Amherst Securities Estimates Nearly Half A Trillion Cumulative Losses At Fannie And Freddie

Tyler Durden's picture

Laurie Goodman of Amherst Securities and formerly of UBS, has come out with a damning report, which estimates that the total losses at Fannie and Freddie could be as high as a mindblowing $448 billion. Keep in mind that so far the government has injected $112 billion into the nationalized entities. Yet if this estimate is correct, another $336 billion will have to be funneled from taxpayers. This money will have to come from new debt issuance and is certain to add to the multi trillion budget deficit. Also, putting the banker tax in perspective, the number is nearly three time greater than the $120 billion expected to be collected over a period of many years, and causing so little ruckus on Wall Street and so much posturing by the President.

Goodman notes:

We assume that all of the nonperforming and re-performing loans default, as do half of the performing loans with negative equity. Our rationale: once a borrower is 60+ days delinquent (our definition of non-performing), he has a very low cure rate—well under 10%. And the reperforming loans have been re-defaulting at an unbelievably high rate. So, for example, prime PLS re-performers have redefaulted at the rate of 10.9% per month over the past 3 months or 75% per annum. It is not unreasonable, as a first approximation, to assume that they eventually default. The hardest category to analyze are performing loans with negative equity. According to our  numbers in Exhibit 13, over the past 3 months, those loans have experienced a default transition rate of 18% per annum and a prepayment rate of 10% per annum. If these numbers remain constant over the life of the mortgages, it suggests 64% of the pool will default, 36% will prepay. (Intuitively, a mortgage will either prepay or default, a tiny percentage pay on schedule to maturity. The % expected to default is [defaults/(defaults + prepays)], which is 18/28 or 64% for this loan cohort.) We believe this puts an upper bound on defaults, as it assumes no housing recovery over the life of the mortgages.

The top section of Exhibit 14 shows our loss estimation calculations assuming 100% of the non-performer and re-performers will default, 75% of the performing borrowers with >120 LTV will default and 25% of the performing borrowers with 100-120 LTV will eventually default. (Since 50% of the performing loans with negative equity have an LTV of 100-120 and the other 50% are >120 LTV, our assumption is the equivalent of a 50% default on the basket of performing loans with negative equity.) We further assume a 50% severity on defaulting loans, in line with the experience of PLS prime loans, corrected for loan size. Thus, we estimate losses of 9.59% on the GSE guarantee business. Interestingly, these numbers were very close to an OFHEO estimate that 9.4% losses were experienced over a 10-year period on the 1983 and 1984 loans made in the oil states (Arkansas, Louisiana, Mississippi, and Oklahoma) during the oil bust in the 1980s. (Texas was excluded, as its economy was more diverse. Houston was hit hard, Dallas was not.) This 9.4% overall loss rate reflects a 11.3% default rate with 61% severity on Freddie, an 18.5% default rate at 66% severity on Fannie.


Putting these estimates to actual numbers yields the following:

The Fannie guarantee business is currently $2.81 trillion, suggesting losses of $270 billion. The Freddie guaranty business is currently $1.86 trillion, suggesting losses of $178 billion. Thus, losses should total $448 billion. Note that we have used the same default rate and severity for Fannie and Freddie. In reality, the Fannie guarantee business has a higher percentage of risk layered loans than the guarantee business at Freddie. Consequently, these loss estimates are probably proportionately too low for Fannie, too high for Freddie. These gross losses will be distributed across four categories – write downs already taken by Fannie and Freddie and reflected in their loan loss provisions, future credit losses to be taken by Fannie and Freddie, losses absorbed by mortgage insurers, and losses absorbed by originators through put backs. Fannie’s loan loss reserves total $66 billion, $57 billion for MBS guaranty losses, $9 billion for loan losses. Freddie’s loan loss reserves total $30 billion, $29 billion for PC guaranty losses, $1 billion for loan losses. The remaining $352 million of losses will show up across the other three categories (Fannie and Freddie future losses, mortgage insurers, and originator put backs) over time.

Obviously these numbers are very assumption dependent, as illustrated in the bottom section of Exhibit 14. If we lower the probability of default to 15% for the performing loans with an LTV of 100-120, and 65% on performing loans with an LTV of >120, the blended default rate on negative equity borrowers is 40% [15%*(0.5) + 65%*(0.5)] and aggregate losses drop to 7.7% or $358 billion.

