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Fitch: Fannie's Earnings, Dividend to Complicate GSE Reform


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Interesting situation here...


Fitch: Fannie's Earnings, Dividend to Complicate GSE Reform

Friday, May 10, 2013 02:30:00 PM (GMT)



Fannie Mae's strong first quarter financial results and its planned $59.4 billion dividend payment to the U.S. Treasury will likely complicate efforts to pursue far-reaching GSE reform, according to Fitch Ratings. Better operating trends at both Fannie Mae and Freddie Mac, driven by continued healing in the housing market and the growing role of recent-vintage mortgages, will likely further reduce pressure on Congress to overhaul the U.S. housing finance system.


The political motivation to overhaul the GSEs and the broader mortgage market remains limited. With the point where taxpayers are effectively made whole on their investment in GSEs now in sight, we believe broad reform will become more challenging to achieve. The Federal Housing Finance Agency has recently undertaken some initiatives to reduce Fannie and Freddie's dominance in the housing market. However, GSEs have been operating under conservatorship for close to five years and continue to dominate the market.


A one-time accounting adjustment, the reversal of a $50.6 billion deferred tax asset (DTA) allowance, drove the bulk of Fannie Mae's first quarter net income of $58.7 billion. The increase in net worth to $62.4 billion requires Fannie to pay a significantly higher dividend to the Treasury under the terms of the amended support agreement. The GSE plans to fund the payment with proceeds from debt issuance.


We think this incremental debt is manageable within the context of Fannie's balance sheet and the debt limit set out in the senior preferred-stock purchase agreement. Fannie's debt was $144 billion below the limit on March 31.


Fannie will make a cash dividend payment of $59.4 billion to the Treasury by June 30. After that payment, total dividends paid by Fannie will represent 81% of its cumulative draw from the Treasury. We believe the cumulative dividends paid by Fannie could exceed the $117 billion in senior preferred stock owned by the Treasury by late this year or early 2014, based on the current earnings run-rate.


Freddie Mac continues to evaluate its DTA allowance, but Fitch believes it will likely follow suit and reverse its $30 billion reserve in the coming quarters, as its financial performance has also improved significantly over the past year. As a result, it would also pay a substantially higher dividend to Treasury. The dividends do not technically reduce the $187 billion injected into the GSEs by the Treasury. However, both entities will have paid cumulative dividends representing over 80% of the Treasury's investment, once Freddie Mac reverses its DTA allowance.


Excluding the impact of the large DTA reversal, Fannie's pretax earnings for the first quarter were strong at $8.1 billion. Results were supported by an increase in net interest income and continued improvement in credit quality. As a result of the Bank of America settlement completed in the first quarter, Fannie recorded a one-time benefit to net interest income. Excluding this benefit, Fannie's core earnings results for the first quarter were largely consistent with fourth-quarter 2012 results.


As asset quality improved, Fannie reduced its total loss reserves by $2.4 billion during the quarter. The serious delinquency rate dropped to 3.02% at March 31, compared with 3.29% at year-end 2012. Net sales prices for REO also rose as the housing market recovery continued in the quarter.


We do not expect the reversals in the DTA allowance for Fannie Mae -- or the potential reversal for Freddie Mac -- to have an impact on ratings for either entity. The ratings are directly linked to the U.S. sovereign rating based on the U.S. government's direct financial support.


For a detailed review of the outlook for the GSEs and reform options, see "U.S. Housing Finance GSEs" Where to From Here?," dated Feb. 28, 2013, at www.fitchratings.com.


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