FHFA: GSEs Could Need Additional $125B under Worst-Case Scenario

Results of an annual stress test of Fannie Mae and Freddie Mac finances show good news and not-so-good news.

The Federal Housing Finance Agency yesterday said under a worst-case scenario, funds authorized by the Treasury Department to use in case of a bailout are adequate to cover losses by Fannie Mae and Freddie Mac. FHFA estimated that Fannie Mae and Freddie Mac would have between $130 billion and $209 billion available in bailout funds from Treasury following the worst-case scenario.

However, the results also noted that under a “severe economic downturn,” Fannie Mae and Freddie Mac could require anywhere from $49 billion to $126 billion in additional monies, depending on treatment of deferred tax assets.

Under the Dodd-Frank Act, certain financial institutions with more than $10 billion in assets to conduct annual stress tests to determine whether they can absorb losses as a result of adverse economic conditions.

The report, Dodd-Frank Act Stress Tests–Severely Adverse Scenario (http://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2016_DFAST_Severely-Adverse-Scenario.pdf), provides updated information on possible ranges of future financial results of Fannie Mae and Freddie Mac under severely adverse economic conditions.

As of December 31, 2015, Fannie Mae and Freddie Mac have drawn a combined $187.5 billion from the Department of the Treasury under the terms of the Senior Preferred Stock Purchase Agreements. The combined remaining funding commitment under the PSPAs as of December 31, 2015 was $258.1 billion.

The 2016 stress test, known as the DFAST Severely Adverse scenario, calls for gross domestic product to decline sharply, reaching a trough in first quarter 2017 with a decline of 6.25 percent from the pre-recession peak. Unemployment increases from the current 4.9 percent to 10 percent by third quarter 2017; inflation rises to 1.9 percent by third quarter 2017 from the current 0.25 percent.

These factors combine to bring short-term Treasury rates to -0.50 percent by the third quarter of this year, remaining at the level for more than a year. Ten-year Treasury rates drop to 0.25 percent before gradually increasing to 1.25 percent in first quarter 2018. Credit losses mount; spreads on domestic investment-grade bonds versus long-term Treasury securities increase to 5.75 percent by the end of 2016. In addition, equity prices fall by 50 percent from the start of the forecast horizon through the end of 2016 and equity market volatility increases substantially, approaching levels last seen in 2008. Home prices decline by 25 percent through third quarter 2018 and commercial real estate prices fall by 30 percent through mid-2018.

“As of December 31, 2015 the combined remaining funding commitment under the PSPAs was $258.1 billion,” the report said. “In the Severely Adverse scenario, incremental Treasury draws are projected to range between $49.2 billion and $125.8 billion depending on the treatment of deferred tax assets. The remaining funding commitment under the PSPAs after the projected draws is $208.9 billion without re-establishing valuation allowances on deferred tax assets. Assuming both Enterprises re-establish valuation allowances on deferred tax assets, the remaining funding commitment is $132.2 billion.”