FHFA: A number of options were considered for reformulating the dividend structure

FHFA has an Office of Inspector General that serves as a type of “regulator of the regulator.”

On their website, it states, “FHFA OIG’s mission is to promote the economy, efficiency, and effectiveness of FHFA’s programs; to prevent and detect fraud, waste, and abuse in FHFA’s programs; and to seek sanctions and prosecutions against those who are responsible for such fraud, waste, and abuse.”

It would be interesting to know how the OIG views the Sweep Agreement today, now that Fannie and Freddie have paid back more than they received from the US Treasury.

However, the OIG wrote a white paper in May 2013 that analyzed the Sweep titled, “Analysis of the 2012 Amendments to the Senior Preferred Stock Purchase Agreements.”

I recommend reading the entire paper as it’s only 25 pages long and a pretty quick read. The following are some excerpts:

“Amendments to the PSPAs

On February 18, 2009, Treasury announced that it was increasing the amount of its commitment under the PSPAs from $100 billion to $200 billion per Enterprise “to provide assurance to market participants that Congress gave these companies a special purpose to support housing finance … [and Treasury] stand[s] firmly behind their ability to provide that support.” This change was memorialized in amendments to the PSPAs dated May 6, 2009. On December 24, 2009, facing the December 31, 2009, deadline for its HERA authorization to commit funds to the Enterprises, Treasury again announced that it was increasing its commitment to support the Enterprises. Treasury committed to provide as much funding as the Enterprises needed to prevent insolvency through 2012, with a cap for later years.

According to Treasury, this formulaic funding cap was intended once again to “leave no uncertainty about the Treasury’s commitment to support these firms as they continue to play a vital role in the housing market during this current crisis.”

Nevertheless, insofar as Treasury was providing billions of additional dollars to the Enterprises to fund the 10% dividends that were paid back to Treasury, various market participants raised concerns about depleting the available commitment amount.

After 2009, Treasury no longer had the statutory authority under HERA to increase the commitment caps for the Enterprises. However, it did have authority to change other aspects of the PSPAs. Nearly 17% of total PSPA draws by Fannie Mae and nearly 10% of total PSPA draws by Freddie Mac had been used to pay the dividends to Treasury through the first quarter of 2012. Treasury decided to focus on ways to ensure that the Enterprises would no longer be required to take draws just to make dividend payments. A number of options were considered for reformulating the dividend structure.

In the end, in 2012, Treasury settled on the “positive net worth” model, in which Treasury would simply take, as dividends, the entire positive net worth of each Enterprise each quarter. Treasury is phasing in this change by establishing a net worth “buffer” such that net worth above the level of the buffer will be paid to Treasury. The buffer was set at $3 billion for each Enterprise initially, to be incrementally reduced to zero over five years. If an Enterprise has positive net worth that is less than the buffer, then the dividend payment to Treasury under the 2012 Amendments would be zero.

As the 2012 Amendments were under consideration, Fannie Mae and Freddie Mac were experiencing a turnaround in their profitability. Due to rising house prices and reductions in credit losses, in early August 2012 the Enterprises reported significant income for second quarter 2012. Fannie Mae had net income of $5 billion and Freddie Mac had net income of $3 billion, and neither required a draw from Treasury under the PSPAs.

On August 17, 2012, less than two weeks after the Enterprises announced their positive quarterly earnings, Treasury and FHFA announced that they had modified the terms of the PSPAs. In its press release, Treasury said that the changes would “help expedite the wind down of Fannie Mae and Freddie Mac, make sure that every dollar of earnings each firm generates is used to benefit taxpayers, and support the continued flow of mortgage credit during a responsible transition to a reformed housing finance market.” (See Appendix A for Treasury’s press release.) The 2012 Amendments modify five areas of the PSPAs.

They: (1) change the structure of dividend payments owed to Treasury; (2) increase the Enterprises’ rate of mortgage asset reduction; (3) suspend the periodic commitment fee; (4) require that the Enterprises produce annual risk management plans; and (5) exempt dispositions at fair market value under $250 million from the requirement of Treasury consent. These changes are described in further detail below.

Changes to the Dividends

As indicated above, the PSPAs’ original dividend rate was 10% of the liquidation preference, which is equal to the amount that each Enterprise has drawn from Treasury each quarter to keep its liabilities from exceeding its assets, plus the initial $1 billion commitment fee per Enterprise. Because of the 10% dividend rate and the large amount drawn in the four years since the inception of the PSPAs, the Enterprises’ combined dividend obligation had risen to approximately $19 billion per year in 2012. Even with the Enterprises’ improving financial conditions, that number is considerable. As Fannie Mae’s CFO was quoted saying, “It’s hard for me to envision that we would be able to make enough every single quarter to cover the dividend payment.”

Thus, even as the Enterprises returned to financial health, they might still have required draws just to make the dividend payments to Treasury.”

“Possible Negative Impact of Accelerated Reduction of Illiquid Assets in the Retained

The faster reduction in the Enterprises’ retained mortgage portfolios required by the 2012 Amendments is intended to reduce their risk exposure and simplify their operations. However, as the Enterprises decrease their portfolios, they may be required to sell less liquid assets at unfavorable prices. The Enterprises’ portfolios typically shrink as mortgagors prepay or the Enterprises sell their holdings. The Enterprises may comply with the mandated reductions that exceed prepayments by selling assets that are readily marketable such as their own MBS, while continuing to hold non-performing whole mortgages or certain private-label MBS that are more difficult to sell. At the same time, many of the mortgages the Enterprises are now adding to their portfolios are delinquent loans that have been removed from their MBS under guarantee programs. FHFA has observed that as the Enterprises’ retained portfolios are becoming smaller, they also are becoming less liquid.”

“Additionally, the 2012 Amendments accelerate the wind down of the Enterprises’ retained mortgage investment portfolios. However, they do not wind down the Enterprises’ securitization business. Indeed, that side of their businesses may continue to prosper, at least in the near term, as a result of improvements in the mortgage markets and recent increases in guarantee fees. Fundamentally, the 2012 Amendments position the Enterprises to function in a holding pattern, awaiting major policy decisions in the future.”

“Although the 2012 Amendments more quickly reduce the Enterprises’ investments, they do not diminish their importance in the housing finance system. Accordingly, the changes to the PSPAs help to safeguard future policymakers’ options to reform the role of the Enterprises in the nation’s secondary mortgage market.”

So, two years later we’re still in a holding pattern. The plane will run out of gas by 2018 if not landed before then. Circumstances have changed dramatically since the FHFA OIG wrote their 2013 White Paper. It is time for them to update their assessment of the situation due to the potential negative repercussions that the mismanagement of the conservatorship could have on the US and global economies.

FHFA OIG May 2013 White Paper

2 thoughts on “FHFA: A number of options were considered for reformulating the dividend structure

  1. They say a number of options are considered but never point out what they are or give any proof that other options were considered

    Who are these shady “market participants” that alerted the treasury of the concern over the GSEs paying their dividends and the need for the third amendment.

    The document clearly shows that treasruy bypassed the law back in 2009 and made the ending of conservatorship their decision and not that of FHFA

    All this should strengthen the resolve that this is a politically motivated sham


    • Good observation. I suspect that the other options that were considered are a part of what is being concealed under the executive privilege. Would be interesting to learn what they were. I am equally curious of these “market participants.” It really doesn’t seem like the FHFA OIG is being as transparent as their mandate dictates…further disappointment.

      There is an abundance of evidence that indicate that UST is directing all actions. The FHFA OIG should have called that out, but they didn’t… Let’s hope that Judge Sweeney has the moral conviction to do the right thing… all indicators point that way…!


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