Wednesday, February 27, 2008

Fannie Mae 10-K

by Tanta on 2/27/2008 01:31:00 PM

Some snippets from the Fannie Mae 10-K, if for some reason you didn't eagerly read the whole thing as soon as it hit the SEC website . . .

On losses:

We have experienced increased mortgage loan delinquencies and credit losses, which had a material adverse effect on our earnings, financial condition and capital position in 2007. Weak economic conditions in the Midwest and home price declines on a national basis, particularly in Florida, California, Nevada and Arizona, increased our single-family serious delinquency rate and contributed to higher default rates and loan loss severities in 2007. We are experiencing high serious delinquency rates and credit losses across our conventional single-family mortgage credit book of business, especially for loans to borrowers with low credit scores and loans with high loan-to-value (“LTV”) ratios. In addition, in 2007 we experienced particularly rapid increases in serious delinquency rates and credit losses in some higher risk loan categories, such as Alt-A loans, adjustable-rate loans, interest-only loans, negative amortization loans, loans made for the purchase of condominiums and loans with second liens. Many of these higher risk loans were originated in 2006 and the first half of 2007. . . .

We expect these trends to continue and that we will experience increased delinquencies and credit losses in 2008 as compared with 2007. The amount by which delinquencies and credit losses will increase in 2008 will depend on a variety of factors, including the extent of national and regional declines in home prices, interest rates and employment rates. In particular, we expect that the onset of a recession, either in the United States as a whole or in specific regions of the country, would significantly increase the level of our delinquencies and credit losses. Increases in our credit-related expenses would reduce our earnings and adversely affect our capital position and financial condition. . . .
On counterparty risk and the CFC-BoA merger:
The challenging mortgage and credit market conditions have adversely affected, and will likely continue to adversely affect, the liquidity and financial condition of a number of our institutional counterparties, particularly those whose businesses are concentrated in the mortgage industry. One or more of these institutions may default in its obligations to us for a number of reasons, such as changes in financial condition that affect their credit ratings, a reduction in liquidity, operational failures or insolvency. Several of our institutional counterparties have experienced ratings downgrades and liquidity constraints, including Countrywide Financial Corporation and its affiliates, which is our largest lender customer and mortgage servicer. These and other key institutional counterparties may become subject to serious liquidity problems that, either temporarily or permanently, negatively affect the viability of their business plans or reduce their access to funding sources. The financial difficulties that a number of our institutional counterparties are currently experiencing may negatively affect the ability of these counterparties to meet their obligations to us and the amount or quality of the products or services they provide to us. A default by a counterparty with significant obligations to us could result in significant financial losses to us and could materially adversely affect our ability to conduct our operations, which would adversely affect our earnings, liquidity, capital position and financial condition.

Our business with our lender customers, mortgage servicers, mortgage insurers, financial guarantors, custodial depository institutions and derivatives counterparties is heavily concentrated. For example, ten single-family mortgage servicers serviced 74% of our single-family mortgage credit book of business as of December 31, 2007. In addition, Countrywide Financial Corporation and its affiliates, our largest single-family mortgage servicer, serviced 23% of our single-family mortgage credit book of business as of December 31, 2007. Also, seven mortgage insurance companies provided over 99% of our total mortgage insurance coverage of $104.1 billion as of December 31, 2007, and our ten largest custodial depository institutions held 89% of our $32.5 billion in deposits for scheduled MBS payments in December 2007.

Moreover, many of our counterparties provide several types of services to us. For example, many of our lender customers or their affiliates also act as mortgage servicers, custodial depository institutions and document custodians for us. 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. . . .

