Fannie, Freddie both pass 2022 stress test despite misalignment on risk rating

Fannie Mae and Freddie Mac, the government-backed mortgage companies, would face a combined credit loss of more than $17 billion under this year's stress test scenario.

Despite the losses, both enterprises are sufficiently capitalized to withstand the financial shocks of a severe recession, according to the Federal Housing Finance Agency, which administers the annual test in accordance with Dodd-Frank requirements.

Fannie Mae performed better under the 2022 scenario than it did last year, registering a total credit loss of $10.8 billion, compared with $14.2 billion in 2021. Freddie Mac, on the other hand, was slightly more adversely impacted, with credit losses of $6.3 billion in the current testing cycle, compared with $5.8 billion last year.

Credit losses are defined as net charge-offs plus foreclosure expenses.

Without establishing a special reserve to offset deferred tax assets, both GSEs would emerge from the stress scenario generating comprehensive income. When factoring in the impact of establishing a valuation allowance — a capital reserve to offset potential losses — on deferred tax assets, Fannie Mae registered a net loss of $6.3 billion.

In response to this year's test results, the FHFA issued a bevy of guidance to both enterprises. It directed the groups to use aligned regional house price paths to project potential loan losses and set similar capital requirements. The agency also broadened its definition of counterparties that must be considered when assessing credit default risks to include mortgage insurers, unsecured overnight deposits, providers of multifamily credit enhancements, nonbank servicers and credit risk transfer reinsurance groups.

The biggest expenses for both government-sponsored enterprises were provisions for credit losses, which combined for $34.9 billion, and losses from disruption to global securities trading markets, including counterparty defaults, which would cost them a combined $7.1 billion under the scenario. 

The projected losses would be offset by portfolio growth and rising home values over the course of the period examined, which spanned the first quarter of 2022 to the first quarter of 2024.

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This year's scenario — which is not a projection of expected financial conditions but rather a fictional set of circumstances concocted to evaluate the enterprises' vulnerabilities — include a global recession that leads to a 3.5% decline in U.S. gross domestic product, a spike in unemployment from 4.2% to 10%, a 29% decline in home prices and a 55% decline in equity prices, among other adverse conditions.

The 2022 scenario included a steeper decline in unemployment and a greater decline in 10-year Treasury yields than the 2021 version. 

Fannie and Freddie have been under FHFA conservatorship since the housing market collapse of 2008. 

As part of the conservatorship agreement between the GSEs and the federal government, the Treasury Department holds the senior preferred stock of the two enterprises. Under the initial arrangement, both Fannie and Freddie could only hold up to $3 billion of capital reserves to absorb potential economic shocks. The remainder of their proceeds being paid to Treasury in the form of a dividend. 

In 2019, as part of then-director Mark Calabria's effort to bring the GSEs out of conservatorship, the FHFA brokered a deal allowing the enterprises to pause dividend payments until Fannie Mae and Freddie Mac reached net worths of $25 billion and $20 billion, respectively. 

In April, then-acting director Sandra Thompson said the FHFA was preparing the enterprises to stand on their own and noted that she did not expect the conservatorship to last as long as it has. Yet, since being confirmed and sworn into the position earlier this summer, she has not provided a timeline for the agency's winddown of the GSE conservatorship.