If Laurie is correct, not only will numerous additional episodes of housing-focused Quantitative Easing be needed, but such a deterioration, once it is acknowledged by the auditors who obviously have no interest in indicating how bad the situation is, would have significant political repercussions which would reverberate from the FHA all the way to the White House. Another implication is that the shadow inventory is likely to continue remaining unsold so as not to blow the bottom out of the supply side in the market, likely confirming that banks will continue to pretend the vast majority of real estate assets on their balance sheets are unimpaired when in actuality they deserve a haircut of 20%,30% or more.

Full Laurie Goodman report.

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Hansel's picture

How many processor cycles does it take to create $.5 T these days?

Commander Cody's picture

The banksters will pay their taxes on the backs of the sheeple.  Move on.  We will also fund the meltdown in real estate.  Move on.  Everybody but the taxpayer (banksters excluded) is made whole.  What a country!

Anonymous's picture

But $5T in their portfolios accrue $300B per year in interest... so losses only come out of interest spread.

I think her loss estimates are high, but with $300B/yr in annual interest on the portfolios... these crisis losses are quite managable.

That's why you pay 10-20% interest on credit cards. If there were NO LOSSES we would all pay us treasury interest rates. Duh!

ghostfaceinvestah's picture

Those portfolios are funded partially with debt, which, even though Bernanke is buying that as well as their MBS, their funding spreads are not healthy, so they actually aren't making that much on their MBS portfolios.

Anonymous's picture

Totally fair point... the interest spread is only 1-3%, so we can call it 2% and thats $100B per year.

Plus they each had about $40B in equity/pref and another $40B in accured loss reserves... so thats $160B in equity.

So... in another year or 2, this will be zero. In fact, if the Govt just took them over and funded the portfolios with T-bills... accurals would = losses in <1 year. Since the spread is ~6%.

But I digress. More importantly, if you think about these losses in terms of 20-yrs timeframe. Its about 50bps/yr on the portfolio. Now unfortunately this was not accrued for, but its not such big deal going forward.

I mean the US homeowner pays something like $750B/year in mortgage interest. Some $500B in losses every 20 years are actually pretty trivial. $1.5T in losses would represent 2yrs in 20 or 10% of interest as losses (60 bps on a 6% mortgage).

You have to put #s in perspective.

ghostfaceinvestah's picture

I agree, you have to put the numbers in perspective, consider too that the GSEs are now charging a lot more in gfees to partially cover the losses from previous years.  The GSEs will end up losing a lot of money, and their equity is worthless, but the drain on the taxpayer won't be nearly as much as the headline numbers.

As I say below, I think the bigger issue is the GSEs reliance on the MI sector.  They are still accepting loans with MI, even though the MIs are rated in the B+ range, and under the scenario Amherst has laid out, they would get wiped out.  As it is, one of the MIs is already in runoff and paying claims at 60 cents on the dollar, which is costing you and me, the taxpayer.

Meanwhile, the originators get to originate loans and carry zero credit risk.  This is the same sort of practice that got us into this mess.  You can cut guidelines all you want, nothing guarantees performance better than skin in the game.

A much better policy for the government would be to force originators/sellers to participate in the mortgages they originate.  Believe it or not, this provision already exists in the GSE charters, where, in lieu of mortgage insurance, originators can opt to retain 10% participation on loans they sell with LTVs over 80.

If we simply struck the mortgage insurance option from the GSE charters, we would have a much healthier mortgage finance system in this country.

Anonymous's picture

You cannot just focus on MI losses, you have to focus on what they are getting paid to insure stuff.

So, as long as MI rates are now more than enough to cover forward losses (considering this point in the cycle, they prob are) then it is good to write more MI, high LTV business.

Ironically... now, and 1-yr ago the key was just writing ALOT of high LTV business because prices were so low that all that stuff will pay off. If someone still has a job today and is will to put even 5% down on a house in winter 2009/10... foreclosure rate will prob be v v low.

Ironically... you dont want leverage when everything looks good and when everything looks really bad... it would be better (both individually and collectively) if everyone levered up.

Markets, they are ironic like that.

ghostfaceinvestah's picture

Well, that is where you and I will disagree, I think the business the MIs are writing today will be breakeven at best. Insuring loans at 95LTV, when unemployment is at 10% where it will probably stay for a while, and where house prices are expected to decline further, is not going to turn out well.  Full documentation and high FICOs won't help in that scenario.

