NEW YORK ( TheStreet) -- The government is going to make a lot of money on its investments in Fannie Mae (FNMA) and Freddie Mac (FMCC) and junior preferred shareholders may eventually get in on the gravy.
In a Heard on the Street article Wednesday, the Wall Street Journal rightly said, "there is no plan, or mechanism, in place" for the company to repurchase $117.1 billion in preferred shares held by the government. But the Journal misses the point that investors in junior preferred shares of Fannie and Freddie may be see a huge payoff over the long term.
Fannie Mae on Tuesday reported record profits for the fourth quarter and for all of 2012, and said it could see a potential $58.9 billion windfall from the recapture of its valuation allowance for deferred tax assets (DTA), as early as the first quarter.
Fannie Mae's shares rose 13% on the news, closing at 90 cents on Tuesday. Sister mortgage giant Freddie Mac saw its shares rise 14% to close at 87 cents. Both Fannie and Freddie -- collectively known as the government sponsored mortgage enterprises -- were taken under government conservatorship at the height of the real estate crisis in September 2008.Under its initial agreement with its regulator, the Federal Housing Finance Agency and the U.S. Treasury, Fannie Mae agreed to pay quarterly dividends at an annual rate of 10%, even if it failed to turn a profit, which forced the insolvent company to make multiple draws from the Treasury in order to continue operating and cover the dividends. Then in August 2012, after Fannie posted profits for the first and second quarters, the agreement with the Treasury was amended so that beginning in 2013, the company would no longer pay a 10% dividend on the government-held preferred, but instead would pay an amount based on the company's "net worth as of the end of the immediately preceding fiscal quarter." Fannie Mae is now, essentially, paying all of its profits to the Treasury, while maintaining a "capital reserve" of $3 billion, which declines by $600 million a year, until it reaches zero in in 2018. If and when the company recaptures some or all of the $58.9 billion DTA, that amount will be added to the previous quarter's profit, less the capital cushion, for a large dividend payment to the government.