The Federal
Housing Finance Agency's Office of Inspector General (FHFA OIG) released a
report today examining the recent changes to the Preferred Senior Stock
Purchase Agreements (PSPAs) between the Department of the Treasury and the two
government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.
The objective of this report was to:
- Describe the 2012 Amendments to the PSPAs;
- Examine their goals; and
- Assess their potential impacts.
OIG
concluded that the changes had the potential to allow for larger payments to
the Treasury than the old dividend structure, hastening the payoff of their
debt to taxpayers. They would also end
the circularity of the GSEs borrowing money from Treasury in order to pay
dividends to Treasury.
When the GSEs
were placed into conservatorship under FHFA, the U.S. Treasury committed to
financially support them when needed to ensure that their liabilities did not
exceed their assets.
Under the
Preferred Senior Stock Purchase Agreements the two companies signed with the
Treasury in September 2008 Treasury agreed to make quarterly payment to the GSEs
if needed in order for them to maintain a zero net worth at the end of each
quarter up to a cap of $100 billion for each GSE. In February 2009 that cap was expanded to
$200 billion for each and later that year was increased further to cover
"quarterly net worth deficits from 2010 to 2012 and then for future years subject
to an intricate formulaic cap. As of January 1, 2013, Freddie Mac had $140.5 billion
in commitment available
under that cap and Fannie Mae's was the greater of $83.9 billion or $124.8
billion less any positive net worth on December 31, 2012.
In return the GSEs agreed to provide Treasury with senior
preferred stock, quarterly dividends, warrants to
purchase 79.9% of each Enterprise's
common stock, and
commitment fees. The GSEs
also agreed to certain covenants including that they reduce their respective
mortgage portfolios by 10 percent each year until they each reached $250
billion.
The senior
preferred stock had an initial value or liquidation preference of $2 billion
which increased dollar for dollar with each draw made from Treasury by a
GSE. As
of December 2012, Treasury held senior preferred stock with
a liquidation preference of $189.5 billion for the two
GSEs - the original $2
billion plus $187.5
billion in draws since then.
Under the
original agreement the stock
certificates required a dividend at an annual rate of 10% of
the liquidation preference, to be paid quarterly. As a result, even before Treasury provided any funds to the
GSEs, they each owed Treasury payments of $100
million per year,
As Treasury provided funds to the Enterprises under the PSPAs
the liquidation preference of the stock increased as did the amount of the dividends, eventually to nearly $19 billion per
year from both GSEs.
In
August 2012 both GSEs announced they had generated positive quarterly earnings
- $5 billion for Fannie Mae and $3 billion for Freddie Mac. Two weeks later Treasury and FHFA announced
modifications to the PSPAs in five areas. The amendments: (1) changed the structure of
dividend payments
owed to Treasury; (2)
increased the GSEs' rate of mortgage asset reduction from 10 percent each year to 15
percent; (3) suspended the periodic
commitment fee; (4) required
that the GSEs produce
annual risk management plans;
and (5) exempt dispositions at fair market value under $250
million from the requirement of Treasury consent.
For
purposes of the OIG report the most important change was that of the dividend
structure so that the GSEs are no longer required to draw funds from Treasury just to pay Treasury dividends.
As of January 1, 2013, the dividend payment is no longer based on a fixed percentage of the liquidation preference. Instead, the dividend is based on a "positive net worth" model,
in which Treasury would
simply take, as dividends, the entire positive net worth of each GSE above a buffer amount. The
buffer was set at $3 billion
for each GSE
initially, to
be incrementally reduced to zero over five years. If an Enterprise has positive net worth that is less than the buffer, then the dividend payment to Treasury under the
2012 Amendments would be zero.
OIG
assessed the financial impact of the changes in dividend structure as follows.
-
As
the GSEs were able to pay to Treasury their dividends for the second and third
quarters of 2012 and Freddie Mac was able to pay in the fourth quarter without
any draws under the PSPAs, the new system could result in larger net payments
to Treasury.
- Accounting treatment related to deferred tax assets might result in substantial one-time
dividend payments from each GSE under the new system. This would be the result
of valuation allowances created during a period where the GSEs did not expect
to have taxable income and which can be used to offset any taxable income in
the future.
-
The
2012 Amendments make it impossible for the GSEs to build up any capital and so,
in the words of Treasury's press release announcing the amendments "will not be allowed to retain
profits, rebuild
capital, and return to the market in their prior form."
OIG said that
the 2012 Amendments had three
intents:
-
Benefit to taxpayers;
-
Continued flow of mortgage credit; and
-
Wind down of the Enterprises.
To some extent, the 2012 Amendments provide the mechanisms to achieve these goals,
with the dividend structure allowing faster payoff of the Treasury debt and
ending the circularity of financing the dividend. This could in turn shore up investor
confidence and promote the continued flow of mortgage credit. The Amendments, while accelerating the wind down
of the GSEs' portfolios, do not wind down their securitization business and,
OIG said that side of the enterprises may continue to prosper, as least in the
near term. "Fundamentally, the 2012 Amendments
position the GSEs to function in a holding pattern,
awaiting major policy decisions in the future."