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Suman Chatterjee
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Financial analyst-writer for the last 5 years. Writes for a number of financial publications including The Street, Motley Fool and Seeking Alpha. Completed his Bachelors in Business Administration (Finance) with GPA 3.0, currently pursuing Chartered Accountancy from ICAI, India. Specializes in... More
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  • Why Is Uncle Sam So Strict On Dear Little Fannie Mae And Freddie Mac? 1 comment
    Aug 21, 2012 2:41 PM | about stocks: BAC, C, CBG, FMCC, FNMA, JPM, WFC

    You might have already heard that the US Treasury has already made crucial tweaks in the bailout program of Freddie Mac (OTCQB:FMCC) and Fannie Mae (OTCQB:FNMA), two GSEs that played huge role in leading the US economy into the dreaded housing bubble in 2007, buying almost 50% of the mortgage-related securities from the banking and the non-banking institutions.

    But why would the government take such a drastic decision? In this article, I want to focus on the decrepit and reckless performance of these government-sponsored companies for the past few years.

    One of the severest recessions in the history of US, which would wreck the very grounding of United States of America, was right after the 9/11 attacks. And ironically, the housing bubble (which would lead to the Great Recession) was an aftermath of Alan Greenspan's act to reassure the Americans after the terrorist attacks.

    Anyway, let's find out how inefficient and burdensome the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corp (Freddie Mac) were these last few years.

    Why Such a Decision?

    Freddie Mac's and Fannie Mae's return on average assets (ROAA, which signifies the return from its current portfolio) is (0.24)% and (0.52)% respectively, compared to 1.26% of Wells Fargo (NYSE:WFC), 0.87% of JPMorgan Chase (NYSE:JPM) and 3.9% of CBRE Group (NYSE:CBG). Although the numbers of the other companies are not something to be proud of, the improving positive numbers tell us that they are reviving back from the dead. It must also be understood that the interest rate hike following the recession has already led to negative income for most of these financial institutions. Fools rush in where angels fear to tread, and that's what happened during the Great Recession.

    Fannie Mae incurred a loss of $16.9bn last year, straight for four consecutive years. If you look at the balance sheet, you will find $2.9 trillion worth of mortgage loans, being adjusted at $48 billion loitering in the storeroom. Damn! I mean, what are they going to do about it? Needless to say, the US government is taking such a drastic step now, which should have been taken earlier.

    In the last quarter ended June 2012, Freddie Mac's net interest income went down to $21.8 million, compared to $25.3 million in the same quarter last year. Looking at the recent financial statement, it is verified that the GSE is running at loss for over a couple of years now. And portfolio doesn't seem to be doing well since over $162 billion worth of PCs were extinguished last year.

    It seems they are not being a facilitator in the housing market, rather being a burden on the government, spiking up government debt with their HUGE amount of senior notes offerings every other year. Since 2008, Fannie Mae and Freddie Mac has "drawn a total of $188 billion in taxpayer funds to stay afloat, while paying more than $45 billion in dividends."

    According to the new bailout program, the unlimited support the Treasury extended to the two companies will expire at the start of next year. After December 31, Fannie Mae's bailout will be capped at $125 billion and Freddie Mac will have a limit of $149 billion.

    Additionally, the companies' corporate debt price rallied as the new policy alleviated the need for Fannie Mae and Freddie Mac to borrow from the government just to make dividend payments, putting them in a better position to service their debt.

    Moreover, as part of the new terms, Fannie Mae and Freddie Mac will be required to reduce their investment portfolios at an annual rate of 15 percent instead of the previous 10 percent. That will put each of them on track to cut their portfolios to a targeted $250 billion in 2018, four years earlier than planned.

    Fannie Mae's investment portfolio, valued at $673 billion as of the second quarter, holds distressed loans and mostly mortgages that were originated before 2008. Freddie Mac's investment portfolio was valued at $581 billion as of June.

    And instead of the previous 10% dividend yield on the money borrowed, the GSEs need to give away all their revenue to the government from now on.

    In this case, I would say the US did take the right decision of dissolving (perhaps!) these two GSEs. "You fixed the major flaw in the initial agreement," said Jim Vogel, interest rate strategist at FTN Financial in Memphis, Tennessee.

    Are You Asking About The Consequences?

    Different people have different opinions.

    Some people are vouching for the dissolution of the two most important housing finance bodies in US.

    "In the short run it protects the borrowers to insure that the GSEs continue to be a viable resource," said David Stevens, President and CEO of the Mortgage Bankers Association. "If something were to happen to the GSEs in the next administration that put them on a path to a different state or eliminated them, this insures that the Treasury maximized, within their authority, the re-collection of every dollar possible."

    Some people just think that these companies will be there. Just lesser participation will result in more capitalization in the market.

    "We see this as a positive for housing, as it ensures that Fannie and Freddie will remain in business," writes Jaret Seiberg of Guggenheim Partners. "Absent Fannie and Freddie, we believe housing finance will become more expensive and less available."

    Some people think that they will start borrowing even harder with this new bailout program, which means heavier burden for the government.

    "The market's worry is that Fannie and Freddie will exhaust this Treasury capital and default on bond payments," the Washington Research Group said in a note to clients. "Just the fear of this could drive up their borrowing costs, which would require them to seek government capital more quickly," it said.

    But some people think differently from the above.

    The Treasury's new agreement with the companies will require them to only turn over any earnings, meaning they won't need to borrow more to cover the dividends in quarters when their profits are too small or non-existent. The compounding effect of the previous accord meant they could have run out of money within as little as seven years, Bank of America Corp. (NYSE:BAC) analyst Ralph Axel said in January.

    Some are just too optimistic about the whole thing.

    The companies' regular need to borrow money from the Treasury to pay the dividends, increasing their burden and leaving them exposed to eventually running out of aid, seemed like a "never-ending, un-virtuous cycle" that worried potential buyers of their bonds, Robert Rowe, an agency debt analyst at Citigroup Inc. (NYSE:C), said in a telephone interview. "You could potentially see some investors, particularly some foreign investors, which have moved out of the market come back to it."

    I would say that it's too hard and too fast to comment on this right now, since it is a macroeconomic aspect, and the housing market is isolated from the other industries in the United States. Even another gas price rise can be of concern! But just when the housing market seems to be recovering, this might be the step you were looking for.

    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.

    Stocks: BAC, C, CBG, FMCC, FNMA, JPM, WFC
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  • michelodu
    , contributor
    Comments (41) | Send Message
    So, would you consider FNMA and FMCC to be a decent value, or are you apprehensive about them being wound down?


    4 Sep 2012, 05:43 PM Reply Like
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