Fannie And Freddie: Analysis Of Q2 Earnings

| About: Fannie Mae (FNMA)

Summary

Both Fannie and Freddie are proving to be extremely resilient, and on the surface at least, appear to be excellently managed.

Both continue to pay dividends to Treasury without principal being reduced, further highlighting the illegal taking that still continues.

Detractors no longer have persuasive counter arguments and are now resorting to outright untruths.

We will need to rely on the courts now. There is likely a desire on the part of the government to leave this issue for the next administration to resolve.

In Light of Global Uncertainties, both Fannie (OTCQB:FNMA) and Freddie (OTCQB:FMCC) Delivered a Strong Q2

For Q2, Fannie and Freddie announced:

Q2 Results

Comprehensive Income Dividend to Treasury
Fannie Mae $2.9 billion $2.9 billion
Freddie Mac $1.1 billion $933 million

In a quarter where many, including me, were expecting another Treasury draw due to tumbling yields, both Fannie and Freddie managed to deliver a strong performance.

Factoring in Q2 Dividends to Treasury, What Would the Principal Amount Outstanding Be?

Assuming that all prior dividend payments in excess of 10% reduced principal:

Fannie Mae (in billions)

Q1'13 Q2'13 Q3'13 Q4'13 Q1'14 Q2'14 Q3'14 Q4'14 Q1'15 Q2'15 Q3'15 Q4'15 Q1'16 Q2'16
Comprehensive Income (10-Q) 58.7 10.3 8.6 6.6 5.7 3.7 4.0 1.3 1.8 4.4 2.2 2.3 0.9 2.9
Actual Dividend Amount 59.4 10.2 8.6 6.6 6.3 3.7 4.0 1.3 2.4 4.4 2.2 2.3 1.5 2.9
Dividend Amount Under 10% Arrangement 2.9 1.5 1.3 1.1 1.0 0.8 0.8 0.7 0.7 0.6 0.5 0.5 0.5 0.4
Aggregate Liquidation Preference on the Senior Preferred (Beginning of Q) 117.1 60.6 51.9 44.6 39.2 33.8 31.0 27.8 27.2 25.4 21.7 20.0 18.2 17.1
Aggregate Liquidation Preference on the Senior Preferred (End of Q) 60.6 51.9 44.6 39.2 33.8 31.0 27.8 27.2 25.4 21.7 20.0 18.2 17.1 14.7
Excess Above 10% 56.5 8.7 7.3 5.5 5.3 2.9 3.2 0.6 1.7 3.8 1.7 1.8 1.1 2.5
Residual Net Worth 3.0 3.0 3.0 3.0 2.4 2.4 2.4 2.4 1.8 1.8 1.8 1.8 1.2 1.2

Freddie Mac (in billions)

Q1'13 Q2'13 Q3'13 Q4'13 Q1'14 Q2'14 Q3'14 Q4'14 Q1'15 Q2'15 Q3'15 Q4'15 Q1'16 Q2'16
Comprehensive Income (10-Q) 7.0 4.4 30.4 9.8 4.5 1.9 2.8 0.3 0.7 3.9 -0.5 1.6 -0.2 1.1
Actual Dividend Amount 12.8 4.4 30.4 9.8 5.1 1.9 2.8 0.3 1.3 3.9 0.0 1.1 0.6 0.9
Dividend Amount Under 10% Arrangement 1.8 1.5 1.5 0.7 0.5 0.4 0.4 0.3 0.3 0.3 0.2 0.2 0.2 0.2
Aggregate Liquidation Preference on the Senior Preferred (Beginning of Q) 72.3 61.3 58.4 29.5 20.4 15.8 14.3 11.9 11.9 10.8 7.2 7.4 6.5 6.1
Aggregate Liquidation Preference on the Senior Preferred (End of Q) 61.3 58.4 29.5 20.4 15.8 14.3 11.9 11.9 10.8 7.2 7.4 6.5 6.1 5.3
Excess (Shortfall) Above 10% 11.0 2.9 28.9 9.1 4.6 1.5 2.4 0.0 1.0 3.6 -0.2 0.9 0.4 0.7
Residual Net Worth 3.0 3.0 3.0 3.0 2.4 2.4 2.4 2.4 1.8 1.8 1.3 1.8 1.0 1.2

Principal Amount If Excess Dividends Reduced Principal

If principal were allowed to be reduced, the Aggregate Liquidation Preference on the Senior Preferred would presently be $14.7 billion for Fannie Mae and $5.3 billion for Freddie Mac.

