The provision for credit losses would be the largest contributing factor to losses at Fannie Mae and Freddie Mac under severely adverse economic conditions. This was revealed in the results of a stress test conducted by The Federal Housing Finance Agency (FHFA) under the Dodd-Frank Act.
According to the FHFA report, apart from provisions for credit losses, the global market shock impact on trading securities and available-for-sale securities would be the largest contributing factor for losses at the two government-sponsored enterprises (GSEs) under FHFA’s conservatorship.
The stress test results also revealed that comprehensive losses decreased in the stress test for 2019 compared to the one conducted in 2018. The decline, according to the FHFA, was “mostly driven by the decrease in provision for credit losses as a result of the less severe decline in home prices” included in the 2019 scenario and “the improvement in the credit profile of the GSEs’ books of business.”
The 2o19 stress test scenario was based on a severe global recession accompanied by stressed commercial real estate and corporate debt markets. FHFA said that the scenario was not a forecast, but a hypothetical future economic environment that was designed to “assess the strength of the Enterprises and other financial institutions and their resilience to unfavorable market conditions.” Additionally, the report said that the planning horizon for the implementation of the 2019 stress test was over a period of nine quarters from December 31, 2018, to March 31, 2021.
Additionally, compared to last year’s stress test scenario, the 2019 severely adverse scenario includes a more severe recession and a larger increase in the unemployment rate. This year’s severely adverse scenario, also includes a decline in the 10-year Treasury yield, a factor that had remained unchanged in the scenario last year resulting in a much steeper yield curve and reflecting a global aversion to long-term fixed-income assets. This results in declines in certain asset prices, including stocks, which are less severe in this cycle versus last year.