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Mark Yu
Mark Yu
Articles (397)  | Author's Website |

Understanding Fannie Mae-Treasury Relationship Crucial

If freed from government control it could provide dividends, capital returns to shareholders

December 06, 2016 | About:

Steven Mnuchin, President-elect Donald Trump’s nominee to be U.S. Treasury secretary, said on Nov. 30 Fannie Mae (FNMA) and Freddie Mac (FMCC) should leave government control and that the incoming administration “will get it done reasonably fast.”

“We will make sure that when they are restructured, they are absolutely safe and don’t get taken over again. But we’ve got to get them out of government control,” Mnuchin said.

(Bloomberg)

Shares of Fannie Mae soared 45.8% accompanied by 25 times the volume (79.7 million shares traded) compared to the previous day while Freddie Mac soared 45.7% on 26 times the volume (39 million shares).

According to the Bloomberg article, there is a big possibility that the Trump administration would be open to allowing both companies to retain profits.

(Quarterly Filing)

Fannie Mae

Found in Fannie Mae’s recent annual filing is the statement that the company has been under conservatorship with the Federal Housing Finance Agency (FHFA) acting as conservator since September 2008 (1).

The FHFA has all the rights, titles, powers and privileges of Fannie Mae with respect to its business operations and assets. Further, Fannie Mae has no fiduciary duties to any other person or organization except to FHFA.

Fannie Mae is a government-sponsored enterprise (GSE) that was chartered by Congress in 1938. Fannie Mae serves an essential role in the functioning of the U.S. housing market and invests in improvement to the U.S. housing finance system.

Fannie Mae stated that its public mission is to support liquidity and stability in the secondary mortgage market (2).

As of the third quarter, Fannie Mae is one of the largest issuers of mortgage-related securities in the secondary market and has an estimated 38% market share of new single-family mortgage-related securities issuances.

Fannie Mae securitizes mortgage loans originated by lenders into Fannie Mae MBS. The company evaluates, prices and manages the credit risk on the loans (and securities) that it guarantees. Fannie Mae also purchases mortgage loans and mortgage-related securities and sells those at a later date.

Fannie Mae funds its business activities by issuing variety of debt securities in the U.S. and international capital markets.

Fannie Mae has no specified termination date in terms of its FHFA conservatorship. Fannie Mae also claimed that it does not know what further changes to its business will be made during this period of conservatorship.

Further, Fannie Mae's agreements with U.S. Treasury and FHFA directors does not permit the company to perform the following:

  • Retain its net worth (other than a limited amount that is set to go to zero by 2018).
  • Rebuild its capital position or pay dividends or other distributions to stockholders other than Treasury.

Fannie Mae has three business segments: Single-Family, Multifamily and Capital Markets

Single-Family

The segment acquires single-family mortgage loans through loan purchases. Fannie Mae acquires these loans by swap transactions or with its Capital Markets dealings (3). A single-family loan is secured by a property with four or fewer residential units.

Fannie Mae then prices and manages the credit risks associated with this type of loan and transfers a portion of the credit risk in its single-family guaranty book of business. Another function of the segment works to prevent foreclosures and reduce costs of defaulted loans.

The segment earns business by receiving compensation for assuming and managing the credit risks found in its guaranty book of business. The segment also seeks additional sales by recognizing interest income not recognized for the loans in its retained mortgage portfolio.

Expenses related to the segment operations are credit-related, administrative expenses and TCCA fees (4).

Fiscal 2015 results

Single-family segment revenue contributed 58.6%, or $13.3 billion, in total Fannie Mae revenue (5). The segment had $5.1 billion in profits, compared to $8.48 billion in FY 2014 (7).

Fannie Mae also provided additional key performance data that may help understand its segment operations, such as single-family’s total rate and delinquency rate for the single-family segment.

Total rate was defined as the single-family segment's guaranty fee income divided by the average guaranty book of business. Delinquency rate, meanwhile, considers the number of single-family conventional loans that are 90 days or more past due or in the foreclosure process.

In fiscal 2015, the total rate for the segment was 0.44%, and the delinquency rate was 1.55%.

Nine months of fiscal 2016

Single-family profits grew 66% to $6.97 billion, compared to the same period last year. The segment’s total rate was at 0.46%, compared to 0.44%, and its delinquency rate was at 1.24%, compared to 1.59%.

