the next hurdle: As we indicated, we believe the bill will likely need the support of 15+ members of the Committee, have no strong opposition from Republican members of the committee, and support from the Administration, industry and consumer groups in order to garner sufficient momentum to receive a full Senate vote in 2014. At this point, the early read is encouraging but much still hinges on the exact language which will be unveiled in the coming week.
· Time is of the essence: As attention turns to campaigning ahead of the mid-term elections in November, which will ultimately divert the focus away from bipartisan legislation, we believe that a vote by the Senate Banking Committee in the next two to three weeks is paramount for momentum to continue on the Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) reform front in 2014. Given the Obama administration’s public support for GSE reform, strong support from the Senate Banking Committee as well as a favorable Senate floor vote in the coming weeks will greatly increase the likelihood of a GSE reform bill being enacted in 2015.