Federal National Mortgage Association FNMA and Federal Home Loan Mortgage Corp FMCC shares are rocking Thursday after the Treasury Department and the Federal Housing Finance Agency announced that Fannie Mae and Freddie Mac will be allowed to retain a portion of their income to start building up a capital cushion. The announcement comes on the heels of tax reform legislation that could put Fannie and Freddie at risk of deferred tax asset write-downs.
Let The Capitalization Begin
Each government-sponsored entity will be allowed to retain $3 billion in the fourth quarter, FHFA Director Mel Watt said in a statement.
“While it is apparent that a draw will be necessary for each enterprise if tax legislation results in a reduction to the corporate tax rate, FHFA considers the $3 billion capital reserve sufficient to cover other fluctuations in income in the normal course of each enterprise’s business,” Watt said. “We, therefore, contemplate that going forward enterprise dividends will be declared and paid beyond the $3 billion capital reserve in the absence of exigent circumstances.”
The capital retention comes as welcome news for Fannie Mae and Freddie Mac investors. If the two GSEs are ever going to be released from government conservatorship, they will first need to build up an adequate capital base.
What Does It Mean?
While capital retention is a step in the right direction for investors, it doesn’t necessarily mean an imminent end to conservatorship. Earlier this year, Height Securities analyst Edwin Groshans estimated it would take roughly a decade for Fannie and Freddie to be adequately capitalized if they were allowed to retain 100 percent of their earnings. Groshans has said Fannie and Freddie common shareholders could experience major dilution if the Treasury chooses to exit its $187.5-billion ownership stake in the two GSEs.
On Thursday, Groshans said capital retention is “a significant positive development” for Fannie and Freddie.
“Legislation that maintains the GSEs as a critical component of the housing finance system and the first capital retention in almost five years are significant indicators that there is a sea change underway in Washington regarding the GSEs,” Groshans said.
Groshans said Fannie and Freddie investors should now be watching anticipated housing finance legislation in 2018.
Fannie and Freddie shares traded higher by about 4 percent Thursday morning. Despite the positive developments for Fannie and Freddie in 2017, both stocks remain down more than 24 percent year-to-date.
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