On August 17, 2012, the US Department of the Treasury (the "US Treasury") announced a Third Amendment to the Amended and Restated Senior Preferred Stock Purchase Agreements ("PSPAs") between the Federal Housing Finance Agency ("FHFA"), as conservator of Government Sponsored Enterprises Fannie Mae ("Fannie") and Freddie Mac ("Freddie") (collectively, "GSEs"). Fannie and Freddie were each placed into conservatorship on September 6, 2008, and have since received collectively almost $188 billion in taxpayer support.1 The modifications to the PSPAs announced last week are consistent with the principles and recommendations articulated in the Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac, which the FHFA submitted to the US Congress in February 2012.
Modification to Agreements with GSEs
According to the US Treasury, the modifications made by the Third Amendment are designed to enhance stability in the housing finance market while reducing over time the role of Fannie and Freddie in that market. The Third Amendment terminates the requirement that Fannie and Freddie each pay a 10% dividend annually to the US Treasury on all amounts of taxpayer support provided to them. Instead, it requires that Fannie and Freddie transfer to the US Treasury on a quarterly basis all profits earned during a quarter that exceed a capital reserve amount for each GSE that is specified in the Third Amendment ("net profit"). Initially, this capital reserve amount is set at $3 billion dollars, and the size of this capital reserve amount is reduced each year by $600 million. Thus, at the end of five years, as of January 1, 2018, there will no longer be a capital reserve amount and thereafter all profits earned in a quarter by Fannie or Freddie will be net profits that must be transferred to the US Treasury. If Fannie or Freddie fails to earn a net profit in any quarter, no amounts will be owed to the US Treasury for that quarter. Thus, as a result of the Third Amendment, Fannie and Freddie will no longer find themselves having to borrow money from the US Treasury, which they then must immediately return to the US Treasury in order to make a 10% dividend payment. The Third Amendment includes the following three key components:
Accelerated Wind Down of the Retained Mortgage Investment Portfolios at Fannie Mae and Freddie Mac
The modified PSPAs require an accelerated reduction of Fannie and Freddie's investment portfolios. Specifically, the GSEs' investment portfolios each must be reduced to $650 billion by December 31, 2012 and thereafter, each year, a further reduction of each portfolio must occur at an annual rate of 15 percent - an increase from the 10 percent annual reduction required in the previous agreements. The 15 percent annual reduction in the size of each investment portfolio shall continue until each portfolio is reduced to $250 billion, a target set in previous agreements. Decreasing the size of each investment portfolio annually by 15 percent rather than 10 percent will allow the $250 billion target to be reached by 2018, four years earlier than previously scheduled.
Annual Taxpayer Protection Plan
The modified PSPAs further require that on an annual basis, each GSE will, under the direction of the FHFA, submit a risk management plan to the US Treasury on each GSE's actions to reduce its enterprise-wide risk profile and taxpayer exposure to mortgage credit risk for both its guarantee book of business and its retained investment portfolio. Fannie and Freddie must each deliver annual plans to the US Treasury no later than December 15, 2012, and not later than December 15 of each year thereafter while each remains in conservatorship.
Full Income Sweep of All Future Fannie Mae and Freddie Mac Earnings to Benefit Taxpayers for Their Investment
Previous agreements required Fannie and Freddie to make a minimum 10 percent fixed dividend payment to the US Treasury on its preferred stock investments in each firm. The modified PSPAs will replace the 10 percent dividend payment with a quarterly sweep of every dollar of profit that each firm earns going forward that exceeds a specified capital reserve amount that each GSE is authorized and required to maintain by the amended PSPAs. The capital reserve amount shall be $3 billion for 2013 and shall be reduced subsequently by $600 million each year so that the capital reserve amount shall be zero for all years on or after January 1, 2018. This variable dividend based on net profits will eliminate the need for the GSEs to borrow from the US Treasury in order to pay the previous fixed 10 percent dividend. For dividend payments, the Third Amendment is effective no later than September 30, 2012 for each quarter commencing January 1, 2013.
SNR Denton Comments
- The US Treasury has declared that the modifications to the PSPAs mark the next step toward gradually winding down Fannie and Freddie "while continuing to support the necessary process of repair and recovery in the housing market".2
- Although the US Treasury press release announcing the Third Amendment to the PSPAs describes "every dollar of profit" as being swept on a quarterly basis, for 2013, it is actually every dollar of profit earned in a quarter over a $3 billion capital reserve amount that must be transferred by Fannie or Freddie to the Treasury. It is unclear what the purpose is of the $3 billion capital reserve amount and why the reserve amount is reduced annually by $600 million until it is reduced to zero in 5 years. Fannie currently has approximately $2.8 billion in equity and Freddie has approximately $1.1 billion in equity.
- The modifications made by the Third Amendment are designed to limit taxpayer exposure resulting from the federal government's investment in Fannie and Freddie. They also will facilitate the eventual wind down of the GSEs by ensuring that Fannie and Freddie cannot retain profits, rebuild capital and return to the market in their prior form. However, it is worth nothing that the accelerated reduction of the retained portfolio will have a significant impact on earnings. Additionally, the quarterly sweep of any profits contradicts the position of those industry observers who expressed the belief that Fannie Mae and Freddie Mac's turning profits would derail restructuring efforts.
- Going forward, if house prices begin to appreciate and loan guarantee fees are increased, the "profit" of the GSEs paid to the US Treasury will increase. This will hasten the speed with which the taxpayers are repaid, but might also prompt some to question whether the elimination of Fannie and Freddie is necessary or appropriate.
1 Initially, the US Treasury agreed to provide each GSE with up to $100 billion in taxpayer support. Subsequently, the $100 billion ceiling was increased to $200 billion for each GSE. In a Second Amendment to the PSPA, dated December 24, 2009, in addition to the previously pledged $200 billion ceiling for each GSE, the US Treasury agreed that it would cover all losses that Fannie and Freddie incur through December 31, 2012. The driver behind the timing of the Third Amendment is the need to avoid market disruptions resulting from the expiration at the end of 2012 of the foregoing pledge to keep Fannie and Freddie solvent.
2 US Department of the Treasury Press Release, Treasury Department Announces Further Steps to Expedite Wind Down of Fannie Mae and Freddie Mac (Aug. 17, 2012). See also Federal Housing Finance Agency Press Release, Statement of FHFA Acting Director Edward J. DeMarco on Changes to Fannie Mae and Freddie Mac Preferred Stock Purchase Agreements (Aug. 17, 2012).
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