It seems clear that the coronavirus pandemic triggered a recession, and now there are questions about whether Fannie Mae and Freddie Mac will still be able to exit conservatorship any time soon. Nomura analysts believe Fannie Mae and Freddie Mac are ready for a recession and see “speed bumps” rather than detours on the road to exiting conservatorship.
Maintain Buy on Fannie Mae, Freddie Mac amid recession
In a recent note, Nomura analyst Matthew Howlett reiterated his Buy ratings on Fannie and Freddie. Although it's still early in the economic downturn and there are still many unknowns, he believes Fannie Mae and Freddie Mac are well positioned for a recession. He also expects them to emerge stronger on the other side.
He explained that the COVID-19 crisis has placed more urgency on policymakers to raise private capital in front of taxpayers. Thus, he sees Republicans and Democrats as more united on the future role of the GSEs because of the disruption in the mortgage market and the increasing need for them to step up during the crisis. He believes the crisis will unite the various parties involved, including the Treasury Department and litigating shareholders, toward a settlement.
He maintained his price target of $5 on Fannie Mae and $4.50 on Freddie Mac.
Fannie Mae and Freddie Mac are ready for recession
Odeon Capital analyst Dick Bove has said he doesn't see the GSEs exiting conservatorship for at least three to five years because of the economic downturn. However, Howlett said Fannie Mae and Freddie Mac are ready for a recession.
He noted that policymakers were motivated to prevent a repeat of what happened to the GSEs in the global financial crisis. As a result, Fannie and Freddie tightened their underwriting standards and shed a significant amount of credit risk to the private markets.
He said the GSEs are now greatly de-risked and in much better shape than they were in between 2007 and 2008. He added that more than half of Fannie's and Freddie's books benefit from some form of credit enhancement. This is the main reason why his forward loss provision forecasts are contained. His model also suggests that Fannie Mae and Freddie Mac won't need to draw upon their preferred stock purchase agreement.
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He expects the Federal Reserve and the Treasury to establish a liquidity facility to aid the GSEs with advances in response to the recent policy change that allows third-party mortgage servicers to pay only four months on loans that are in forbearance. Howlett doesn't believe Federal Housing Finance Agency Director Mark Calabria would have intervened unless he had been assured that the policy changes would not disrupt the capital planning process for Fannie and Freddie.
Updates to recapitalize and release timeline
The reposed capital rule is expected from the FHFA by late May, although everything is in flux right now due to the COVID-19 pandemic and social distancing measures. Howlett expects the new capital rule to be finalized by early fall. There is no official timeline from the FHFA on recapitalization and release from conservatorship for the GSEs. However, he said if Joe Biden wins the presential election, Calabria's and Treasury Secretary Steven Mnuchin's terms are in jeopardy. It's widely expected that if he wins the White House, his administration would stop the privatization process and maintain the Fannie and Freddie conservatorships.
Howlett believes Calabria is still willing and able to utilize a consent decree allowing the GSEs to exit conservatorship sometime between the November elections and the inauguration in late January. He believes that this action would coincide with the settlement of the lawsuits involving the GSEs and approval of a confidential capital restoration plan.
"This move would effectively put the GSEs on an unstoppable track to raise capital and fully exit FHFA's capital restraint (by YE 2023 based on our model)," Howlett wrote.
Revisions to expected credit loses
Even after the revised current expected credit losses model due to the recent policy changes, his model still suggests Fannie will be above its statutory minimum capital level of $22 billion by the fourth quarter. His revised model puts Freddie at its statutory minimum capital level of $19 billion by the first quarter of 2021.
He expects the GSEs to elect the five-year transition option to delay any capital effect until 2022. Thus, he revised his capital model to avoid the day one impact of current expected credit losses. The impact will then have to be phased out into regulatory capital in quarterly amounts through 2025. His model suggests the GSEs should be able to make up for capital depletion in subsequent periods through their strong earnings outlook.
"It's conceivable that Fannie/Freddie's projected 2021 capital raise is delayed by one or two quarters to make up this shortfall," Howlett explained. "It is also possible that deal sizes are larger, but we are still maintaining our projection for a $60bn raise which includes common, convertible preferred and straight preferred equity."