Bailout Funds Would Shrink If Profit Jumps at Fannie Mae

A quirk of Fannie Mae ’s bailout agreement with the U.S. Treasury could reduce the amount of aid that the government would be able to provide the company if it reports a huge profit for the fourth quarter of 2012.

Fannie Mae said earlier this month that it would delay the filing of its annual report because it hasn’t yet determined whether the company is profitable enough to trigger an accounting change that could restore value to some or all of nearly $62 billion in tax benefits that had been written down after the company was taken over by the government four years ago.

Reversing the write-downs of those so-called deferred tax assets would increase Fannie Mae’s net worth, the vast majority of which would go to the U.S. Treasury as a dividend payment.

A big increase in Fannie’s net worth would also generate a drop in its remaining bailout funds going forward, which would be ironic since the Treasury has repeatedly revamped the agreement to erase any concerns among bondholders that the companies might not have enough money to meet their obligations.

It helps to understand how the federal backstops for Fannie and its smaller sibling, Freddie Mac , are structured:

In September 2008, Fannie and Freddie were placed into conservatorship. The Treasury agreed to inject up to $100 billion in each company so that the firms could function normally until Congress and the White House decided how to revamp them. The Treasury has purchased senior preferred shares in the companies, and in exchange, Fannie and Freddie had to pay to the Treasury dividends of 10% annually on those senior preferred shares. (The dividend payment setup was revamped last year.)

In February 2009, the Obama administration increased to $200 billion the total amount of money they’d invest in each company, doubling the $100 billion limit.

In December 2009, the Obama administration said that for 2010, 2011 and 2012, any money invested into the companies by the Treasury wouldn’t count against the $200 billion limit for each company. At the time, Fannie had used up $75 billion in Treasury aid, leaving $125 billion remaining; Freddie had used around $51 billion, leaving $149 billion. The move was made to “leave no uncertainty” about the Treasury’s commitment to make sure those companies would meet their obligations to bondholders, the Treasury said at the time.

The Treasury backstops included an interesting wrinkle that’s only now getting attention. They said that if Fannie, for example, had a negative net worth at the end of 2012, then it would have the entire $125 billion in unused support available into the future.

But if Fannie had a positive net worth at the end of 2012, then the remaining funding available would be the following: either $125 billion less Fannie’s positive net worth at the end of 2012, or $125 billion less the amounts that Fannie had received from the Treasury in 2010, 2011, and 2012, whichever was greater. (Fannie received around $41 billion from the Treasury in that three-year period, meaning Fannie’s remaining funding would be reduced by its positive net worth as of December 31, 2012, up to $41 billion.)

How do the deferred tax assets fit in here? If those deferred tax assets lead to a large boost in Fannie’s net worth, then Fannie might have as little as $84 billion left in aid from the Treasury.

(For its part, Freddie Mac, which has already reported its earnings for 2012, saw its $149 billion in remaining aid fall to $140 billion when it reported positive net worth of nearly $9 billion. It said it hadn’t yet reached the thresholds needed to reverse the write-downs of its tax credits.)

Of course, if Fannie stays profitable, then it won’t need any of that $84 billion. And even if Fannie were to lose more money, it seems unlikely that the company would witness losses of the magnitude of the 2007-11 period. A spokesman for the Treasury Department declined to comment, as did representatives of Fannie Mae and its regulator, the Federal Housing Finance Agency.

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