Uncle Sam: Fannie Mae Financial Winner

NEW YORK ( TheStreet) -- The U.S. government was the big financial winner on Thursday, after Fannie Mae ( FNMA) announced its first-quarter results would enable it to pay the U.S. Treasury a dividend of $59.4 billion.

Mortgage giants Fannie Mae and Freddie Mac ( FMCC) -- together known as the government sponsored enterprises, or GSEs -- were taken under government conservatorship in September 2008 at the height of the credit crisis. Both GSEs were bailed out. The federal government holds $117.1 billion in senior Fannie Mae preferred shares, and $72.3 billion in senior Freddie Mac preferred shares.

Because Fannie and Freddie have been profitable for several quarters, both GSEs have stopped taking additional draws from the Treasury, effectively freezing the bailouts at the current levels. Under their amended agreement with their regulator, the Federal Housing Finance Agency and the Treasury, Fannie and Freddie are required to pay dividends to the government equal to all capital in excess of $3 billion apiece.

Fannie on Thursday reported first-quarter earnings of $58.7 billion, which included the release of $50.6 billion of its valuation allowance for deferred tax assets (DTA). The company said in its earnings release that it "expects to remain profitable for the foreseeable future," meaning the dividend gravy will continue to flow to the federal government.

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.

The company's first-quarter earnings were boosted by $800 million before taxes from the 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.

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."

Freddie Mac on Wednesday reported a first-quarter profit of $4.6 billion and announced it would pay a $7.0 billion dividend to the government. Freddie did not recapture any of its $30.1 billion DTA, but when it does, there will be an extraordinary dividend payment to the Treasury. Freddie has paid or announced $36.6 billion in dividends on government-held senior preferred shares so far.

Once it makes the dividend payment announced on Thursday, Fannie Mae will have paid the Treasury $95 billion on the $117.1 billion in senior preferred shares held by the government. That is a very high yield for an investment of less than five years.

If Fannie manages to remain similarly profitable through the end of this year, it is possible its dividends to the government may come close to or even exceed the amount of the bailout investment by the end of 2013.

How Much Is Enough, and What About the Junior Preferred?

No matter how much in dividends the GSEs managed to pay the government, there is no mechanism in place for either to repurchase any of the senior preferred shares held by the Treasury.

Meanwhile, investors holding the GSEs junior preferred shares have had their dividends suspended since September 2008.

Judging from the market action, it seems that investors expect to realize value from the preferred shares, either from a restored dividend, or maybe from some sort of payout if and when President Obama and Congress come to an agreement for the GSEs ultimate structure.

Fannie's preferred series E shares, with a coupon of 5.10% and a par value of $50.00, closed at $9.00 on Thursday, rising over 16% for the session and nearly sixfold 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, were up 7.5% on Thursday to close at $5.05. The Freddie preferred series Z shares have risen 186% from $1.75 at the end of last year.

To illustrate just how lucrative speculative investments in GSE junior preferred shares might be, consider the potential yields if the dividends are restored.

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 Thursday's close would see a dividend yield of 25.00%.

The Freddie preferred series Z shares are supposed to pay annual dividends of $1.34 a share. If the full dividend were restored, an investor who purchased the shares at Thursday's close would be looking at a dividend yield of 26.53%.

Fannie's common shares were down 3% to close at 87 cents, while Freddie's common shares declined 4% to close at 85 cents.

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

>Contact by Email.

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.

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