In order to avoid a possible taxpayer draw from the U.S. Treasury resulting from changes in the corporate tax code, the Federal Housing Finance Agency (FHFA) has reinstated government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac’s capital reserves, as originally established under their Senior Preferred Stock Purchase Agreements (PSPAs), at $3 billion each, effective Dec. 31.
In a statement, Mel Watt, director of the FHFA, said his agency and the Department of the Treasury “have agreed to reinstate a $3 billion capital reserve amount under the PSPAs for each enterprise beginning in the fourth quarter of 2017.”
As per their PSPAs, the GSEs’ capital buffers have been drawn down incrementally over time and will go to zero as of Jan. 1, which is when the new corporate tax code takes effect.
“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 in the statement. “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.”
By reinstating the GSEs capital reserves administratively, the FHFA has presumably avoided the need for an emergency Treasury draw, which would require congressional action.
During the Mortgage Bankers Association’s Convention & Expo in October, Watt indicated that that the situation with the drawdown of the GSEs’ capital buffers was dire. Although the companies are on much better footing, financially, since the meltdown of 2008, the incremental drawdown of their taxpayer buffer means there was greater risk of the need for a taxpayer bailout, he warned.
“The challenge is that additional draws of taxpayer support would reduce the amount of taxpayer backing available to the enterprises under the PSPAs and the foreseeable risk that the uncertainty associated with such draws or from the reduction in committed taxpayer backing could adversely impact the housing finance market,” Watt said. “This challenge is significantly greater today than it was last year and will continue to increase unless it is addressed.”
Watt also acknowledged, at the time, that corporate tax reform could result in a reduction in the value of the enterprises’ deferred tax assets and that this, in turn, could result in short-term, non-credit related losses to the enterprises.
“The greater the reduction in the corporate tax rate, the greater the short-term losses to the enterprises would be,” he said.
Watt further pointed out that, beside the potential impact of changes in the corporate tax structure, the GSEs have been at risk due to a range of other economic factors, including “housing market disruptions, natural disasters like hurricanes, or short periods of distress in the economy.”
These all could result in “credit-related losses to the enterprises in a given quarter.”
Watt warned, however, that any action the FHFA takes to recapitalize the GSEs should not be misinterpreted as a step toward “recap and release,” i.e., recapitalizing the companies and returning them to the private sector in their current reformed state – an action which would give shareholders in the companies a chance to recoup on their investments. He emphasized that although the FHFA has done much to rehabilitate the companies, housing finance reform is the domain of congress, not the agency.