But that is neither here nor there, the bigger issue for me is that lenders can still securitize 90% of what they originate and retain no credit risk.  That is "lending" in name only.

rawsienna's picture

the 5T is the guarantee biz, not the portfolio. It earns about 30bp vs defaults of 10% with 50% severities..30 bp running vs 500bp of loss

ghostfaceinvestah's picture

good point, i missed the poster's slip up on that.  the bigger issue is the portfolio will earn something on the interest rate spread (assuming they hedge their duration risk properly).

Where did the 30bps number come from?  Not that I am doubting you,I am just not sure of the numbers, most of the fees are upfront - they still charge an "adverse market fee" of 25bps up front, plus all the delivery fees, plus the 10bps per year gfee, equals out to about 30bps per year?  could be.

If it does add up to 30bps per year, average loan life of say 5 years, that is 150bps of income.  500bps of loss * 5T = 250b sounds about right (though I think the default rate is higher, severity is lower, more in line with Amherst after credit enhancement), offset by 7.5B of fee income, plus whatever the portfolio can earn, a good ballpark figure, i.e. the taxpayer will get something back, the common is worthless.

Anonymous's picture

I think Paulson conspired to destroy the corrupt Fannie and Freddie. Why else would the gov first encourage banks to own the preferreds then let the preferred go broke, only to provide tarp funds instead.

bugs_'s picture

I am finding the half trillion figure hard to accept.

In the late 80's the Savings & Loan crisis precipitated
a 500B(.5T) loss to the taxpayers.  That was in 1989
dollars folks!  I can only express myself in chumba
terms - there is no freaking way its a half a freaking
trillion loss in 2010 freaking dollars.


Anonymous's picture

I believe Kyle Bass said the same thing yesterday.

Anonymous's picture

Hey theat CRA-77 thing worked as planned

Anonymous's picture

It will eventually wind up being 3 trillion - in Ameros.

pbmatthews's picture

Meanwhile, Freddie and Fannie continue to underwrite more and more mortgages that will likely default as well.  (If I recall they now collectively write over 50% of all the new sub-prime mortgages in the US.)

My point, Ms. Goodman's work states what she believes the loss will be if nothing else changes.

Yet the pile of potentially bad mortgages created by Freddie and Fannie gets larger day by day.

Flounder's picture

Exactly.  The government managers are trying to keep all the fans turned off around this mess so that nothing hits them.

"Fannie and Freddie consistently mislabeled the bonds they bundled together, lying to investors about the number of subprime mortgages that were being included. Of the 26 million subprime and Alt-A loans outstanding in 2008, Fannie and Freddie held or guaranteed 10 million, and other government agencies had another 5.2 million. Combined, that is almost 60 percent of the total. Another 7.7 million of those mortgage-backed securities were issued by banks, but Fannie and Freddie mislabeled the mortgages they passed on to the banks. Very risky mortgages were mischaracterized as AAA-rated ones."

ghostfaceinvestah's picture

It is worse than you think.

Note Laurie's point that these losses will be distributed across four areas, one of which is the mortgage insurers.

Truth is, the MIs will absorb most of the loss.  At least up to the extent they can pay their claims.

What they can't pay will come back to the GSEs.  And there will be a lot they can't pay, they are basically insolvent under her loss assumptions (yet amazingly they assume 65% of their currently delinquent loans will cure, versus Laurie's 10% assumption).

Instead of cutting the MIs off and cutting their losses, the GSEs are allowing them to roll the dice by continuing to write new business, and even expanding their guidelines, in an attempt to "grow their way out of their problems".  Pardon me, but insuring loans with a 95LTV in the face of 10% unemployment and further house price declines is not going to work.

In the end the taxpayers will pay for this nonsense, of course.

ghostfaceinvestah's picture

One point though, as bad as the stuff Fannie and Freddie still allow via the mortgage insurers, the junk guaranteed by the FHA is far, far worse, much of it is basically subprime.

deadhead's picture

ghost...i always appreciate your insights into this area and thank you for sharing your experiences in this sector.

MarkD's picture

I was checking county deeds yesterday and came across a mortgage on a single fam home on 1.7 acres in my town that just sold for $200k and was financed 100% by the US Department of Agriculture.

I asked my niece who is a realtor if she ever came across this and this is what she said.....

Yup..New loan came out mid 09…thru HUD…it is called “rural housing”  100% financing...Department of Agri…I have had one person use this loan…not as picky as FHA, and you don’t need to put down the 3.5%...but you have to be out of city…There are 40  year fixed loans too.


