Fannie And Freddie Profits Not Going To Investors

| About: Fannie Mae (FNMA)

Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) will release their quarterly reports in August 2013 and both are expected to have profitable quarters. However, investors will see none of the profits because the government changed the rules in 2012 under the so-called "Sweep Amendment." Dividends from Fannie Mae and Freddie Mac were capped at a fixed amount of 10 per cent and all profits are automatically moved into the U.S. Treasury without paying off the government loan.

So far in 2013, Fannie Mae and Freddie Mac have paid $66 billion to the U.S. Treasury as the housing market recovered and their finances improved. The government projects a total of $238 billion in revenues due to the government's Sweep Amendment from these government-sponsored enterprises "GSEs" over the next decade. The government has no incentive to remove the Sweep Amendment because it the money goes straight into the U.S. Treasury for government spending, with no strings attached.

Investors will have to hold these shares for several years and multiple lawsuits to determine if they will ever pay off, or if the government will continue to keep the profits, or close Fannie and Freddie down.

There are multiple lawsuits being filed by investment groups attempting to repeal the Sweep Amendment and allow Fannie and Freddie to pay off their loans to the government and return future profits to the preferred and common shareholders. With billions of dollars at stake, the legal posturing could take years for the cases to get to court and be settled.

One lawsuit was filed by Berkowitz Group in federal court in the District of Columbia and names the Federal Housing Finance Agency, which regulates Fannie and Freddie, as a defendant in addition to the U.S. Treasury Department. Berkowitz is among a group of professional investors who have been betting on the junior preferred shares of the housing giants on the theory that since the government-sponsored enterprises are profitable, they will one day repay the government, with money left over to pay dividends on junior preferred.

In June 2013, the Police Retirement System of Austin, Texas, and a bank from the state of Washington, sued the government over its takeover of Fannie Mae and Freddie Mac, seeking billions of dollars in damages.

July 8, 2013, Perry Capital, one of the largest U.S. hedge funds, is suing the U.S. Treasury over the terms of large dividend payments it has been receiving from Fannie Mae and Freddie Mac, the mortgage companies taken over by the government during the depths of the housing crisis in 2008. The hedge fund, which has invested in Fannie Mae and Freddie Mac, alleges the Treasury violated the rules associated with its control of the companies in 2012 when it created the Sweep Amendment that allows the U.S. Treasury to sweep all profits into the U.S. Treasury without paying off the loans associated with the bailout. Perry Capital is asking the U.S. Treasury to use the dividend money to pay off its loans in the government-sponsored enterprises.

The suits from Berkowitz and Perry, however, do not challenge the takeover but the 2012 amendment, arguing that it violates the principles of "conservatorship". This is key to understand they do not want the government to dismantle, but allow them to pay off their loans and return control back to the investors.

During the second quarter, Fannie Mae was highly engaged in the marketing of government loans. As of July 11, 2013, Fannie Mae announced that the company issued approximately $7.6 billion of multi-family mortgage backed securities (MBS) in the second quarter of 2013, backed by new multi-family loans delivered by its lenders. Fannie Mae also resecuritized $3.0 billion through its Fannie Mae Guaranteed Multifamily Structures (Fannie Mae GeMS) program in the second quarter.

Manny Menendez, Senior Vice President of Multifamily Capital Markets & Pricing at Fannie Mae stated "Our lenders continued to originate Multifamily DUS bonds at consistent levels in the second quarter. These investments are helping attract a broader investor base to our Multifamily MBS."

It is clear that the government and the leadership in Fannie Mae see the GSEs as vital players in the lending markets as no other entities have the size, strength (by backing of the government) and liquidity to be able to provide the billions of dollars required in the funding of residential, GeMS and commercial investments required to keep the U.S. markets operational.

It is our position that the short-term investment will not provide a return to investors, and the long-term is based on the success of lawsuits and litigation. Hope is not a factor in our investment process. We recommend that if you do not own any shares in Fannie Mae or Freddie Mac, do not buy in. If you own and believe in the long term that will provide a huge pay day, you may choose to stay in. The best short- and long-term play would be to cash out and invest in other investments that are returning a double-digit return on your investment in the market today.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Information for this article is from Fannie Mae and Freddie Mac official statements, website releases, government statements to the press and lawsuits filed in various courts. Investors should conduct their own research and decide if the investments are in their best interests.