If you’ve been playing close attention, you knew this day was coming, but that doesn’t make it any less shocking.
Fannie Mae needs money from the government for the first time since 2012.
The government-sponsored enterprise reported Wednesday morning that it suffered a net loss of $6.5 billion in the fourth quarter of 2017.
The loss is more than the $3 billion that Fannie and Freddie Mac are now allowed to hold, which means that Fannie Mae needs a draw from the Treasury of $3.7 billion to eliminate its budget deficit.
According to Fannie Mae’s earnings materials, the company expects the Federal Housing Finance Agency to submit a request to the Treasury on the company’s behalf for $3.7 billion. The money will be used to eliminate the GSE’s net worth deficit.
So, how did we get here?
The easy answer is to credit the Republican tax plan, and in many ways, that’s correct…but it’s far more complicated than that.
The first inklings that Fannie and Freddie could need more money from the Treasury came just over a year ago, when President Donald Trump and Congressional Republicans first began floating their tax reform proposal.
The issue was going to be whether the Republicans’ tax plan reduced the corporate tax rate from the previous federal statutory rate of 35% to something in the 20% range.
Why did this matter to Fannie and Freddie? It’s all about the GSEs’ deferred tax assets and the GSEs’ limited capital reserves.
Under the terms of the Preferred Stock Purchase Agreements that went into effect when the government took the GSEs into conservatorship, Fannie and Freddie send dividends to the Treasury each quarter that they are profitable.
The PSPAs also stipulated that each of the GSEs’ capital base was required to be reduced over time, with their capital reserves due to be drawn down to $0 on Jan. 1, 2018.
That all changed in December when the FHFA reached a new agreement with the Treasury that allows the GSEs to withhold billions from the Treasury to ensure that each has enough capital on hand to “cover other fluctuations in income in the normal course of each Enterprise’s business.”
The agreements stipulated that Fannie and Freddie were each now allowed to hold $3 billion in their capital reserves. And late last year, each of the GSEs made their scheduled dividend payment to the Treasury, but for the first time in a long time, Fannie and Freddie kept some of their profits for themselves.
Collectively, the GSEs made dividend payments in December to the Treasury of $2.897 billion. Of that, $2.249 billion came from Freddie Mac and $648 million came from Fannie Mae.
With the $2.897 billion sent to the Treasury for the third quarter, Fannie and Freddie have now paid approximately $278.783 billion to the Treasury in dividend payments since the fourth quarter of 2008.
But the third quarter amounts are far less than the amount of profit that each GSE made in that quarter, which is where the money in question came from.
Based on some rough calculations, Freddie withheld $2.451 billion from the Treasury, while Fannie withheld $2.352 billion.
But, as it turned out, Fannie keeping that $2.352 billion was not enough to cover the losses it suffered in the fourth quarter thanks to the Republican tax plan.
The new tax law reduced the corporate tax rate from 35% to 21%, the first reduction to that rate in 15 years.
That affected each of the GSEs’ deferred tax assets, which include “deferred fees, basis differences related to derivative instruments, mortgage related assets and allowance for loan losses.”
To put it simply, the calculations Fannie and Freddie used for their deferred tax assets were based on a corporate tax rate of 35%, but lowering it to 21% meant that they would need to write down their DTAs and likely wouldn’t have enough money in their coffers to cover the difference.
And that’s exactly what happened.
This is how Fannie Mae explained the situation in its fourth quarter earnings:
The primary driver of changes in the company’s net income for full year 2017 and the fourth quarter of 2017 was a $9.9 billion provision for federal income taxes in the fourth quarter resulting from the remeasurement of the company's deferred tax assets due to the Tax Cuts and Jobs Act (Tax Act). As a result, Fannie Mae reported a net worth deficit of $3.7 billion as of December 31, 2017.
But as stated above, the news that Fannie needs more money isn’t exactly new.
The GSE itself said as much in its 3rd quarter 10-Q filling with the Securities and Exchange Commission (emphasis added by HousingWire):
The current Administration proposes reducing the U.S. corporate income tax rate. 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.
That was before the tax plan was passed, and when the tax plan passed, the writing was on the wall: Fannie was going to need more money from the Treasury.
It’s about to increase by $3.7 billion, and likely more than that, depending on what Freddie Mac’s earnings look like.
On the plus side, it appears that Fannie’s need for funding was not caused by poor business performance. In fact, the draw could have been even worse.
The GSE reported a net loss of $6.5 billion, based on the tax write-down of $9.9 billion. That means the company would have made a profit of $3.4 billion in the fourth quarter without the tax issue.
For the year, Fannie’s net income was $2.5 billion, which again would have been increased by $9.9 billion without the tax write-down.
According to Fannie Mae CEO Timothy Mayopoulos, the company’s footing is solid.
“Our 2017 results demonstrate that the fundamentals of our business are strong. While the fourth quarter was affected by a one-time accounting charge, we expect to benefit from a lower tax rate going forward,” Mayopoulos said.
“As we mark 80 years of serving America’s housing market, our focus is on building a strong, stable housing finance system for the future. We are doing this by delivering innovative solutions for our customers and demonstrating leadership on our country’s most persistent housing challenges,” he continued. “We are in a strong position to serve the changing needs of homeowners and renters, and to advance our vision to be America’s most valued housing partner.”
Mayopoulos also said that the new lower tax rate will benefit Fannie going forward, which Fannie detailed in its earnings:
The decrease in Fannie Mae’s net income and comprehensive income in 2017 was driven primarily by a $9.9 billion provision for federal income taxes resulting from the enactment of the Tax Act. This one-time charge was due to the remeasurement of the company’s deferred tax assets using the lower corporate tax rate enacted in the fourth quarter of 2017 with an effective date of January 1, 2018. Fannie Mae expects its future net income will benefit from the lower federal corporate income tax rate. The company expects its effective tax rate to be approximately 20 percent in 2018.
Let’s consider this a bump in the road for Fannie Mae – one that could have been avoided and was certainly predicted.
But that doesn’t blunt the fact that Fannie needs money from the Treasury…again.
So, could this have been avoided?
Certainly. As previously stated, Fannie needing a draw has been telegraphed for over a year.
It could have been avoided if Congress had truly pursued housing finance reform at any point in the last five years, or even the last 12 months.
It also could have been avoided if the FHFA and the Treasury had allowed the GSEs to retain capital for more than just one quarter, as many in the industry have been calling for over the last few years.
Or if anyone in the government had done anything substantive about the GSEs’ seemingly never-ending conservatorship at any point in the last few years.
Instead, Fannie is left needing money from the Treasury. And Freddie’s earnings, which are coming Thursday, will likely show that Freddie needs a draw too.
But hopefully these are the only draws Fannie and Freddie will need ever again.
[Update: This article is updated with the total amount that the GSEs have paid to the Treasury since 2008.]