Fannie Mae-No Politics (FNMA)

[Dollars1]

"Congress established Fannie Mae and Freddie Mac as GSEs to support mortgage lending. A key function of the GSEs is to purchase mortgages and package those mortgages into securities, which are subsequently sold to investors, and guarantee the timely payment of principal and interest on these securities. Leading up to the financial crisis, increasingly difficult conditions in the housing market challenged the soundness and profitability of the GSEs, thereby threatening to undermine the entire housing market. This led Congress to pass the HERA. This Act created the FHFA, with enhanced regulatory authority over the GSEs, and provided the Secretary of the Treasury with certain authorities intended to ensure the financial stability of the GSEs, if necessary. In September 2008, FHFA placed the GSEs under conservatorship and Treasury entered into a SPSPA with each GSE. These actions were taken to preserve the GSEs’ assets, ensure a sound and solvent financial condition, and mitigate systemic risks that contributed to market instability. The actions taken by Treasury, as authorized by section 1117 of HERA, thus far are temporary and are intended to provide financial stability. The purpose of Treasury’s actions is to maintain the solvency of the GSEs so they can continue to fulfill their vital roles in the home mortgage market while the Administration and Congress determine what structural changes should be made to the housing finance system. Draws under the SPSPAs are designed to enable the GSEs to maintain a positive net worth. The SPSPAs were structured to ensure any draws result in an increased investment in the GSEs as further discussed below. Per SFFAC No. 2, Entity and Display, these entities meet the criteria of “bailed out” entities. Accordingly, the government has not consolidated them into the financial statements, but included disclosure of the relationship(s) with the bailed out entities and any actual or potential material costs or liabilities in the consolidated financial statements. Senior Preferred Stock Purchase Agreements Under the SPSPAs, Treasury initially received from each GSE: 1) 1,000,000 shares of non-voting variable liquidation preference senior preferred stock with a liquidation preference value of $1,000 per share and 2) a non-transferable warrant for the purchase, at a nominal cost, of 79.9 percent of common stock on a fully-diluted basis. The warrants expire on September 7, 2028. Under the August 2012 amendments to the SPSPAs, the quarterly dividend payment changed from a 10.0 percent per annum fixed rate dividend to an amount equivalent to the GSE’s positive net worth above a capital reserve amount. The capital reserve amount was initially set at $3.0 billion for calendar year 2013, declined to $2.4 billion on January 1, 2014, and $1.8 billion on January 1, 2015, and will continue to decline by $600 million at the beginning of each calendar year until it reaches zero by calendar year 2018. The GSEs will not pay a quarterly dividend if their positive net worth is below the required capital reserve threshold. Cash dividends of $20.4 billion and $72.5 billion were received during fiscal years ended September 30, 2015, and 2014, respectively. Dividends received in fiscal year 2014 were primarily attributable to a federal income tax benefit that was recognized in the earnings of one GSE in fiscal year 2014. The SPSPAs, which have no expiration date, provide that Treasury will disburse funds to the GSEs if at the end of any quarter, the FHFA determines that the liabilities of either GSE exceed its assets. The maximum amount available to each GSE under this agreement was previously based on a formulaic cap which ended December 31, 2012, at which time, the maximum amount became fixed. Draws against the funding commitment of the SPSPAs do not result in the issuance of additional shares of senior preferred stock; instead the liquidation preference of the initial 1,000,000 shares is increased by the amount of the draw. There were no payments to the GSEs for the fiscal years ended September 30, 2015 and 2014. Senior Preferred Stock and Warrants for Common Stock In determining the fair value of the senior preferred stock and warrants for common stock, Treasury relied on the GSEs’ public filings and press releases concerning their financial statements, as well as non-public, long-term financial forecasts, monthly summaries, quarterly credit supplements, independent research regarding preferred stock trading, independent research regarding the GSEs’ common stock trading on the OTC Bulletin Board, discussions with each of the GSEs and FHFA, and other information pertinent to the fair valuations. Because of the nature of the senior preferred stock and warrants, which are not publicly traded and for which there is no comparable trading information available, the fair valuations rely on significant unobservable inputs that reflect assumptions about the expectations that market participants would use in pricing. The fair value of the senior preferred stock considers the amount of forecasted dividend payments. The fair valuations assume that a hypothetical buyer would acquire the discounted dividend stream as of the transaction date. The fair value of the senior preferred stock increased at September 30, 2015 when compared to 2014 primarily reflecting higher forecasted
