Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC), which are together known as the government-sponsored enterprises, or GSEs, have been nationalized, and their investors have been expropriated. The nationalization and expropriation are de facto rather than de jure; i.e., in a formal sense, the GSEs remain investor-owned companies with common and preferred stock equity investors.
The Senior Preferred Stock Purchase Agreements (SPSPAs) set forth the terms of Treasury support of the GSEs during conservatorship. The SPSPAs are separate agreements between the Treasury and the two GSEs, with FHFA acting on behalf of Fannie Mae and Freddie Mac. The expropriation has been done via the 3rd Amendment to the SPSPAs' net worth sweep, which sweeps essentially all of the GSEs' total comprehensive income to Treasury.
I've argued in the past that the U.S. Treasury (Treasury) is effectively the co-regulator of the GSEs along with Financial Housing Finance Agency or FHFA. However, it may be more accurate to say that Treasury is the co-conservator of the GSEs along with the FHFA. It appears that FHFA handles the details of regulation of the GSEs, but anything important is covered in the SPSPAs, and Treasury takes the lead, with FHFA following along.
Investors should do their own due diligence given the political risk that is associated with investments in GSE common and preferred stocks. It is possible, however, that the financial/economic issues will eventually be sorted out in ways that are favorable for GSE equity investors.
1. The GSEs have repaid Treasury in terms of "net investment"
As of December 31, 2016, Fannie Mae will have paid senior preferred dividends that are $38.249 billion in excess of draws on the Treasury. Fannie Mae has paid dividends of $154.398 billion, compared to draws of $116.149 billion. No draws have occurred since 1Q2012.
Freddie Mac will have paid senior preferred dividends that are $30.112 billion in excess of draws as of year-end 2016, with dividends of $101.448 billion and draws of $71.336 billion. No draws have occurred since 2Q2012.
Combined, the GSEs will have paid dividends of $255.846 billion in excess of $187.485 billion of draws on the Treasury. Treasury is ahead by $68.361 billion relative to "net investment."
2. Rep. Capuano's bill provides a framework for retrospectively restating GSE payments to Treasury as senior preferred dividends and principal repayments
Representative Michael E. Capuano (D-MA) introduced H.R. 1036, known as the "Let the GSEs Pay Us Back Act of 2015" on February 24, 2015. It seems likely that Rep. Capuano will re-introduce this bill in the next session of Congress.
This bill provides a financial/economic framework for determining whether Treasury has been fully repaid for its support to the GSEs since 2008. This bill retrospectively re-calculates the dividends on the senior preferred stocks, reclassifying them into dividend payments (using a five percent dividend rate) and principal payments. Thus:
(3) Treatment of dividends paid.--That any dividends paid by the enterprise to the Department of the Treasury under the Senior Preferred Stock Agreement before such modification of such Agreement shall be treated as payments of principal and interest due under the loan referred to in paragraph (2), and shall be credited against payments due under the terms of such loan (in accordance with the amortization schedule established for such loan pursuant to paragraph (2)(E)), first to such loan having the earliest origination date that has not yet been fully repaid until such loan is repaid, and then to the next such loan having the next earliest origination date until such loan is repaid.
The SPSPAs do not allow for the GSEs to repay the Senior Preferred Stock. In contrast, TARP provided an exit strategy regarding government preferred stock investments in banks. This is just one aspect of the punitive nature of the support provided by Treasury to the GSEs, relative to the way that Goldman Sachs and other banks were treated. Moreover, a 10 percent dividend rate was required, rather than the five percent rate that was used in most cases under TARP.
H.R. 1036 includes the following provisions:
1. Senior preferred stock dividends are terminated as of the date of the modification and Treasury shall not accrue further dividends.
2. Draws on the Treasury shall be treated as loans originated on the date of the last draw for each applicable year, the principal shall be equal to the aggregate amount of draws, the term shall be 30 years, the interest rate shall be five percent, the loan shall be fully amortized over the term of the loan, and shall be repaid by the GSEs based on the amortization schedule established for the loan.
I calculate that Fannie Mae has fully repaid Treasury in terms of principal and interest as of year-end 2016. I calculate interest payments of $30.175 billion and principal payments of $116.149 billion. Thus, actual payments to Treasury of $146.324 billion would exceed the required interest and dividend payments per H.R. 1036 by $8.074 billion.
Similarly, I calculate that Freddie Mac has fully repaid Treasury in terms of principal and interest as of year-end 2016. I calculate interest payments of $26.339 billion and principal payments of $71.336 billion. Thus, actual payments to Treasury would exceed the required interest and dividend payments per H.R. 1036 by $3.774 billion.
I would not expect Treasury to reimburse the GSEs for payments that are in excess of those required by H.R. 1036. Treasury would be considered to be fully repaid for the draws on the Treasury.
3. Treasury and FHFA would agree that Treasury has been fully repaid and the warrants would be cancelled
My assumption is that the SPSPAs would remain in place until such time as the GSEs have been adequately re-capitalized and are essentially self-supporting. I assume a collateral-based line of credit at a 50 basis point premium to the applicable 30-day Treasury Bill rate would replace the current arrangements. The GSEs would each pay a 50 basis point commitment fee to Treasury each year for the option to draw on the Treasury if necessary. I assume that the collateral-based line of credit would stay in place until 2028.
Under the "Call it Even" plan, the senior preferred stock and the warrants to own 79.9 percent of the GSEs would be cancelled.
The Call it Even plan is in the public interest, consistent with the interests of U.S. taxpayers, mortgage holders, and real estate owners. The Call it Even plan would support the U.S. mortgage and housing markets.
The Call it Even plan would support financial recapitalization of the GSEs. In order to accomplish this, existing GSE common and preferred holders must be treated fairly. Assuming that the GSEs continue to be profitable, the Call It Even plan would support resumption of GSE preferred stock dividends as well as small dividends on GSE common stocks.
Disclosure: I am/we are long VARIOUS GSE PREFERRED STOCKS, SUCH AS FNMAS AND FMCKJ.
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: I am a consulting economist.
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