Saturday, March 18, 2017

Tim Howard on FNMA's TDR-related reserves

Troubled debt restructurings is an “in-the-weeds” subset of the DTAs that I decided not to get into in this post, because it’s very technical. But since you asked….(and here again, for simplicity’s sake I’ll use Fannie’s figures, but Freddie has a similar issue).
One of the main ways FHFA and Treasury were able to run up Fannie and Freddie’s losses so much in the 2008-2011 period was through making mammoth additions to their loss reserves. At December 31, 2007, Fannie Mae had a single category of loss reserves totaling $3.4 billion. Four years later, at December 31, 2011, Fannie had five categories of loss reserves totaling $93.2 billion. Of this nearly $90 billion increase (every dollar of which resulted in the need to draw an equal amount of non-repayable senior preferred stock from Treasury), $63.2 billion were from actions that that required Fannie to designate the affected loans as Troubled Debt Restructurings (or TDRs). These TDR-related loss reserves fell into two categories: reserves on loans purchased from mortgage-backed securities pools ($16.3 billion), and reserves for loans the company modified ($46.9 billion).
If a loan is designated as a TDR, a company is required to use a very conservative “life of loan” accounting treatment that locks up the loss reserve for the life of the loan even if the loan returns to performing status. In a case of a loan modification– which a company does in the hopes that the loan WILL return to paying status– it has to write off immediately not only its estimate of future losses but also the present value of foregone interest payments. If the loan becomes current again, the written-off amount will be brought back into income– either as foreclosed property income (if the write down was an estimated loss) or as net interest income (if it was foregone interest)– only as the loan amortizes (i.e., extremely slowly) or in a lump sum when the loan pays off.
FHFA used TDR accounting very aggressively for Fannie during the 2008-2011 period. For example, the use of TDR accounting for the loans bought out of MBS pools ($16.3 billion as of December 31, 2011) was discretionary; GAAP did not require it–Fannie, that is FHFA, chose to do it. And the $46.9 billion in reserves for “individually impaired” modified loans was ballooned in two ways. First, Fannie (and Freddie) HAD to modify all loans that met the standards for Treasury’s Home Affordable Mortgage Program (HAMP), whereas banks could choose whether to modify HAMP-eligible loans or not. Second, Fannie’s write-downs on modified loans were far larger than other institutions’–an average of 27.5 percent of the loan balance, nearly triple the average 10.5 percent write-down of the largest bank modifier of single-family mortgages (Bank of America, whose loans were of much lower quality than Fannie’s).
Even today, nine years after the crisis and five years after Fannie’s peak loss-reserve total, Fannie still has $28.5 billion in TDR-related loss reserves ($21.9 billion in individually impaired single-family loans, and $6.6 billion in fair value losses on loans bought out of MBS pools). The vast majority of these reserves are on loans that are now performing, but Fannie can’t get at the reserves until the loans amortize or pay off.
FHFA (and Treasury) did a REALLY good job figuring out how to lock up for a very long period of time a substantial amount of what otherwise would have been Fannie Mae’s capital. 
It’s possible there are ways for Fannie and Freddie to unlock some of their TDR-related reserves, but I don’t know what those ways are. Perhaps their accountants do.

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