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Categorized | Financial

Fannie and Freddie at risk of multibillion-dollar writedowns

Posted on November 24, 2016

US taxpayers face pumping billions of dollars into the mortgage guarantors Fannie Mae and Freddie Mac if Republicans push through tax cuts that would force the pair to take big writedowns.

Some investors believe that development would spur the Trump administration to privatise the pair, which are bedrocks of the $10tn US home loans market.

Fannie and Freddie currently benefit from US rules that allow companies to use losses incurred in previous years to lower taxes on future profits. But if Republicans reduce corporate tax rates, those “deferred tax assets” would be worth less and would have to be written down.

That would put the two groups, which have received about $188bn worth of government support since the crisis, at risk of needing additional public funds for the first time since 2012.

Investors and analysts said the disclosure highlighted Washington’s failure to reform the two institutions, which have been in a limbo status of government “conservatorship” — neither fully public nor private — since the financial crisis.

Several other companies including Citigroup, AIG and General Motors are also at risk of writedowns for similar reasons. Sid Sankaran, chief financial officer at AIG, estimated last week that a reduction in the tax rate to 20 per cent could result in a $6bn “remeasurement” at the insurer, which has about $16bn in DTAs.

However, Fannie and Freddie have wafer-thin capital buffers and are less able to absorb losses than the other companies with DTAs.

They are required to pay billions of dollars in profits to the US Treasury. By the end of 2015 they had paid it about $241bn worth of dividends. Their capital buffers, already dwindling, are due to drop to zero by 2018.

Fannie, which has DTAs worth about $35bn, acknowledges in the small print of its corporate filings that a corporate tax cut could “result in a net worth deficit for the quarter in which the reduction occurs”.

Such a deficit would force it to draw on Treasury funds “to avoid being placed into receivership”, the disclosure says. Dick Bove, banking analyst at Rafferty Capital Markets, estimated that a cut in corporate taxes from the current rate of 35 per cent to 25 per cent would trigger a writedown at Fannie of about $4bn.

Freddie, whose DTAs are worth about $19bn, warns in its filings that a reduction in corporate tax as a factor that “could influence whether we could require a draw” from the Treasury.

The size and timing of any writedown is unclear. President-elect Donald Trump and Republicans in Congress have all advocated tax cuts, but any reform package would need to be agreed upon.

Shares in Fannie and Freddie have leapt since the election on hopes a Trump administration will end the conservatorship, or at least allow Fannie and Freddie to keep more of their earnings and build up capital. Hedge fund manager Bill Ackman predicted right after the election that Mr Trump would return Fannie and Freddie to private ownership.

Michael Ciklin of Perini Capital, an investor in Fannie and Freddie’s preferred stock, said the possible need for another Treasury top-up because of changes to the tax code “highlights the absurdity of this whole situation”.

“Having to bail out companies again that generate [this amount of] earnings is insane. The DTA issue has the potential to be a replay, another non-cash accounting charge that triggers a draw.” 

Mr Bove said the threat of DTA writedowns “will force the new president, and Congress, to act”.

Mel Watt, director of the Federal Housing Finance Agency, which oversees the two groups, has already warned that a large quarterly loss — and the resulting need for more Treasury funds — “could undermine confidence in the housing finance market”.

The two groups’ total assets of $5.3tn are worth more than those of the biggest two US banks, JPMorgan Chase and Bank of America, combined.

The FHFA declined to comment and the Treasury did not respond to a request for comment.