Minimum statutory capital requirement for fannie and freddie

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The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (Safety and Soundness Act), which created the Office of Federal Housing Enterprise Oversight (OFHEO), one of FHFA’s predecessor agencies, established leverage-like minimum and critical capital standards and a risk-based capital standard for Fannie Mae and Freddie Mac (the Enterprises) for use in determining their capital classifications.

Minimum Capital Standard

The Safety and Soundness Act defines the minimum capital requirement as the sum of:

1. 2.50 percent of the aggregate on-balance sheet assets of the enterprise, as determined in accordance with generally accepted accounting principles;
2. 0.45 percent of the unpaid principal balance of outstanding mortgage-backed securities and substantially equivalent instruments issued or guaranteed by the enterprise that are not included in paragraph (1.a); and
3. 0.45 percent of other off-balance sheet obligations of the enterprise not included in paragraph (1.b) (excluding commitments in excess of 50 percent of the average dollar amount of the commitments outstanding each quarter over the preceding 4 quarters), except that the Director shall adjust such percentage to reflect differences in the credit risk of such obligations in relation to the instruments included in paragraph (1.b).

The minimum capital requirement is met with Core Capital. The Safety and Soundness Act defines core capital as the sum of: i) the par or stated value of outstanding common stock; (ii) the par or stated value of outstanding, perpetual, noncumulative preferred stock; (iii) paid-in capital; and (iv) retained earnings.

Critical Capital Standard

The Safety and Soundness Act defines the critical capital requirement as the sum of:

1. 1.25 percent of the aggregate on-balance sheet assets of the enterprise, as determined in accordance with generally accepted accounting principles;
2. 0.25 percent of the unpaid principal balance of outstanding mortgage-backed securities and substantially equivalent instruments issued or guaranteed by the enterprise that are not included in paragraph (2.a); and
3. 0.25 percent of other off-balance sheet obligations of the enterprise not included in paragraph (2.b) (excluding commitments in excess of 50 percent of the average dollar amount of the commitments outstanding each quarter over the preceding 4 quarters), except that the Director shall adjust such percentage to reflect differences in the credit risk of such obligations in relation to the instruments included in paragraph (2.b).

The critical capital requirement is also met with Core Capital.

Risk Based Capital Standard

In addition, the Safety and Soundness Act required OFHEO to establish a risk-based capital stress test by regulation such that each Enterprise could survive a ten-year period with large credit losses and large movements in interest rates. The statute specified two interest rate scenarios, with falling and rising rates, and provided the interest rate paths for each scenario. The statute set parameters for a benchmark loss experience for default and loss severity but provided OFHEO discretion to determine other aspects of the capital test. The statute defined total capital as the measure used to meet the eventual risk-based capital requirements, where total capital is the sum of core capital and a general allowance for foreclosure losses, plus “any other amounts from sources of funds available to absorb losses incurred by the enterprise, that the Director by regulation determines are appropriate to include in determining total capital.” To implement this statutory language, OFHEO developed a risk-based capital simulation model and issued a series of Federal Register notices to solicit public comment. OFHEO issued its Final Rule on risk-based capital in 2001, which included consideration of the comments received.

Capital Classification Process

The Safety and Soundness Act (both in 1992 and today, as amended) requires the Enterprises to maintain the capital necessary to meet certain minimum and risk-based capital levels and requires the FHFA Director to periodically classify the Enterprises’ capital adequacy using the following [scheme]:

• Adequately capitalized – An enterprise shall be classified as adequately capitalized if the enterprise (1) maintains an amount of total capital that is equal to or exceeds the risk-based capital level established for the enterprise; and (2) maintains an amount of core capital that is equal to or exceeds the minimum capital level.
• Undercapitalized – An enterprise shall be classified as undercapitalized if the enterprise (1) does not maintain an amount of total capital that is equal to or exceeds the risk-based capital level established for the enterprise; and (2) maintains an amount of core capital that is equal to or exceeds the minimum capital level established for the enterprise; or
• Significantly undercapitalized – An enterprise shall be classified as significantly undercapitalized if the enterprise (1) does not maintain an amount of total capital that is equal to or exceeds the risk-based capital level established for the enterprise; (2) does not maintain an amount of core capital that is equal to or exceeds the minimum capital level established for the enterprise; and (3) maintains an amount of core capital that is equal to or exceeds the critical capital level established for the enterprise; or the enterprise is otherwise classified as significantly undercapitalized.
• Critically undercapitalized – An enterprise shall be classified as critically undercapitalized if the enterprise (1) does not maintain an amount of total capital that is equal to or exceeds the risk-based capital level established for the enterprise; and (2) does not maintain an amount of core capital that is equal to or exceeds the critical capital level for the enterprise; or is otherwise classified as critically undercapitalized.

If an Enterprise is classified as other than adequately capitalized, it triggers a series of prompt corrective actions.

Historical capital classification information is available here.

FHFA and Conservatorship

Effective July 30, 2008, the Housing and Economic Recovery Act of 2008 (HERA) created FHFA as a new independent agency of the Federal Government. HERA transferred to FHFA the oversight responsibilities of the Federal Housing Finance Board over the Federal Home Loan Banks (Banks) and the Office of Finance, which acts as the Banks’ fiscal agent, the oversight responsibilities of OFHEO over the Enterprises, and certain functions of the Department of Housing and Urban Development (HUD) with respect to the affordable housing mission of the Enterprises.

On September 6, 2008, the Director of FHFA appointed FHFA as the conservator for each Enterprise, pursuant to authority in the Safety and Soundness Act. Because the ability of the Enterprises to obtain adequate capital was fatally impaired due to the financial crisis, capital support for the Enterprises was provided by the Senior Preferred Stock Purchase Agreements with the Treasury Department when the Enterprises were put into conservatorship. Accordingly, FHFA suspended the capital classifications as well as the OFHEO capital regulation.

FHFA issued new capital standards for the Enterprises in December 2020. A description of Enterprise capital standards under FHFA is available here.