When mortgage finance companies Fannie Mae and Freddie Mac reported their second-quarter earnings this week, analysts were less interested in the companies’ bottom lines than in what might be called their forward guidance.
Ever since 2012, when the two companies were directed to send their quarterly profits to the U.S. Treasury and whittle their remaining capital buffers to zero by 2018, they’ve complied – and used their earnings releases to announce the amounts to be transferred.
But as 2018 draws nearer and capital shrinks, the enterprises’ regulator has grown more concerned about what could happen if either company has a bad quarter. Fresh language in the earnings releases reflects the desire of the regulator, the Federal Housing Finance Agency, to remind Congress of how precarious the state of affairs has become for the two. But it also serves as a reminder of how far the companies have come since their crisis-era bailout, not thanks to Congressional action, but in spite of its inaction.
“Our dividend requirement to Treasury in September 2017 will be $2.0 billion,” Freddie’s /zigman2/quotes/202741363/delayed FMCC +0.40% release, issued Tuesday, read. “If the Conservator declares a senior preferred stock dividend equal to our dividend requirement and directs us to pay it before September 30, 2017, we would expect to pay a dividend of $2.0 billion by September 30, 2017.”
On Thursday, Fannie /zigman2/quotes/208846331/delayed FNMA 0.00% wrote that it had “a positive net worth of $3.7 billion as of June 30, 2017. As a result, the company will pay Treasury a $3.1 billion dividend in September 2017 if the Federal Housing Finance Agency (FHFA) declares a dividend in this amount.”
Analysts and reporters seized on the conditional language to question whether Mel Watt, FHFA’s director, was making good on a suggestion that he might withhold a quarterly dividend payment in order to keep some protective capital for the enterprises. Management of both companies deferred that question to FHFA.
“Before the crisis these institutions were basically large hedge funds and now they’re mortgage guarantee funds.”
But other new language, summarized by a comment from Fannie, hinted at the future beyond the next few quarters. “Fannie Mae has transitioned from a portfolio-focused business to a guaranty-focused business,” the company wrote.
“Here we are coming on nine years later, and they’ve done what they needed to do,” said Mark Zandi, chief economist for Moody’s Analytics. “That’s appropriate. Before the crisis these institutions were basically large hedge funds and now they’re mortgage guarantee companies. People think they’ve been standing still but they’ve evolved into what we want them to be.”
That evolution, which began in the darkest moments of the financial crisis, has been choppy. The terms of the 2008 bailout were amended in 2012 to direct quarterly payments be swept to Treasury. That’s wiped out holders of the companies’ stock, and they’ve fought the federal government in court since then.
Even as Congress has flailed, making several attempts to reform the housing finance system that ultimately failed, Fannie and Freddie have focused on developing new ways for private investors to take risk off their books.
They’re also trying to keep mortgage lending accessible but safe. Both have introduced products that allow borrowers to make low-single-digit down payments, but thanks to prudent underwriting, Fannie said its serious delinquency rate had fallen for 28 straight quarters, while Freddie’s was at its lowest point since 2008.
Capital Alpha’s Charles Gabriel on Wednesday wrote that “Watt has overseen Fannie and Freddie competently, if not boldly — in our view, not a bad call on his part, frustrating as it’s been along the way.”
But Gabriel called testimony from Watt in May, in which he reminded the Senate Banking Committee that he has the authority to withhold a Treasury dividend, “still-underappreciated.”
“This threat could yet provide the grist for targeted legislation (e.g., to direct the GSEs’ toward annual rather than quarterly dividends), if GSE legislation (predictably) comes to seem stalled later this year,” Gabriel noted.
Zandi also believes that changing the quarterly Treasury payout to an annual one has merits. And he too has little hope for comprehensive housing finance reform before 2019, after the midterm elections – but he isn’t sure much needs to be changed with the way Fannie and Freddie are functioning now.
In a reform proposal Zandi and several partners released last year, the future Fannie and Freddie were envisioned as almost utilities, guaranteeing mortgages through a common platform for standardized, homogenized securities that allows them to share the risk with the private sector.
That future state, down to the common securitization platform, is nearly here, Zandi told MarketWatch. As Freddie CEO Don Layton said on its earnings call, “This is not your parents’ Freddie Mac.”