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CECL may cause Fannie, Freddie to draw billions of dollars from Treasury in 2020

Some in Washington fear that an accounting change may blunt efforts to reform the U.S. housing finance system and cost taxpayers billions of dollars.

Government-sponsored enterprises Fannie Mae and Freddie Mac are required to comply with a new accounting approach that will overhaul how financial institutions record loan losses. If the GSEs do not adopt a phased-in approach, compliance with the new standard could lead to a draw from the Treasury.

The Current Expected Credit Loss standard, known as CECL, will force the entities to calculate the lifetime losses of their loans, available-for-sale debt securities and other amortized assets and recognize them at origination. This pull-forward of losses is largely expected to increase allowances and reserves across the industry.

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"When you have to come up with a huge amount of reserves here against the portfolio of the GSEs and their limited way of getting income, there's just no way for them to raise the kind of money needed to reserve," Rep. Blaine Luetkemeyer, R-Mo., said in an interview. "I think it's nuts."

Luetkemeyer is ranking member of the Subcommittee on Consumer Protection and Financial Institutions of the House Financial Services Committee and has been studying CECL since the Financial Accounting Standards Board finalized the accounting change in 2016. The GSEs may have to reserve anywhere from $50 billion to $100 billion to account for CECL, Luetkemeyer said, citing estimates from multiple industry sources in touch with his office.

Other estimates of how much the GSEs would have to reserve are more conservative.

Keefe Bruyette & Woods analyst Bose George estimated that the entities may need to reserve for cumulative losses of about $10 billion to $12 billion collectively, but pushed back against concerns that the reserving may be seen as a material weakness for the companies.

"I'm sure there will be people complaining about the issue," George said in an interview. "In the end, it's just a technical issue caused by a new accounting standard."

The GSEs also have the option of adopting a regulatory phase-in of the initial CECL adjustment over three years if Congress and their conservator, the Federal Housing Finance Agency, choose. Phasing in the capital hit means the entities could avoid drawing from the Treasury and use retained earnings to build the capital over time, according to an October 2018 Congressional Research Service white paper.

But how much capital the GSEs can hold has been a sticking point for the FHFA. The agency requires that any excess capital above $3 billion be returned to Treasury. Over the lifetime of the conservatorship, the size of this capital buffer fluctuated until December 2017, when FHFA flattened the level to $3 billion.

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Luetkemeyer sent FHFA Acting Director Joseph Otting a letter in February asking for detailed information about what CECL's impact on the GSEs will be. The congressman said the agency responded March 6 with confirmation that it received his request and that it would begin working on estimates.

Otting, who is also the Comptroller of the Currency, deflected any estimates to Fannie and Freddie and told reporters at a March 11 event that he is not concerned about any draw the GSEs may incur.

"The GSEs are highly profitable, [and] there are very few issues in their portfolios," Otting said. "And there's a bigger issue with the GSEs than just CECL."

Fannie and Freddie have not released their own estimates of how much they may have to reserve.

Fannie warned in a recent regulatory filing that the standard will "likely decrease, perhaps substantially," its capital and increase its allowance for credit losses. The moves could result in "a net worth deficit" when it adopts the standard in the first quarter of 2020. The deficit could be in the billions of dollars and necessitate a draw from Treasury, as is required when either of the GSEs report negative earnings figures steep enough to exhaust their capital buffer.

A spokesperson for Freddie Mac said in a statement that the company is still studying what the impact may be. "This accounting change could increase the risk that we will need to request a draw from Treasury in the period of adoption," the person said. The implementation date will be Jan. 1, 2020, according to both GSEs' annual filings.

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The reserving calculations are happening amid efforts by Congress and the White House to reform the housing finance system.

Sen. Mike Crapo, R-Idaho and chairman of the Senate Banking Committee, released an outline spelling out priorities for GSE reform that would release the enterprises from conservatorship and regulate them like other public companies.

At the White House, rumors have flown of a "road map" for GSE reform that Otting was purportedly pursuing that would unilaterally release Fannie and Freddie from conservatorship. Those rumors were tamped down by FHFA director nominee Mark Calabria during his confirmation hearing.

But CECL's impact on the GSEs has largely gone unnoticed on Capitol Hill, despite the interest from a few key lawmakers.

KBW's George said the likelihood of a Treasury draw for the GSEs could raise lawmakers' attention to the ongoing issue that the GSEs are not allowed to hold capital beyond the $3 billion threshold.

"From that standpoint, it puts a spotlight on the issue," George said. "It needs to be a little more imminent before people start to pay attention on this. It's probably not on many people's radar yet."

Jim Parrott, owner of housing finance consulting group Falling Creek Advisors, agreed that while CECL may not be pushing GSE reform, it might as 2020 gets closer.

"Interest in housing finance reform is affected dramatically by folks' perception of the status quo: The more comfortable with it they are the less open they are to the uncertainty that comes with any significant reform," Parrott wrote in an email. "Though that may well change as the date draws nearer and its impact sinks in."