Five Factors Driving the Future for Fannie Mae and Freddie Mac

Fannie Mae and Freddie Mac have a regulatory mandate to shrink. But that's easier said than done, given the government-sponsored enterprises' outsized presence in the mortgage industry, as their latest quarterly results show.

To be sure, Fannie and Freddie have gotten smaller. In 2008, the year the GSEs were put into federal conservatorship, the value of Fannie and Freddie's combined portfolio of mortgage assets was $1.6 trillion, according to the Federal Housing Finance Agency. By the end of 2014, that figure had been cut in half, to $800 billion, but that hasn't curbed the industry's reliance on the two mortgage giants.

"Over 50% of all mortgages are sold to Fannie and Freddie," noted Rick Roque, managing director of retail lending at Michigan Mutual, a national retail and wholesale lender based in Port Huron, Mich.

With that in mind, here are five takeaways from the GSEs' second-quarter financial results that mortgage executives believe could have implications for them.

Market Share Shift a Sign of Competition Heating Up

Fannie is still the largest issuer of single-family mortgage securities, but its dominance has slipped of late. Meanwhile, Freddie Mac has put extra emphasis behind growing its single-family book of business, and has taken market share away from Fannie.

Mortgage professionals say they have noticed Freddie Mac getting more aggressive for their business and the competition heating up.

"It looks like they're definitely competing with each other again," said Brian Koss, executive vice president at Mortgage Network. "It's not where we're seeing, 'Oh, they're getting all our business now,' but if one does get out ahead a little, the other one's right behind."

G-Fee Profits Keep Rolling In

The GSEs' recent earnings are strong, but they have been increasingly concentrated in guarantee-fee revenues. That's got some in the industry worried.

Fannie Mae's net interest income, including G-fees, rose to $5.7 billion in the second quarter from $5.1 billion in the first. More than 40% of Freddie's net interest income in the second quarter was derived from management and G-fees.

"That would be a concern, that the government gets addicted to this sort of return that the GSEs have been getting recently, and that the 'let's bump the G-fees so we can pass a highway bill,' [mentality] means the G-fees become this Trojan horse to tap into their revenue," Koss said.

Refis Dominate Recent Gains

The GSEs' recent profits have also been increasingly dependent on refinancing activity that could be transitory. Refis began representing the majority of new single-family funding gains for the GSEs this year, financial results show.

But in some ways that could be a glass half-empty view of the situation: the gains in refinancing after years of low rates show the segment can be more resilient than expected.

"The results reflect an extraordinarily strong first half for lenders, which demonstrates the impact a low interest rate environment can have on a market even when it appears that everyone has already refinanced their mortgage," Dave Worrall, president of RoundPoint Mortgage Servicing Corp., said after Freddie's earnings release.

Time to Open Up the Credit Box

But while refinancing activity has continued longer than many expected, neither mortgage executives nor the GSEs are planning on relying on it alone.

And when refis drop, one alternative is to expand credit. That's something the GSEs have been careful about, given their experience with overly aggressive lending during the downturn. But more recently, Fannie's and Freddie's regulator has been trying to loosen credit standards that have gotten too tight, notably by reviving past programs to offer lower-down payment loans.

The GSEs' earnings suggest they are running cleaner books of business today and taking on only modest amount of risk through such expanded-criteria loans. Fannie Mae's serious delinquency rate had dropped to 1.66% at the end of June. The GSE said it has dropped for 21 quarters since the first quarter of 2010, when it was 5.47%. Freddie Mac's serious delinquency rate was 1.53% as of June 30 and the lowest it has been since November 2008.

Expanding credit when the GSEs had more significant liabilities on their books would've been imprudent, but now it makes more sense — particularly given that homeownership rates have dropped and the loosening of standards still sounds like it has had only a marginal effect on lending.

"Underwriting guidelines are probably still a little stringent but I am encouraged that they are making some adjustments," said Anthony Kellum, president of Kellum Mortgage and Kellum Capital Group.

Risk Sharing Needed to Offset Shrinking Capital Reserves

While the GSEs' improved delinquency rates may make room to expand their lending criteria, regulatory mandates are shrinking Fannie and Freddie's capital buffer against risk and putting more emphasis on risk-sharing initiatives with the private sector.

"That's an ideological decision that some would argue is a good thing," said Roque.

Recent earnings show both GSEs' risk sharing activity is growing.

How effective such new risk management efforts are could ultimately help determine what direction broader GSE reform goes in from here. And given how many loans lenders are still selling to Fannie and Freddie even as those two GSEs shrink, mortgage executives will be watching it closely.