Multifamily

According to Fannie Mae, this segment provides mortgage market liquidity for properties with five or more residential units (8). The segment works with Fannie Mae's Delegated Underwriting and Servicing program to securitize multifamily mortgage loans in swap transactions.

The segment, as in single-family, also prices and manages credit risks on this type of loan. Also, the segment works to prevent foreclosures and reduce costs of defaulted loans.

Unlike the single-family segment, Fannie Mae is not tasked to pay TCC fees in its multifamily segment. The segment generates revenue similarly to its single-family operations.

Fiscal 2015 results

Multifamily segment revenue contributed 7.1%, or $1.6 billion, in total Fannie Mae revenue (5). The segment had $1.5 billion in profits, compared to $1.46 billion in fiscal 2014 (9).

Some of the additional key performance data by the multifamily segment were its effective guarantee fee rate and credit loss ratio. In addition, the multifamily segment also had delinquency figures.

The effective guarantee fee rate is calculated by multifamily segment guaranty fee income divided by the average multifamily guaranty book of business. Credit loss ratio is obtained by dividing multifamily segment credit losses by the average multifamily guaranty book of business.

Multifamily effective guaranty fee rate in fiscal 2015 was at 0.69%, credit loss ratio was at -2.7 basis points. Fannie Mae defined the negative value in credit loss ratio as a result of recoveries on previously charged-off amounts. Meanwhile, multifamily delinquency rate was at 0.07%.

Nine months of fiscal 2016

Multifamily profits grew -10.7% to $1 billion, compared to the same period last year. The segment’s effective guaranty rate was at 0.72% compared to 0.68%, credit loss ratio was at 0.1 basis points compared to 0.4, and its delinquency rate was at 0.07% compared to 0.05%.

Capital Markets

This segment manages Fannie Mae's mortgage-related assets and other interest-earning nonmortgage investments.

Fannie Mae funds its purchases primarily through proceeds from debt issuance in domestic and international capital markets. The segment also purchases loans from large group of lenders, securitizes these loans, and may sell the securitized loans to dealers and investors (10).

Fiscal 2015 results

Capital markets segment revenue contributed 22.7%, or $5.17 billion, in total Fannie Mae revenue (5). The segment had $5.48 billion in profits, compared to $8.1 billion in FY 2014 (9).

Nine months of fiscal 2016

Capital markets profit declined by 47% to $2.2 billion for the period.

Consolidated Figures

In fiscal 2015 results, Fannie Mae’s net revenue grew -12% to $22.76 billion while profits grew -21.9% to $10.6 billion. During the nine months of fiscal 2016, Fannie Mae’s net revenue grew -8% to $16 billion while profits grew -18.8% to $6.79 billion.

(Annual and quarterly filings)

Senior preferred stock and warrant

Here is the interesting part: Fannie Mae allocates huge amount of earnings in its issued senior preferred shares.

During the event of conservatorship, Fannie Mae issued 1 million shares of Variable Liquidation Preference Senior Preferred Stock, Series 2008-2 to the U.S. Treasury. The preferred shares were valued at $1 billion upon initial liquidation. In addition to the preferred shares, Fannie Mae also issued a warrant to the U.S. Treasury whereby it provided the rights to purchase 79.9% of total number of Fannie Mae shares outstanding.

According to Fannie Mae, the company did not receive any cash proceeds as a result of issuing the preferred shares and warrant. The issuance of both preferred shares and warrant was an initial commitment fee the company paid for the Treasury’s assistance and funding from the Great Recession onward.

Further, the dividends payable in any period are not paid in cash and will be accrued and added to the liquidation preference of the senior preferred stock.

(Press Release)

For periods through Sept. 30, Fannie Mae has requested cumulative draws totaling $116.1 billion and paid $151.4 billion in dividends to Treasury.

Under the senior preferred stock purchase agreement, the payment of dividends does not offset prior draws. As a result, Treasury maintains a liquidation preference of $117.1 billion on the company’s senior preferred stock. Also, Fannie Mae is not permitted to redeem the senior preferred stock prior to the termination of Treasury’s funding commitment under the senior preferred stock purchase agreement.

(Quarterly Filing)

Cash, debt and book value

As of September, Fannie Mae had $26.6 billion in cash and $3.2 trillion in debt. I am not so sure what to make of the debt-equity ratio, but Fannie Mae reported a positive shareholder equity and book value of $4.18 billion, compared to $4 billion last year.

Cash flow

(Quarterly filing)

Fannie Mae did not deliver positive cash flow from operations during the recent nine-month operations nor did it last year. But as observed, its investing activities delivered some worthy figure of $176.3 billion, -9% compared to last year’s.