Our ability to generate revenue from the purchase and securitization of mortgage loans depends on our ability to acquire a steady flow of mortgage loans from the originators of those loans. We acquire a significant portion of our mortgage loans from several large mortgage lenders. During 2007, our top five lender customers accounted for approximately 56% of our single-family business volume. Accordingly, maintaining our current business relationships and business volumes with our top lender customers is critical to our business. Some of our lender customers are experiencing, or may experience in the future, liquidity problems that would affect the volume of business they are able to generate. If any of our key lender customers significantly reduces the volume or quality of mortgage loans that the lender delivers to us or that we are willing to buy from them, we could lose significant business volume that we might be unable to replace, which could adversely affect our business and result in a decrease in our market share and earnings. In addition, a significant reduction in the volume of mortgage loans that we securitize could reduce the liquidity of Fannie Mae MBS, which in turn could have an adverse effect on their market value.

Our largest lender customer, Countrywide Financial Corporation and its affiliates, accounted for approximately 28% of our single-family business volume during 2007. In January 2008, Bank of America Corporation announced that it had reached an agreement to purchase Countrywide Financial Corporation. Together, Bank of America and Countrywide accounted for approximately 32% of our single-family business volume in 2007. We cannot predict at this time whether or when this merger will be completed and what effect the merger, if completed, will have on our relationship with Countrywide and Bank of America. Following the merger, we could lose significant business volume that we might be unable to replace, which could adversely affect our business and result in a decrease in our earnings and market share. . . .
On reserve calculations:
As the housing and mortgage markets deteriorated during 2007, we adjusted certain key assumptions used to calculate our loss reserves to reflect the rise in average loss severities, which more than doubled from 2006, and default rates. Prior to the fourth quarter of 2006, we derived loss severity factors using available historical loss data for the most recent two-year period. We derived our default rate factors based on loss curves developed from available historical loan performance data dating back to 1980. In the fourth quarter of 2006, we shortened our loss severity period assumption to reflect losses based on the previous year rather than a two-year period to reflect a trend of higher loss severities. Given the significant increase in loss severities during 2007 resulting from the decline in home prices, in the fourth quarter of 2007 we further reduced the loss severity period used in determining our loss reserves to reflect average loss severity based on the previous quarter. Additionally, for loans originated in 2006 and 2007, we transitioned to a one-year default curve and subsequently to a one-quarter default curve to reflect the increase in the incidence of early payment defaults on these loans. Statistically, the peak ages for mortgage loan defaults generally have been from two to six years after origination. However, our 2006 and 2007 loan vintages have exhibited a much earlier and higher incidence of default.
On the book of business:
Our conventional single-family mortgage credit book of business continues to consist mostly of traditional fixed-rate mortgage loans and loans secured by one-unit properties. Approximately 89% of our conventional single-family mortgage credit book of business consisted of fixed-rate loans, and approximately 96% consisted of loans secured by one-unit properties as of December 31, 2007. The weighted average credit score within our single-family mortgage credit book of business remained high at 721, and the estimated mark-to-market LTV ratio was 61% as of December 31, 2007.

Approximately 20% of our conventional single-family mortgage credit book of business had an estimated mark-to-market LTV ratio greater than 80% as of December 31, 2007. Of that 20% portion, over 62% of the loans were covered by credit enhancement. The remainder of these loans, which would have required credit enhancement at acquisition if the original LTV ratios had been above 80%, was not covered by credit enhancement as of December 31, 2007. While the LTV ratios of these loans were at or below 80% at the time of acquisition, they increased above 80% subsequent to acquisition due to declines in home prices over time. There was no metropolitan statistical area with more than 4% of these high LTV loans; the three largest metropolitan statistical area concentrations of these high LTV loans were in New York, Detroit and Washington, DC.

The most significant change in the risk characteristics of our conventional single-family business volume for 2007, relative to 2006 and 2005, was an increase in the percentage of fixed-rate mortgages acquired and a decrease in the percentage of adjustable rate mortgages acquired, driven in part by the shift in the primary mortgage market to a greater share of originations of fixed-rate loans. Fixed-rate mortgages represented 90% of our conventional single-family business volume in 2007, compared with 83% in 2006. Additionally, based on the higher risk nature of interest-only and negative amortizing ARMs, we significantly reduced our acquisition of these loans to less than 7% of our business volume in 2007, from 12% in each of 2006 and 2005. We anticipate relatively few negative amortizing ARM loan acquisitions in 2008.

