UPDATE:US Tsy Freezes Fannie/Fred; To Collect All Earnings
--Updating 11:39 ET Story With Additional Quotes, Details
WASHINGTON (MNI) - The Treasury Department Friday announced it is freezing the size of Fannie Mae and Freddie Mac and from now on will collect every dollar of their profits while accelerating the shrinkage of their retained portfolios.
Fannie and Freddie "will not be allowed to retain profits, rebuild capital and return to their prior form," Treasury said.
Although described by the Department as expediting the wind-down of the government sponsored enterprises, the net effect of the latest changes may be to increase the chance of their survival in their current state, but with much smaller investment portfolios, as reform fervor wanes, some analysts said.
It turns out that the net profits Fannie and Freddie reported earlier in the week for the second quarter will be the last they get to keep. Net profits from now on will go to the Treasury.
Fannie Wednesday had reported $2.2 billion in net second quarter profit and Freddie a day earlier said it earned $1.2 billion. Both also sent the Treasury Department even larger quarterly dividend payments, a round-trip routine now also at an end.
No longer will Treasury be forced to give Fannie and Freddie more money than the government collected in dividends on bailout-acquired shares, as happened in 12 of 13 quarters up until this year.
The Treasury announcement, in so far as it reduces doubt about Treasury's actual commitment to the GSEs, "should be a positive and reduce one big worry that has nagged at some investors for four years," FTN Executive Vice President Jim Vogel told MNI. The government's 2009 guarantee of open-ended further support runs out at the end of this year.
From this year forward, however, Treasury's commitment to keep the net worth of Fannie and Freddie positive no matter what it costs has been circumscribed. Future aid is capped at around $275 billion. Given the improved quality of mortgage underwriting since 2009, Treasury and the GSEs have reason to hope any possibility of future large-scale bailouts has been greatly reduced if not eliminated.
The change "solidifies the GSEs' capital base," Moody's analyst Brian Harris told MNI. "Prior to the amendment it was likely that the companies would have to borrow money from the Treasury -- in the form of preferred stock -- in order to pay the dividend. The amendment eliminates that possibility."
The changes mean that if Fannie and Freddie have future quarters without profits they get a free pass, without the need to pay Treasury anything. At the same time, by collecting all profits, Treasury has reduced the threat taxpayers will have to give the GSEs even more money to sustain their positive net worth.
Treasury has already pumped nearly $190 billion into Fannie and Freddie and has gotten about $47 billion back in dividends on shares it acquired when the two institutions were placed in a government conservatorship. The new agreement in effect acknowledges that none of the outstanding government bailout money will ever be repaid.
At the same time, by placing the GSEs on a more sustainable long-term path, analysts wonder if the incentive for Congress to create a new housing finance system in which their role is diminished, one mostly supported by private sources of credit, is fading. For now, Fannie and Freddie provide the bulk of mortgage support and housing industry enthusiasm for any phase-out of the GSEs appears to be flagging.
The day's action "stops the clock on needing to come up with an alternative housing finance structure," Michael Cloherty of RBC said.
Treasury GSE specialist Michael Stegman said the measures "promote a responsible transition and protect taxpayer interests," although no one yet knows to what the two GSEs will be transitioning to, if Congress eventually tackles a new national housing finance regime.
The modification of Treasury's conservatorship agreement specifies the retained portfolios of both GSEs must shrink faster than had been scheduled, going from $650 billion at the end of this year to $250 billion four years earlier than otherwise. That is estimated to be in 2018 instead of 2022, a Treasury spokesman told MNI.
Fannie's retained portfolio of mortgages was at $772.8 billion at the end of the second quarter and Freddie's at $656.1 billion.
The portfolio shrinkage speeds up to 15% a year from the previous 10%. The exact levels year-to-year will depend on the portfolios' market returns. That both Fannie and Freddie had accumulated huge investment portfolios to begin with was a sign, critics said, that both had lost sight of the role Congress intended as their top executives pursued greater profits and bonuses.
The Federal Housing Finance Agency that is the regulator for Fannie and Freddie said the latest changes are consistent with its own strategic plan for their future.
FHFA Acting Director Ed DeMarco issued a statement saying the changes assure the government will be "gradually contracting their operations and maintaining foreclosure prevention activities and credit availability."
In reporting positive earnings so far this year, both Fannie and Freddie said the biggest reason was that they have been able to reserve less against losses, as the performance of newer mortgages continues to improve.
But Fannie also warned that its performance in the second half of this year may not be as positive as the first half, citing a number of possible reasons. Analysts said the main downside risk for the GSEs is higher interest rates that could hurt housing's recovery and impede the ability of mortgage holders to keep up with payments.
Fannie and Freddie have to recapture mortgages that stop performing, extracting them from pools of mortgage backed securities it has guaranteed. Part of the latest agreement specifies they both have to report annually to Treasury how it plans to "reduce taxpayer exposure to mortgage credit risk for both its guarantee book of business and retained investment portfolio," the Department said.
The American Bankers Association applauded the day's "responsible" Treasury announcement and said, "Much more work needs to be done to reform the secondary (mortgage) market."
The Mortgage Bankers Association said Treasury's actions were "clear and appropriate" and the trade group said it wants to emphasis "the importance of ensuring continued liquidity that will provide the affordable mortgage financing necessary to support the housing market."
By late Friday, neither Freddie nor Fannie had issued a statement reacting to the Treasury announcement, nor had the American Securitization Forum, that represents participants in the mortgage-backed securities market.
** MNI Washington Bureau: 202-371-2121 **