Fannie and Freddie Shareholders Benefit more than Homeowners

The White House unveiled the “Homeowner Affordability and Stability Plan”, or what I call the Fannie Mae (FNM) Freddie Mac (FRE) status quo plan, this morning. Lucky for me enough details were revealed this morning that I did not have to listen to our overexposed, overly staged President Obama lecturing me. My initial analysis is that this part of the Administration’s mortgage plan should benefit, or at least not inflict additional pain to current GSE shareholders.

Full details won’t be available until March 4, but let’s see what we know so far: The Treasury will now be able to purchase up to $200B in preferred stock each from Fannie and Freddie. This insures that the forces for fully killing GSE shareholders lost out to deficit funding reality. Also, there was no mention of curtailing Fannie and Freddie fee increases to as much as 3.5% on April 1. Together these show that the Administration wants to return the GSEs into viable independent entities.

President Obama has shown great strength in holding back the Congressional onslaught from the real estate and home builder lobbies to rein in Fannie and Freddie fees. This program is limited to refinancing loans either held in GSE portfolios or securitized by Fannie and Freddie. Again, there is no help to real estate brokers and home builders. The President is clearly not interested in generating home sale transactions.

The program is voluntary for lenders and borrowers still have to go through normal underwriting. The loan limit is 105% of the current appraised value, including any fees financed. So if you back out fees the realistic loan limit is closer to 100% of appraised value for the 105% LTV. Only primary mortgages for owner-occupied properties qualify; second lien holders would have to voluntarily subordinate. Help will be limited to borrowers whose payments exceed 31% of their monthly gross income.

What we don’t know: Whether the interest charged will be a market rate or a subsidized rate was not revealed. We also don’t know if PMI will still be required for LTV ratios above 80%. My guess is it will be market rates and PMI because strong GSEs are vital to the economy.

A quick examination shows that not many weak borrowers will qualify for this program or gain bank approval. Certainly second lien holders wouldn’t agree to subordinate unless borrowers were put in a better position to pay them. So what is the purpose of this program? I believe the underlying purpose is to free up strong homeowners to spend more at the mall or buy a new car with the savings on lower monthly mortgage payments. This could be stimulus number two.

President Obama has presented us with a very creative form of cash-out refinancing, without the stigma. The stimulus is further enhanced with the 5-year $1,000 per year monthly principal reductions just for paying on time. Trouble is most qualifying borrowers might not get enough of a payment reduction to justify the costs of refinancing. The real benefit would be to those refinancing from variable rate loans. But the extra security of their new 15 or 30-year fixed loan might come at the expense of a high rather than lower monthly payment.

The dynamics are interesting. Borrowers can’t be so strong that their payments are less than 31% or their gross income, but must be strong enough to pass underwriting and most likely not be carrying and a home equity loan. True of most government programs, a very thin needle must be thread.

The effects on Fannie and Freddie should be neutral to positive for shareholders. The GSEs will collect new fees with each refinancing. Borrowers will be better underwritten, reducing default risk. The downside is the possible reduction in portfolio interest income. Now is the time for the Treasury to lower the dividends on its GSE preferreds. The new motto should be “Let’s build a stronger Fannie-Freddie together.”

The details on the program for non-GSE mortgages were even sketchier. “Cram downs” were endorsed for loans not exceeding the GSE limits. Banks would not be required to write down principal. But participants must lower payments to 38% of gross income through a combination of rate reductions and term extensions. After which the government would buy down the interest rate to 31% of a qualifying borrower’s gross income. This appears to be modification, rather than a refinancing program. The FDIC will be selling insurance to banks modifying loans. Little details on who qualifies were provided.

Disclosure: Author is long FNM and FRE.

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