End of Q2

Fannie Mae Freddie Mac
Aggregate Liquidation Preference on the Senior Preferred $14.7 billion $5.3 billion
Quarterly Dividend Required (10%) $367.5 million $132.5 million

Had excess dividends to Treasury reduced principal, Fannie Mae would presently be required to pay $367.5 million per quarter in dividends to Treasury, and Freddie Mac would be required to pay $132.5 million.

This is Not Simply an Accounting Issue

In an August 17, 2012, email sent by Chris Russell to Jim Parrott, it was stated that:

In regards to them keeping additional profits, in my mind that is only an accounting issue, gov recoups now (per new method) or later when we liquidate them and then realize those gains for the taxpayer.

This argument is so pathetic that it violates Finance 101: the Time Value of Money. A dollar today is worth more than a dollar tomorrow, and isn't simply a minor accounting or timing issue.

Time Value of Money Illustration

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 NPV (10%)
Cash Flow Stream 1 $10 $1 $1 $1 $1 $1 $1 $1 $1 $1 $14.33
Cash Flow Stream 2 $1 $1 $1 $1 $1 $1 $1 $1 $1 $10 $9.61

As can be seen, Cash Flow Stream 1 is clearly more valuable than Cash Flow Stream 2 (assuming a 10% discount rate). NPV of Cash Flow Stream 1 > NPV of Cash Flow Stream 2 ($14.33 > $9.61).

In Q1 2013, Fannie Mae posted a record profit of $58.7 billion, and Freddie Mac posted a record profit of $30.4 billion in Q3 2013. These record quarters can not be brushed aside as simply an immaterial accounting issue (collect now versus collect later).

These are the two quarters that "literally" allowed Fannie and Freddie to escape (using their own terminology).

John Carney of the Wall Street Journal Making Arguments He Knows To Be False

In an August 2 article, titled "Hopes Dim For Freddie Mac Shareholders," Carney wrote:

Under the current arrangement with the U.S. Treasury, Freddie will pay a dividend equal to $993 million. That's far less than the $1.8 billion the company would have owed prior to a 2012 change to its bailout.

That $1.8 billion is in relation to the Aggregate Liquidation Preference of $72.3 billion, which Treasury has not allowed to be reduced despite billions in excess payments. Carney knows this, yet he continues to perpetuate distortions.

And in an August 4 article, titled "Fannie Mae Results Cast Pall on Shareholder Lawsuits," he wrote:

This variability in results once would have been a threat to the company - and the stability of financial markets. Under the original terms of Fannie Mae's bailout, it was required to pay a fixed dividend equal to 10% of the government's $117.1 preferred stake in the company - around $2.9 billion on a quarterly basis.

The stability of financial markets was never in threat. We now know that insiders were aware that both Fannie and Freddie were about to become amazingly profitable. Carney also continues to disregard the excess dividends paid to Treasury and the Time Value of Money (Finance 101).

John Carney has covered this issue for long enough. He should know by now that the arguments he is making are false. Why does he continue to have a platform to spread mistruths?

It's Up to the Courts Now for a Near-Term Resolution

Prior to the Q2 earnings release, I wrote an article stating there was a slight possibility that the government would act to prevent another Treasury draw. That, as we now all know, did not occur.

With 2016 being an election year, I now think there is no chance that the government will act unilaterally to resolve this issue. There is likely a strong desire within the government to leave this issue for the next administration to resolve (Trump or Clinton).

Our best hope now is a favourable court ruling. I am confident that if the judges take their time to really understand the mechanics of the Third Amendment (declining capital balance, sweeping of all profits, no principal reduction possible, indefinite duration, etc.), they will come to realise just how fundamentally unjust it is.

Disclosure: I am/we are long FNMA, FMCC.

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.

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