These folks owned a mobile home back in 02 in a nearby town and they also had tax liens on the property. And they get a mortgage with zero money down? Unreal.


Thanks for all the info GFI......always worth the read.

Anonymous's picture

But house prices are really continuing to decline... especially in the worst areas and the worst foreclosure auctions.

Two of my friends went down to Miami last year to flip foreclosures. The made great money the first 6 months bc they could buy nice, grade 8-9 condos, at $100/sq ft at court auction. Now those prices... when you can find a good court auction are $300/sq ft. And the court auctions are far fewer.

These condos are still down from peaks of $500-800/sq ft. But it is nothing like 1-yr ago.

You see the same thing in the senior tranches of the Alt-A mortgage credit bonds... up about 100% over crisis values. In fact, both comm and resi mortgage credit bonds had a great Nov, Dec price move.

rawsienna's picture

it is the FHA that you need to worry about. They have doubled their volume and are underwriting most of the 90+ ltv loans.  GSE doing very little in that area.  GNMA was 10% of market now 40%. As Laurie points out, the biggest risk to default is when current ltv go over 110%.  Most FHA loans start out with 95+ LTV noot even including the tax credit or seller financed downpayments.  I said it before and I will say it again. THe idiots in Washington still have not learned the lesson - If a borrower has little or no skin in the game, you should not lend them money.  

ghostfaceinvestah's picture

Don't worry, Fannie/Freddie and their MI friends are looking to take some of that action.

"Some mortgage insurers and lenders are beginning to relax their down-payment requirements, in a sign of increased confidence in the housing market.

The changes, which are being done on a market-by-market basis, mean buyers in some parts of the country can now borrow 95% instead of 90% of a property's value."

crosey's picture

Updated version of the ditty:  "Sold my soul to the government store."

Anonymous's picture

thank you barney frank....

Anonymous's picture

It simply does not matter. Everything everywhere is "better than expected" and always will be from now on. We are going up tomorrow, and next week, and next month, and next year. Nothing will actually get better, but good times will perpetually be just around the corner, and the all-seeing market will anticipate and discount the coming party. It can't get any better than this (which is the only rational statement in this comment).

john_connor's picture

It doesn't matter anymore, although this will turn into a Trillion dollar fiasco.  The whole thing is just a back door way of shifting bankster losses to the taxpayer without calling it "TARP".  These are sad days indeed.


Anonymouse's picture

So if bonuses are proportionate to losses, Mr. Williams should be expecting$18MM this year!

Anonymous's picture

Winning the trial, losing your house

Like some others, Bartels complains that the way the Making Home Affordable program is set up, with the government “compensating” lenders for up to 95% of their losses on foreclosed homes, makes it more profitable in many cases for lenders to foreclose as opposed to modify. And that, he believes, accounts for a large percentage of people being turned down when they ask to have their mortgages reworked.

Anonymous's picture

Happy New Year -- But Not to You, Aurora Loan Services

Happy New Year. Wish me a happy anniversary, too. I'm celebrating the first anniversary of my effort to modify my mortgage through Aurora Loan Services.

You are going to see a lot of this post in the near future, because I'm going to cross-post it everywhere until I find someone who knows someone in Aurora Loan Services or its regulator. I've never wanted to bring a company down before, but I do now.

I wasn't quite angry enough until last week, when I read an article in the Times that made me realize I was not an isolated case, but an example of a widespread and apparently deliberate policy on the part of this particular servicer to deny homeowners programs the government has sought to extend, even though failing to extend these programs helps no one but Aurora itself.

Anonymous's picture

Obviously these numbers are very assumption dependent.....

And don't account for a substantive rise in interest rates due to failed treasury auctions OR $600 trillion in interest rates swaps that have NO collateral or capital behind them just like credit default swaps had NO collateral or capital behind them.

This article skirts the obvious question.

Why should ANYONE in America pay their mortgage , credit cards or auto loans OR buy U.S. Treasury IOU'S?

buzzsaw99's picture

Phoney and Fraudie are toxic waste dumps, their losses will be in the trillions but we will never know due to fraudulent accounting.

bugs_'s picture

Phoney and Fraudie!! LOL  and Barney!!

Anonymous's picture

BarackObama: The people need your help with loan modifications.

In other words, loan modifications are a SCAM!

Let's hear your story on loan modification.

Gordon_Gekko's picture

That's it? Ben shits that much in a day.

ghostfaceinvestah's picture

I think her estimates are pretty solid, I see loss rates around 10% for their current portfolios.

