May 12, 2013
How Fannie Mae made its profit
Mortgage buyer and insurer Fannie Mae was in the news again this week.
First, let me review a little of the history of how we got here. Fannie Mae (otherwise known as the Federal National Mortgage Association) was created by an act of the United States Congress in 1938 as a government-sponsored enterprise (GSE) intended to purchase loans that had been guaranteed directly by the U.S. government through the FHA. Subsequently Fannie got into the business of buying loans that were not guaranteed by FHA, as well as issuing its own guarantees on bundles of other loans that it put together and resold to private investors. In 1970, Congress chartered the Federal Home Loan Mortgage Corporation (Freddie Mac) to do the same thing and act as a competitor to Fannie. But in 2008 with mortgage loans going bad, Fannie and Freddie did not have adequate capital to fulfill their guarantees, and the federal government took both Fannie and Freddie into conservatorship, where they remain today.
Now this week Bloomberg reported
Fannie Mae (FNMA), the mortgage-financier seized by U.S. regulators in 2008, will pay the Treasury Department $59.4 billion after reporting a record quarterly profit driven by rising home prices and declining delinquencies....
After its latest payment, Fannie Mae will have sent the Treasury a total of $95 billion, compared with the $117.1 billion of capital infusions that the company has received. Freddie Mac, which yesterday reported a $4.6 billion profit, will have paid $36 billion, after drawing $72 billion of aid, and Chief Executive Officer Don Layton said it may release $30.1 billion of tax-credit writedowns as soon as next quarter.
The coming large payments from the companies will probably help delay the amount of time the U.S. government has until running out of room under its debt ceiling to sometime in October, the Bipartisan Policy Center said today in a posting on its website.
But if you study Fannie Mae's 10Q report, you'll find that most of the 2013:Q1 reported profit came from Fannie's decision to recredit itself with $50.6 B in deferred-tax assets. The company's theory prior to 2008 was that, with all its previous losses, it wouldn't have to pay much future taxes as a result of carrying those losses forward. Fannie had been counting the taxes it wouldn't have to pay in the future as one of its main net assets in 2008. When Fannie was taken into conservatorship in 2008, there was a decision that maybe the enterprise would never go back to being a "private" company that owed any taxes, so those deferred-tax assets were written off as a big loss. Now the enterprise is putting them back on the books, as a result of which it claimed a huge after-tax profit for 2013:Q1. So Fannie plans to pay the U.S. Treasury (the GSE's current owner) a big dividend.
It's pretty amusing to see how this is getting covered by some of the press. For example, CNN's headline was Fannie Mae, Freddie Mac to help cut deficit:
U.S. taxpayers will soon reap a nearly $67 billion benefit from the recovering housing market, which will help to shrink deficits and delay the need to raise the country's debt ceiling.
To translate, you don't need to worry so much about the outstanding government debt because maybe some day Fannie is going to be a private company again that won't have to pay taxes for quite a while. Because the taxes that Fannie isn't going to pay in the future count as an asset to its current owner (the U.S. government), we can now declare ourselves to be better off financially than we were a week ago.
But I have another question about the rest of that $59 B in income earned by Fannie. The U.S. government is currently the residual claimant who receives the income from the fees that Fannie is collecting for guaranteeing mortgage-backed securities. So who is the residual guarantor of those securities?
Posted by James Hamilton at May 12, 2013 11:54 AMdigg this | reddit
I was first interested in this because people have been talking about potential value in junior preferred shares. The dividend on those has been suspended by Congress.
Posted by: jonathan at May 12, 2013 12:42 PM
You can fool some of the people all of the time...
Plus, remember the little people that Fannie Mae helped. Like Franklin Raines. Why shouldn't a fine DC insider have a shot at a lucrative second career?
Posted by: c thomson at May 12, 2013 01:16 PM
One would hope that the financial press would be able to differentiate cash and non cash items. Sadly they seem to miss the difference on a regular basis.
Posted by: Chris of Stumptown at May 12, 2013 02:07 PM
Creative streams of accounting, how should one treat the MBS 1.2 trillion USD dollars purchase by the Fed, an intra company’s loan, a subordinated loan? as investment? When applied to the total public injected funds the non cash profit is still making the return bleak.
Posted by: ppcm at May 12, 2013 11:56 PM
The GSEs are a politically charged subject, usually without the recognition that without them, the housing market would have completely collapsed and taken overall economy with it. They also provided an avenue for banks to continue their mortgage lending, earning the up front fees, strengthening their (banks') balance sheets.
My complaint with the GSEs prior to their bust was that they were not charging very much for the insurance they were providing. $24B/yr interest spread profit on a $3T book is 0.8%. They could probably boost that a little without harming markets.
Where they have had a real positive impact is with improved underwriting and standards. Anyone get a mortgage from 2009-today and remark how much more documentation you need, or how the amount you could get is much less than 2006-2008?
As much as some in government might dislike the GSEs, the constituency for the GSEs is too large to disband them immediately. The best route I see to reducing their influence and exposure is to reduce the conforming limit, and to eliminate the geographic special limits. This will annoy some (some who like to bark about how they don't need gov't help), but can be phased and with limited impact.
Posted by: winstongator at May 13, 2013 03:27 AM
Journalists don't understand anything regarding accounting. Remember they think the Postal Service Retirement Health Benefits Fund's (PSRHBF) liability accounts for future employees that have not even been born yet.
Obviously accrual-based accounting is beyond their comprehension.
Posted by: Jay at May 13, 2013 04:31 AM
great post, demasking this media spin nonsense (and not only the CNN clowns).
