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As required under the Dodd-Frank legislation, Fannie Mae conducted a stress test reflecting three hypothetical economic scenarios: a “base” scenario, an “adverse” scenario and a “severely adverse” scenario. The results of the severely adverse scenario were published recently by the Federal Housing Finance Agency (FHFA) and Fannie Mae.

The hypothetical severely adverse scenario was created by the Federal Housing Finance. The results of the test can be found here.

“The stress test is an exercise required by the Dodd-Frank legislation to test the adequacy of a financial institution’s capital structure under different hypothetical scenarios,” says Kelli Parsons, Fannie Mae Senior Vice President and Chief Communications Officer. “Under the senior preferred stock purchase agreement (SPSPA) as amended in August 2012, Fannie Mae’s ability to accumulate capital is severely restricted and the company is required to reduce its capital on a yearly basis.”

According to Parsons, the stress test also provides insight into whether Fannie Mae has sufficient funding commitment under the SPSPA to absorb losses resulting from extreme economic conditions, such as those described in the severely adverse scenario.

“As of December 31, 2013, the remaining funding commitment under the SPSPA was $117.1 billion,” says Parsons. “Based on the severely adverse scenario, in which a sudden shock creates a deep recession, Fannie Mae would require incremental Treasury draws of $34.4 billion.” If the company were required to make a one-time accounting adjustment relating to its deferred tax assets, that number would be $97.2 billion, depending on the accounting treatment of deferred tax assets. The remaining funding commitment under the SPSPA would be $83.1 billion without re-establishing a valuation allowance against deferred tax assets. If Fannie Mae re-established a valuation allowance against deferred tax assets, the remaining funding commitment would be $20.4 billion.”

According to Parsons, these results of the severely adverse scenario are not surprising given the company’s limited capital. “Under the terms of the senior preferred stock purchase agreement, Fannie Mae is not permitted to retain capital to withstand a sudden, unexpected economic shock of the magnitude required by the stress test.”

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