Fannie Mae-No Politics (FNMA)

[navycmdr]

Here’s what else tax reform means: another bailout of Fannie and Freddie

Published: Dec 5, 2017 2:19 p.m. ET

The consequences of tax reform will hit the enterprises at exactly
the moment they run out of capital.


Fannie Mae headquarters in Washington, D.C.

By ANDREA RIQUIER

The tax legislation currently under discussion in Congress is almost certain to have one big unintended, and uncomfortable, consequence.

Fannie Mae and Freddie Mac, the two giant mortgage financiers, hold billions of dollars of “deferred tax assets” on their balance sheets. These assets include items like credits that can be used to defray tax bills in future years.

But if the corporate tax rate is reduced, the value of those assets would tumble.

Mark Zandi, chief economist for Moody’s Analytics, estimates that the hit to the assets, which are currently worth about $45 billion, would be about $20 billion, assuming the corporate rate is cut to 20% from 35%.

Losses of tens of billions would be tough for any corporation to withstand. But Fannie FNMA, +0.08% and Freddie FMCC, +0.35% will have it especially hard. Under the terms of a 2012 directive from Congress, the two are required to send their quarterly profits to the Treasury, thereby reducing their capital buffers to zero by 2018.

Read: Congress wouldn’t do it, so Fannie and Freddie reformed themselves
https://www.marketwatch.com/story/congress-wouldnt-do-it-so-fannie-and-freddie-reformed-themselves-2017-08-03

That means a quarterly loss could force either or both to draw money from Treasury — in effect, taking a taxpayer bailout.

Over the years, as their capital has dwindled, the two enterprises have used their quarterly earnings reports to remind investors of how precarious their positions are becoming.

“This variability of GAAP earnings, which may not reflect the economics of our business, and the declining capital reserve required under the terms of the Purchase Agreement (ultimately reaching zero in 2018) increase the risk of our having a negative net worth and thus being required to draw from Treasury,” Freddie Mac wrote in its most recent 10-Q. “We could face a risk of a draw for a variety of reasons, including interest-rate volatility and spread volatility.”
http://otp.investis.com/clients/us/federal_homeloan/SEC/sec-show.aspx?FilingId=12348243&Cik=0001026214&Type=PDF&hasPdf=1

Mel Watt, director of the Federal Housing Finance Agency, the regulator of the two enterprises, told the Senate Banking Committee in May that reform is “urgently needed” to keep the housing finance system running smoothly. If Fannie or Freddie needed to draw funds, Watt said, it would undermine private investors’ confidence in the broader housing finance system.

Read: Fannie and Freddie are nearly out of money and Washington is getting anxious
https://www.marketwatch.com/story/fannie-and-freddie-are-nearly-out-of-money-and-washington-is-getting-anxious-2017-05-11

But six months later, Congress has made no real attempt at reforming the housing finance system to allow the enterprises to hold capital buffers, or otherwise avoid such pitfalls.

In response to a MarketWatch request for comment, FHFA pointed only to Watt’s May testimony. It’s worth noting that Fannie Mae has mentioned tax reform and the deferred tax assets explicitly in its quarterly earnings filings.
http://www.fanniemae.com/resources/file/ir/pdf/quarterly-annual-results/2017/q32017.pdf

“The current Administration proposes reducing the U.S. corporate income tax rate,” the company wrote. “Under applicable accounting standards, a significant reduction in the U.S. corporate income tax rate would require that we record a substantial reduction in the value of our deferred tax assets in the quarter in which the legislation is enacted. Thus, if legislation significantly lowering the U.S. corporate income tax rate is enacted, we expect to incur a significant net loss and net worth deficit for the quarter in which the legislation is enacted and we could potentially incur a net loss for that year.”

Some housing finance watchers are skeptical that a draw will have any impact.

“I don’t think there will be any fallout at all from this draw,” Zandi told MarketWatch. “Investors are attaching an increasingly high probability to tax legislation and are connecting the dots for what it means for every business, including Fannie and Freddie.”

If investors were truly worried, they’d be driving up the cost of mortgage-backed securities, which would in turn pressure mortgage rates up, which hasn’t happened, Zandi said.
https://www.marketwatch.com/story/mortgage-rates-sink-for-now-but-a-big-bond-yield-climb-looms-2017-11-30

Neither will it nudge Congress to action, Zandi said. “It highlights why Congress needs to act because at some point we’ll go into a downturn and the losses are not related to accounting, they’re related to credit.” In such a case, losses could total in the hundreds of billions, not tens of billions, and mortgage investors will become nervous.

But Rob Zimmer, a lobbyist for small mortgage lenders, sees it differently. He knows from frequent conversations with Congressional Republicans that all are keenly aware of the self-inflicted headline risk of allowing Fannie and Freddie to take more taxpayer money.

“Back home they will be asked about it,” he said. “How are they going to respond when constituents ask, how did you let this happen again? Who are they going to blame, Obama?”