But note that, as I said above, not all these losses will fall on the GSEs.  As Laurie says in her note:

"These gross losses will be distributed across four categories – write downs already taken by Fannie and Freddie and reflected in their loan loss provisions, future credit losses to be taken by Fannie and Freddie, losses absorbed by mortgage insurers, and losses absorbed by originators through put backs."

Look at any of their monthly summary reports - most of their delinquencies are on "credit enhanced" loans - loans insured by mortgage insurers.  Those guys are gonna absorb much of the losses, until they finally run out of money, which they all will, and the losses come back to the GSEs.

Rainman's picture

you assume Ben won't buy up this insurance paper from troubled mortgage insurers. QE has no boundaries. 

Anonymous's picture

Predatory Lending is a major contributor to the economic turmoil we are currently experiencing.

Here is an example of what I am talking about:
Scott Veerkamp / Predatory Lending (Franklin Township School Board Member.)

Please review this information from U.S. Senator Jeff Merkley regarding deceptive lending practices:
"Steering payments were made to brokers who enticed unsuspecting homeowners into deceptive and expensive mortgages. These secret bonus payments, often called Yield Spread Premiums, turned home mortgages into a SCAM."

The Center for Responsible Lending says YSP "steals equity from struggling families."
1. Scott collected nearly $10,000 on two separate mortgages using YSP and junk fees. 2. This is an average of $5,000 per loan. 3. The median value of the properties was $135,000. 4. Clearly, this type of lending represents a major ripoff for consumers.

rawsienna's picture

Actually - Jaimie Dimon had it right. THe real enablers were Basel II (thank you RObert Rubin for your self serving pushing of that disaster) , the rating agencies and the originate to distribute model. Basel II allowed banks to leverage AAA rated structured bonds almost like treasuries - dramatically lowered capital requirements.  Demand was huge and the rating agencies obliged thru the structured products market . THese aaa cdo traded at L+25 and funded at l-50 levered 35-50x.  ALso, little Timmy G and Dr Greenspan were big supporters but teflon ROberst Rubin was key.  Without Basel 2, housing bubble would not have been as bad

Anonymous's picture

Pretty sure an "unsuspecting" homeowner reading a "deceptive" mortgage refers to someone who had no idea what they were doing because they did not read or understand the loan document they signed. In which case, they had NO business getting a mortgage at all. I know, the commission structure caused them to execute a bad mortgage.

But now they are a "victim" - most Americans favorite status. They bear absolutely no responsibility, but are unable to show where in the loan document they were "misled."

Anonymous's picture

Sigh. People still do not get it. The US imports 4.35+ billion barrels of oil a year. The price went from $35 at its March low to the present $80 a barrel.

This is 350ish billion a year draining away each year. How can this ever create a V?

deadhead's picture

Well, at least FHA Commissioner David Stevens is on record that FHA won't need any government bailouts. Phew, I was worried there for a bit........

You Cant Handle the Truth's picture

Half a trillion?  

Heck that's just the market cap of (AAPL + MSFT.)

Chump change these days.

Anonymous's picture

One way to attempt to overcome this difficulty is to combine a request for a HAMP mortgage modification with a chapter 13 bankruptcy filing.

TimmyM's picture

The GSEs including FHA are performing a backdoor bailout that dwarfs Tarp and all the Fed programs. As the few trillion outstanding in private label MBS and their derivatives get refied or modified with taxpayer subsidies and backstops, unrealized bank losses are transferred to the taxpayer. The toxic asset purchase plan would not work because markdowns destroyed bank capital. All the Tarp preferred crap to banks was mostly just for appearance sake. The counterparty rippoff was bad, but the real bailout is GSE subterfuge.

Anonymous's picture

I finance commercial real estate on behalf of a life insurance company. Fannie and Freddie own the apartment finance market by underpricing by 50bps-100bps the rest of the market. Our taxpayer dollars are being used to the tune of $20B/yr. to subsidize market rate privately held apartments that for the most part don't need the subsidy.

Anonymous's picture

I've come to the conclusion that the Bush Administration conspired to bring down the socialist Fannie and Freddie programs after being unsuccessful at ending Social Security with private accounts. The banks had incentives to own Fannie and Freddie paper before the collapse and Tarp payments were used to reimburse them for those losses, tho was not ehough to save hundreds of community banks. Your government cused the financial crisis, intentionally. Obama is firing back with socialist health care. The war rages....