GSEs expected to unload delinquent loans after Treasury change

Analysts expect Fannie Mae and Freddie Mac to begin unloading more distressed mortgages from their portfolios after the Treasury Department accelerated their wind down.

Both government-sponsored enterprises will now be required to cut their retained portfolios by 15% annually over the next several years until hitting $250 billion. Treasury increased this from a 10% annual reduction. Fannie holds $672 billion and Freddie has $581 billion in their portfolios as of June, according to their latest monthly summary reports.

"However, it should be noted that the GSEs are currently reducing their investment portfolio at least this much," said analyst Sarah Hu of RBS Securities.

Freddie is already below its target for 2012, but Fannie still has to trim $20 billion this year, according to JPMorgan Chase ($53.66 0.31%) analysts (click on the graph below to expand).

After natural runoffs from prepayments and other reductions, Fannie may have to cut roughly $30 billion more by other means in 2013, while Freddie could get to its next target without making more sales.

More than half of the GSE portfolios are made up of delinquent loans and other mortgages securitized into private-label bonds.

The GSEs could sell more of these loans into rental programs, or they could bundle up previously modified mortgages on their books. Fannie has already started urging attorneys to foreclose faster after all possible options are exhausted, which could clear out more nonperforming mortgages.

In the second quarter, Fannie reported half the credit losses it suffered from one year prior, part of the major reason it turned its first consecutive profit in five years.

"However," Barclays Capital analysts noted Friday, "the primary driver of profitability was net interest income from the portfolio; as this was slated to shrink 10% per annum, it could not be counted on as a sustainable source of revenues."

Which is where the second part of the Treasury action came in. It eliminated the required 10% dividend payment from Fannie and Freddie each quarter and instead will sweep any and all profits into its coffers going forward. This will speed up the pay back and relieve market fears about a GSE capital shortage.

The Treasury will cap the bailouts given to the GSEs after 2012. Fannie and Freddie often had to take the money just to make the dividend payment, which now, no longer exists. Moody's had warned the GSE ratings could be changed separately from the U.S. sovereign ratings if the Treasury failed to provide more clarity on its support of Fannie and Freddie after 2012.

"With the change in support, we see virtually no chance of the post-YE12 capital supports being exhausted over a multi-decade period. This is primarily because of the high quality of the post-conservatorship guarantee book, coupled with our view that provisioning for legacy credit losses is essentially complete (also in line with the Q2 results)," BarCap said. "In our view, this puts to rest any worries about GSE credit risk even in intermediate/longer maturities."

It does place more pressure on Congress to get moving on housing finance reform sooner rather than later. Mortgage industry trade groups used the Treasury action Friday to renew their call to do so gently.

The government finances more than 90% of the mortgage market.

"We support efforts to protect the taxpayers, but want to emphasize the importance of ensuring continued liquidity that will provide the affordable mortgage financing necessary to support the housing market. It is critical that the transition of Fannie Mae and Freddie Mac's role in financing real estate does not limit the availability, or increase the cost, of financing," said Mortgage Bankers Association David Stevens.

jprior@housingwire.com