Stress Test Scenario Would Not Exhaust GSEs' Stockpiles

Fannie Mae and Freddie Mac have released results of their respective performances on the "Severely Adverse scenario" of the stress tests required under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Federal Housing Finance Agency (FHFA), conservator of the two GSEs, provided the key scenario assumptions for the 2016 annual stress test in March 2016 with a nine-quarter planning horizon running from the first quarter of 2016 through the first quarter of 2018.  The tests assumptions beginning with the GSEs' 12/31/2015 balance sheet information.

The test assesses capital adequacy through the sufficiency of the remaining funding commitment for each GSE under the Preferred Stock Purchase Agreement (PSPA) that was part of the conservancy.  Fannie Mae currently has $117.6 billion and Freddie Mac $140.5 billion remaining on their respective commitments.

As outlined by FHFA, the scenario is a severe recession in which unemployment peaks at 10% in the middle of 2017 and the GDP declines until the end of the first quarter of 2017 then grows to 3 percent over the next year.  There is also a national decline in home prices of 25 percent through the first quarter of 2018 with those areas that have seen brisk gains in recent years particularly affected.  There will be a peak decline of 30 percent in commercial real estate prices.

Short-term interest rates fall below zero in the third quarter of 2016 and remain negative; the 10-year T-bill drops 200 basis points immediately and stays below 2 percent as core inflation declines to almost zero in 2016.  Mortgage rates fall initially, then rise to over 4% after 2016.

Finally, the Severely Adverse scenario assumes a global market shock affecting asset prices and a counterparty default scenario.

The resulting performance of the GSEs depend to a great extent on the accounting treatment of the valuation allowance (VA) on the companies' deferred tax assets (DTA).   In the case of Fannie Mae, the company would require an additional $22.8 billion in funding from the U.S. Treasury to withstand the downturn without reestablishment of the VA.  This would leave an $94.8 billion remaining on its available draw under the PSPA.  If the VA was reestablished the requirement would be $73.0 billion with a residual of $44.5 billion.

For Freddie Mac, the Severely Adverse scenario without re-establishing a valuation allowance on the DTA) indicates $26 billion of additional draws, leaving $114 billion of remaining PSPA funding.  With the re-establishment of the VA that company would require $53 billion of additional draws, leaving $88 billion of remaining PSPA funding.