Fannie Mae also made more payments to redeem its debt and related consolidated trusts leaving it with negative $159.67 billion in financing activities.

Conclusion

Understanding Fannie Mae and its relationship with the U.S. Treasury is essential prior to joining the crowd in buying its shares to build up conviction.

From what I understood, the company earns a ton of money but produces no operational cash flow and is heavily in debt. Part of the reason may be its commitments to the Treasury.

It certainly is hard to value Fannie Mae using traditional valuation measures, such as price-earnings (P/E) and price-book (P/B) value. Nonetheless, if Fannie Mae was indeed let go from the government’s control, then it could rather provide dividends and as it already demonstrated, capital returns, to its common shareholders.

I would personally refrain joining the ride secondary to uncertainties surrounding the restructuring mentioned by the Treasury appointee, and would wait for Fannie Mae to deliver steady sales, profit and (if possible) free cash flow growth prior to purchasing the shares. This may be years in development.

In summary, Fannie Mae is an easy pass.

Notes

(1) Wikipedia:

The Federal Housing Finance Agency (FHFA) is an independent federal agency created as the successor regulatory agency resulting from the statutory merger of the Federal Housing Finance Board (FHFB), the Office of Federal Housing Enterprise Oversight (OFHEO), and the U.S. Department of Housing and Urban Development government-sponsored enterprise mission team, absorbing the powers and regulatory authority of both entities with expanded legal and regulatory authority, including the ability to place government sponsored enterprises (GSEs) into receivership or conservatorship.

(2) 10-K: Secondary mortgage market is where existing mortgage-related assets are purchased and sold and to increase the supply of affordable housing.

Fannie Mae does no business in origination of loans or lending money to home buyers or as observed in primary mortgage market activities.

(3) Me: Acquire is defined by Fannie Mae as a referral to both its securitizations and purchases of mortgage-related assets.

(4) 10-K: TCCA fees consists of a portion of single-family home's (or Fannie Mae's) guaranty fees that is remitted to U.S. Treasury. Fannie Mae expects this expense to increase in future periods.

(5) Me: Revenue was based on this table provided Fannie Mae in its 10-K page 21

(6) Me: the single-family segment results can be found on page 86 of Fannie Mae’s 10-K. Credit-related income (or expense) consists of the benefit (provision) for credit losses and foreclosed property income (expense).

(7) Me: single-family segment had $5.132 billion in net income attributable to Fannie Mae in fiscal 2015. Dividing this figure to $13,326 (segment revenue in fiscal 2015) gave an assumed margin of 38.51%.

(8) 10-k: These units maybe classified as apartment communities, cooperative properties, seniors housing, dedicated student housing or manufactured housing communities.

(9) Me: The multifamily segment results can be found on page 89 of Fannie Mae’s 10-K. I divided $1.507 billion (net income attributable to Fannie Mae) by the segments revenue of $1,612 to obtain the assumed profit margin.

Supposed assumed profit margin for Capital Markets segment was 106%.

(10) 10-K: other capital markets primary business activities included: responsibility in issuing structured Fannie Mae MBS for customers in exchange for a transaction fee. Further, the segment provides other fee-related services to its lender customers.

Capital markets segment also manages the interest rate risk on Fannie Mae's portfolio by issuing a variety of debt securities in a wide range of maturities and by using derivatives.

(11) Press release: In August 2012, the terms governing the company’s dividend obligations on the senior preferred stock were amended. The amended senior preferred stock purchase agreement does not allow the company to build a capital reserve.

Disclosure: I do not have shares in Fannie Mae.

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About the author:

Mark Yu
A doctor in physical therapy (DPT) with a passion for finance. Not a registered financial analyst. Value seeker. Long only. Global investing. Long-term investing.

Attempts to dissect company filings per day. Dislikes goodwill and intangible assets.

For quicker reading--jump ahead to an article's conclusion.

One company (review) a day keeps the speculation (hopefully) away.

Would typically invest $500 to $3000 of own money per buy recommendation.

"The only source of knowledge is experience"

"I have no special talent. I am only passionately curious." Albert Einstein

"To strive, to seek, to find, and not to yield." Alfred, Lord Tennyson

"We find one a year, that's terrific. You do not need a hundred or a thousand great investment ideas to do well. You need a couple. And, the discipline is the most important thing." Warren Buffett

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