GSE earnings derived from guarantee fees, lower volatility and risk in the mortgage lending industry, and lower forecasted mortgage loan losses due to reduced credit risk assumed by the GSEs. The fair value of the warrants is impacted by the nominal exercise price and the large number of potential exercise shares, the market trading of the common stock that underlies the warrants as of September 30, the principal market, and the market participants. Other factors impacting the fair value include, among other things, the holding period risk related directly to the assumption of the amount of time that it will take to sell the exercised shares without depressing the market. The fair value of the warrants increased at the end of fiscal year 2015 when compared to 2014 primarily due to increases in the market price of the underlying common stock of each GSE. Contingent Liability to GSEs As part of the annual process undertaken by Treasury, a series of long-term financial forecasts are prepared to assess as of September 30, the likelihood and magnitude of future draws to be required by the GSEs under the SPSPAs within the forecast time horizon. Treasury used 25-year financial forecasts prepared through 2040 and 2039 in assessing if a contingent liability was required as of September 30, 2015 and 2014, respectively. If future payments under the SPSPAs are deemed to be probable within the forecast time horizon, Treasury will estimate and accrue a contingent liability to the GSEs to reflect the forecasted equity deficits of the GSEs. This accrued contingent liability will be undiscounted and will not take into account any of the offsetting dividends that could be received, as the dividends, if any, would be owed directly to the General Fund. Such recorded accruals will be adjusted in subsequent years as new information develops or circumstances change. Based on the annual assessment, Treasury estimated no probable future funding draws as of September 30, 2015 and 2014, and thereby accrued no contingent liability. As of September 30, 2015 and 2014, the maximum remaining contractual commitment to the GSEs for the remaining life of the SPSPAs was $258.1 billion. Refer to Note 20-Commitments for a full description of other commitments and risks. Estimation Factors Treasury’s forecasts concerning the GSEs may differ from actual experience. Estimated senior preferred values and future draw amounts will depend on numerous factors that are difficult to predict including, but not limited to, changes in government policy with respect to the GSEs, the business cycle, inflation, home prices, unemployment rates, interest rates, changes in housing preferences, home financing alternatives, availability of debt financing, market rates of guarantee fees, outcomes of loan refinancings and modifications, new housing programs, and other applicable factors. Regulatory Environment To date, Congress has not approved a plan to address the future of the GSEs, and thus the GSEs continue to operate under the direction of their conservator, the FHFA, whose stated strategic goals for the GSEs are to: (1) maintain foreclosure prevention activities and credit availability to foster liquid, efficient, competitive, and resilient national housing finance markets; (2) reduce taxpayer risk through increasing the role of private capital in the mortgage market, and (3) build a new single-family securitization infrastructure. The Temporary Payroll Tax Cut Continuation Act of 2011 (TPTCCA) was funded by an increase of 10-basis points in the GSEs’ guarantee fees which began in April 2012, and is effective through October 1, 2021. The increased fees are to be remitted to Treasury and not retained by the GSEs. Accordingly, the increased fees do not affect the profitability of the GSEs. For fiscal years 2015 and 2014, the GSEs remitted to the Treasury the increased fees totaling $2.4 billion and $1.9 billion, respectively."

Investments in GSEs as of September 30, 2015 (In billions of dollars) Investments Cumulative Valuation Gain/(Loss) Gross Fannie Mae senior preferred stock........................................ 117.0 (61.7) Freddie Mac senior preferred stock....................................... 72.1 (35.5) Fannie Mae warrants common stock .................................... 3.1 6.2 Freddie Mac warrants common stock ................................... 2.3 2.8 Total investments in GSEs ................................................. 194.5 (88.2) Investments in GSEs as of September 30, 2014 Fair Value 55.3 36.6 9.3 5.1 106.3 Fair Value 52.7 31.4 7.7 4.0 95.8 Cumulative Valuation Gain/(Loss) Gross (In billions of dollars) Investments Fannie Mae senior preferred stock........................................ 117.0 (64.3) Freddie Mac senior preferred stock....................................... 72.1 (40.7) Fannie Mae warrants common stock .................................... 3.1 4.6 Freddie Mac warrants common stock ................................... 2.3 1.7 Total investments in GSEs .................................................. 194.5 (98.7) https://www.fiscal.treasury.gov/fsreports/rpt/finrep/fr/15frusg/02242016_FR(Final).pdf