The most significant change in the risk characteristics of our conventional single-family book of business as of the end of 2007, relative to the end of 2006, was an increase in the weighted average mark-to-market LTV to 61% as of December 31, 2007, from 55% as of the end of 2006. This increase was driven by a decline in home prices across the country, particularly in states such as California and Florida, which had previously experienced rapidly rising rates of home price appreciation and are now experiencing sharp declines in home prices.

In recent years there has been an increased percentage of borrowers obtaining second lien financing to purchase a home as a means of avoiding paying primary mortgage insurance. Although only 10% of our conventional single-family mortgage credit book of business had an original average LTV ratio greater than 90% as of December 31, 2007, we estimate that 15% of our conventional single-family mortgage credit book of business had an original combined average LTV ratio greater than 90%. The combined LTV ratio takes into account the combined amount of both the primary and second lien financing on the property. Second lien financing on a property increases the level of credit risk because it reduces the borrower’s equity in the property and may make it more difficult for a borrower to refinance. Our original combined average LTV ratio data is limited to second lien financing reported to us at the time of origination of the first mortgage loan. . . .

Alt-A mortgage loans, whether held in our portfolio or backing Fannie Mae MBS, represented approximately 16% of our single-family business volume in 2007, compared with approximately 22% and 16% in 2006 and 2005, respectively. During 2007, private-label securitization of Alt-A loans significantly decreased and Fannie Mae assumed a larger role in acquiring Alt-A mortgage loans; however, the actual amount of our acquisitions of Alt-A loans decreased in 2007 from 2006. In order to manage our credit risk in the shifting market environment, we lowered maximum allowable LTV ratios and increased minimum allowable credit scores for most Alt-A loan categories. We also limited our acquisition of some documentation types and made other types ineligible for delivery to us. Finally, we implemented pricing increases to reflect the higher credit risk posed by these mortgages. As a result of these eligibility restrictions and price increases, we believe that our volume of Alt-A mortgage loan acquisitions will decline in future periods.

We estimate that Alt-A mortgage loans held in our portfolio or Alt-A mortgage loans backing Fannie Mae MBS, excluding resecuritized private-label mortgage-related securities backed by Alt-A mortgage loans, represented approximately 12% of our total single-family mortgage credit book of business as of December 31, 2007, compared with approximately 11% and 8% as of December 31, 2006 and 2005, respectively. The majority of our Alt-A mortgage loans are fixed-rate, and the weighted average credit score of borrowers under our Alt-A mortgage loans is comparable to that of our overall single-family mortgage credit book of business. . . .

We estimate that subprime mortgage loans held in our portfolio or subprime mortgage loans backing Fannie Mae MBS, excluding resecuritized private-label mortgage-related securities backed by subprime mortgage loans, represented approximately 0.3% of our total single-family mortgage credit book of business as of December 31, 2007, compared with 0.2% and 0.1% as of December 31, 2006 and 2005, respectively. . . .

We have also invested in highly rated private-label mortgage-related securities that are backed by Alt-A or subprime mortgage loans. As of December 31, 2007, we held or guaranteed approximately $32.5 billion in private-label mortgage-related securities backed by Alt-A loans and approximately $41.4 billion in private-label mortgage-related securities backed by subprime loans. These amounts include resecuritized private-label mortgage-related securities backed by Alt-A and subprime mortgage loans.
On workouts:
Of the conventional single-family problem loans that are resolved through modification, long-term forbearance or repayment plans, our performance experience after 24 months following the inception of these types of plans, based on the period 2001 to 2005, has been that approximately 60% of these loans remain current or have been paid in full. Approximately 9% of these loans were terminated through foreclosure. The remaining loans continue in a delinquent status.