Posted by: Johannes at May 13, 2013 05:07 AM
Income before taxes was 8.1 Billions versus 2.7 in the prior period.
Some pretty impressive gains in loan quality. Over a 10% drop in one quarter in loans seriously delinquent (90 versus 99 Billion), and the percentage of LTV below 80% rose, and the % above 125% declined, and the changes were material.
You can see the real estate recovery in their 10Q - particularly if you compare against the 2010 1Q as I did for about 20 minutes.
Posted by: fladem at May 13, 2013 08:41 AM
I was curious about the source of repayment of this nearly $60 bn to the Treasury when the source of the gain is purely an accounting write-up.
Well, first of all, the 10-Q states: "Our dividend payment for the second quarter of 2013 will be $59.4 billion, which is calculated based on our net worth of $62.4 billion as of March 31, 2013..."
So it hasn't been paid yet. Net income was all of $17 bn in 2012, so that's not a source of full repayment; nor does there seem to be adequate cash on hand (although this is hard to judge). Is it some other asset liquidation?
If the source is not from the asset side of the balance sheet, what could it be? It could be additional borrowing from the Treasury, but then paying the dividend makes no sense and will just draw political fire. It could be an additional loan from banks or capital markets; but does levering up Fannie Mae look feasible when it's equity is so low? Probably not.
However, the re-instatement of tax benefits could be the indication that the government is thinking about re-privatizing the company. It's probably a good time to do it, given low interest rates and strong equity valuations. Thus, the $60 bn to be paid from the government looks like it could come, at least in part, from a public securities offering sometime during Q2.
Posted by: Steven Kopits at May 13, 2013 10:31 AM
I think the key point here is that there is enough case flow to believe that Fannie WILL pay $60 Billion in taxes - an assumption that if correct means this is not just an accounting trick but rather a reflection of the true state of the business.
Posted by: fladem at May 13, 2013 06:58 PM
No, Flad, it's more than that.
Fannie Mae says it will pay $60 bn in Q2, not in higher taxes over many years. It's $60 bn in the next 60 days.
Posted by: Steven Kopits at May 13, 2013 07:50 PM
FNMA - I bought this stock b/c I heard the company has returned to profitability and is now able to repay the bailout, just like AIG and many other large banks.
Otherwise, FNMA wouldn't be trading in the stock market, that would be irresponsibility on behalf of authorities, right?
Posted by: Chicken at May 14, 2013 09:14 PM
Good catch. It will also be very interesting to see how they finance this. Does Fannie have that much cash lying around? Or is it going to sell debt, basically raising off-balance-sheet funds for Treasury to help it dodge the debt limit?
Posted by: Tom at May 15, 2013 03:36 AM
Tom, FNMA is an GSE, meaning they can completely rely on taxpayer largess to ensure their assets and honor their warranties in times of trouble, at near zero expense. Mind you, Wall Street uses the press as a means to modulate this money pump, so just make sure to stay on top of the news flow.
Meanwhile, the USGov is TBTF and it's hard to find such a sweet deal anywhere else and fantastic work, if you can get it! Up another 22% today beats any of the hard working(heavily taxed) wealth creators by a country mile, that's where I've placed my entire nest egg, backed by the FED and US government.
Posted by: Chicken at May 15, 2013 12:24 PM
The interesting aspect of this is that any other entity would have had to go through bankruptcy proceedings, thus disallowing the use of NOL deductions (and the ability to recognize a deferred tax asset).
Posted by: Lance at May 15, 2013 03:23 PM
It is real money getting paid now.
Where did it come from? It came from the fact that they don't need capital.
They pay out their net worth to the government quarterly. So what if some of it is based on an intangible asset?
Posted by: Tom at May 16, 2013 06:32 AM
Further in the 10K, notes to financial statements:
"Under the terms of the senior preferred stock purchase agreement, starting January 1, 2013, we are REQUIRED to pay Treasury each quarter a dividend, when, as and if declared, equal to the excess of our net worth as of the end of the preceding quarter over an applicable capital reserve."
They aren't allowed to recapitalize. IIRC, this was considered a plus, since it would eliminate the pressure to reprivatize the firm.
Posted by: Tom at May 16, 2013 06:42 AM
Thanks, Tom, I think that almost answers the question. With that rule Fannie almost can't be paying from its own cash. It will almost certainly be borrowing.
Posted by: Tom at May 17, 2013 07:25 AM
There are two things that make it extremely unlikely that these two companies will be returned to the private sector and taken out of conservatorship in the immeditarte future.
unlike Chrysler with all the protection that that affords a company and it's shareholders. 2) as long as both companies are paying the government a dividend and not being allowed to pay down the debt they owe, they can't be regarded as clear of the debt burden.
It's a master stroke for the US government but maybe they arent willing to take the risk of the market traders playing games with the stock price plus borrowings on capital markets and harming the fragile recovery in the mortgage market.
I see the stock of both companies heading down to the 50 cent level.
It would be nice if the preferred stock did the same again!
Posted by: Jimmy40 at June 26, 2013 12:05 PM
Re comment Posted by: fladem at May 13, 2013 08:41 AM asking the source of the ~$60bn FNMA repayment to the Treasury:
The ~$60bn source of the income being posted to be repaid, but not yet paid is the recovery of the excess servicing fee receivable (esfr), which is the interest only (I/O)difference between the interest rate the loans were originated and the average interest of the securities sold. While FNMA has this profit, until it can be sold, it remains an asset on the books of the company, or one they transfer as an asset to the government or Fed, the better receiver.
Posted by: Pieter Schoonheim Samara at August 13, 2013 02:28 AM