van Doorn: Fannie Mae Is a Government Cash Machine

Updated from 12:25 p.m. ET with, with a correction to show that Fannie has pretty much fully tapped its DTA, and with very strong late afternoon market action for junior preferred shares of Fannie Mae and Freddie Mac.

NEW YORK ( TheStreet) -- Fannie Mae ( FNMA) on Thursday reported a first-quarter profit of $58.7 billion, setting up a $59.4 billion dividend to the U.S. Treasury.

The government-sponsored mortgage giant and its rival Freddie Mac ( FMCC) were taken under government conservatorship at the height of the financial crisis in September 2008. Under the revised terms of the bailout agreement, the two companies are required to pay quarterly dividends to the U.S. government equal to their net worth in excess of $3 billion.

The U.S. government has $117.1 billion in Fannie Mae preferred shares and $72.3 billion in Freddie Mac preferred shares as of March 31. Both companies -- known as the GSEs -- have been able to stop drawing additional funds from the Treasury because of their sustained profitability.

Fannie Mae's first-quarter pre-tax net income was $8.1 billion, increasing from $7.6 billion in the fourth quarter and $5.4 billion in the first quarter of 2012.

With continued profitability, the company was able to release $50.6 billion of its valuation allowance for deferred tax assets, setting up the extraordinary dividend to the government.

Fannie in the first quarter saw an $800 million pre-tax benefit from a major settlement of a long-term dispute with Bank of America ( BAC). The Bank agreed to pay Fannie $3.6 billion in cash and pay roughly $6.75 billion to repurchase about 30,000 mortgage loans.

Fannie said the agreement "addressed $11.3 billion of unpaid principal balance, or 97 percent, of Fannie Mae's outstanding repurchase requests made to Bank of America as of December 31, 2012." Illustrating the importance of the settlement, Fannie added that Bank of America's share of Fannie's total mortgage repurchase claims against lenders declined "to 10 percent of its total repurchase requests outstanding as of March 31, 2013, compared with 73 percent of Fannie Mae's total repurchase requests outstanding as of December 31, 2012."

Uncle Sam Is Getting Paid

Fannie Mae has now paid the Treasury $95.0 billion in cash dividends since the company was taken under conservatorship. To illustrate how fat a yield that has been to the government, we can use a very conservative back-of-the-envelope calculation.

It has been less than five years since Fannie Mae was taken under conservatorship, and because of the multiple draws from the Treasury, the government's preferred stake in the company has been less than the current $117.1 billion during this time. But if we base our dividend yield calculation on five full years and the entire $117.1 billion, the government's annual dividend yield on the Fannie Mae preferred shares has been 16.23%.

Not a bad investment, considering that the government managed to ensure the continued liquidity of the U.S. mortgage market, while eventually raking in a huge return.

While further DTA releases will be small ones, by the end of the year, assuming Fannie Mae remains as profitable as it was during the first quarter, the government will have earned dividends on its Fannie Mae investment close to or even exceeding its total investment, in just over five years.

No matter how much in dividends Fannie Mae manages to pay the federal government, there is no mechanism in place for Fannie to repurchase the outstanding preferred shares.

What About the Junior Preferreds?

Investors who hold junior preferred shares in Fannie Mae and Freddie Mac, which had their dividends suspended in September 2008, are hoping for a positive outcome after years of waiting.

The political discussion on the eventual fate of Fannie Mae and Freddie Mac continues in Washington. The prospect of a big payday junior preferred shareholders who scooped up those shares at heavy discounts is distasteful to some members of Congress, but there's no denying the two mortgage giants exist, they are quite profitable, and they are positioned to repay the government, if and when they are allowed to.

There may be various legal remedies for the junior preferred shareholders, over time.

Fannie's preferred series E shares, with a coupon of 5.10% and a par value of $50.00, closed at $7.75 on Wednesday, rising nearly fourfold from $1.60 at the end of 2012.

Freddie's preferred series Z shares, with a coupon of 5.375% and a par value of $25.00, closed at $4.70 on Wednesday, rising 169% from $1.75 at the end of last year.

Day-traders will obviously be looking for very quick gains on the volatile junior preferred shares, for investors who can go in for a period of years, the common shares could eventually provide very large returns, if the GSEs manage to restore the dividends. For investors going in at these discounted prices, the dividend yields will be very high.

Fannie's preferred series E shares are supposed to pay annual dividends of $2.25 a share. If the dividend were restored, an investor who went in at Wednesday's close would see a dividend yield of 32.90%.

President Obama and the Congress have shied away from radically transforming Fannie and Freddie Mae, mainly because of the fear that private investors wouldn't be able to step in quickly enough to keep the U.S. mortgage market liquid. With the GSEs turning into cash machines, investors can expect a renewed cry for comprehensive GSE reform.

And no matter what happens, those junior preferred shareholders will have legitimate claims on these two huge companies. Fannie Mae had $3.3 trillion in total assets as of March 31, while Freddie Mac had $2.1 trillion in total assets.

Fannie Mae's common shares were down over 4% in late afternoon trading to 86 cents, while the company's preferred series E shares were up 16% to $9.00.

Freddie Mac's common shares were up down 5% to 84 cents, while its preferred series Z shares were up 7.5% to $5.05.

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.