Fannie Keeps Shoveling Cash to Uncle Sam

NEW YORK ( TheStreet) -- Fannie Mae ( FNMA) on Thursday announced second quarter earnings of $10.1 billion, and said it would pay the government a dividend of $10.2 billion in September.

This was Fannie Mae's sixth-consecutive quarter of profits. The second-quarter results nearly doubled the $5.1 billion the company earned during the second quarter of 2012.

Fannie's common shares were up 1% in premarket trading, to $1.56.

Fannie Mae and its sister mortgage giant Freddie Mac ( FMCC) were taken under government conservatorship in September 2008. Under the modified terms of the bailout agreement, the two companies -- known as the government-sponsored enterprises, or GSEs -- must pay all profits to the U.S. Treasury, save minimal capital buffers of $3 billion for each company.

The companies stopped taking draws from the Treasury during the second quarter of 2012.

Freddie Mac ( FMCC) on Wednesday announced second-quarter earnings of $5.0 billion, increasing from $4.6 billion the previous quarter. Freddie also announced it would pay the U.S. Treasury a dividend of $4.4 billion in September.

The government's senior preferred stake in Fannie Mae totals $117.1 billion, and following the September payment, the company will have paid the Treasury cash dividends totaling $105 billion.

The government has a $72.3 billion senior preferred stake in Freddie Mac, and once Freddie's September dividend is paid, the company's dividend payments to the Treasury will total about $41 billion.

Under their modified bailout agreement, neither Freddie Mac nor Fannie Mae are allowed to repurchase any of the government-held preferred shares, no matter how profitable the GSEs become and no matter how much in dividends they pay the government.

Private investors have challenged the modified bailout agreement through a series of lawsuits with the hope of recapturing some value. One possibility -- which still seems remote -- is for the government's preferred stake to be converted to common shares, as was successfully done as part of the epic bailout of American International Group ( AIG). That bailout resulted in a profit to U.S. taxpayers of $22.7 billion, according to the Treasury.

President Obama in a speech on Tuesday called for the wind-down of Fannie Mae and Freddie Mac, while still providing a limited government backing for mortgage loan securitization.

This is essentially the approach favored by senators Mark Warner (D. Va.) and Bob Corker (R., Tenn.). The senators in June introduced legislation to wind-down Fannie and Freddie over five years, privatize most of the U.S. mortgage market, while putting in place a limited government backstop in the form of a "Federal Mortgage Insurance Corporation (FMIC), modeled in part after the FDIC." The Federal Deposit Insurance Corp. insures bank deposits by charging premiums to all U.S. banks and savings and loan associations.

FBR analyst Edward Mills, in a note on Tuesday, said the president's speech was likely to be "all but an endorsement of the Corker-Warner GSE reform proposal and would make any efforts at a recap of Fannie Mae and/or Freddie Mac even more unlikely."

Then again, with the Republicans in control of the House of Representatives, the president's support of the Corker-Warner bill could make it even more unlikely for the bill to be passed.

It also seems quite a tall order to wind down Fannie and Freddie in only five years. Most of the securitized and portfolio loans held by the GSEs are 30-year fixed-rate mortgage loans, and a combined $5.2 trillion in assets would be an astronomical amount to sell to private investors.

What gives hope to the junior preferred and common shareholders of Fannie and Freddie is that the companies keep booking tremendous profits. Institutional investors holding the shares are braced for a multiyear battle.

It will be very interesting to see if the continued profitability of Fannie Mae and Freddie Mac may eventually cause a change in the tone of political discussions. With over $5 trillion in assets between them, profits at an annual pace of roughly $60.4 billion, and dividends to the government that will soon exceed the size of the bailout, there may eventually be a change of heart among politicians, increasing the possibility that the GSEs could be recapitalized and go on functioning.

Peter Kovalski -- portfolio manager of the Alpine Financial Services Fund ( ADFSX) -- says he isn't considering taking a position in common or preferred shares of Fannie or Freddie, because "whenever you have politicians involved, there is no logical way to predict what will happen."

"They don't do what is in the best interest of their constituents or the country. They do what is best for them to stay in power," Kovalski says, adding "if the government were not involved, I could delve into the financials and make an educated decision on whether or not to buy."

-- 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 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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