Fitch: Corporate Tax Cuts Could Result in More Fannie/Freddie Treasury Draws
Fitch Ratings, New York, said a reduction in the U.S. corporate tax rate from the current federal statutory rate of 35 percent could present Fannie Mae and Freddie Mac with significant deferred tax asset write-downs.
Fitch said under current tax rates, Fannie Mae and Freddie Mac capital buffers are required to shrink to zero by Jan. 1, 2018. However, a DTA write-down would likely trigger them to draw from the US Treasury to cover these losses.
“The GSEs may not have sufficient capital reserves to avoid a net worth deficit in 2017 if they incur a loss in a quarter, and after Jan. 1, 2018, they will have no capital reserves to absorb losses,” wrote Fitch Managing Director Christopher Wolfe. “This would require them to draw funds under their Senior Preferred Stock Purchase Agreement with the U.S. Treasury to avoid being placed into receivership.”
Under the terms of their conservatorship with the Federal Housing Finance Agency, remaining funding available to Fannie Mae and Freddie Mac totaled $258.1 billion at Sept. 30, 2016. Fannie Mae and Freddie Mac had $35.1 billion and $18.7 billion, respectively, of net DTAs on their balance sheet, for a total net DTA of $53.8 billion at the end of the same period. These DTAs consisted primarily of deferred fees, basis differences related to derivative instruments, mortgage related assets and allowance for loan losses.
“The GSEs determined in the past that it was more likely than not that their net DTAs would be realized; therefore, a valuation allowance was not necessary,” Wolfe said. “However, a legislative change resulting in a lower federal corporate income tax rate could result in write-downs.”
Firch noted while a tax cut would enhance the GSEs’ long-term profitability, it also would produce a significant one-time hit to earnings. Fitch estimated if the applicable corporate tax rate is reduced to 20 percent from the current 35 percent, Fannie Mae and Freddie Mac would write down their DTAs by $15.0 billion and $8.0 billion, respectively.
“Moreover, in accordance with the dividend provision of the SPSPA and quarterly directives from their conservator, the GSEs are obligated to pay the U.S. Treasury the amount if their net worth from the preceding fiscal quarter-end exceeds the applicable capital reserve amount,” Fitch said. “This capital reserve amount was $1.2 billion for 2016; it decreased to $600 million in 2017 and will decrease to zero in 2018. The GSEs will no longer retain any of their net worth commencing in 2018 and will be unable to build capital as the entire amount of their net earnings will be remitted to the Treasury at the end of each quarter.”
Fannie Mae’s remaining funding under the agreement is $117.6 billion; Freddie Mac had $140.5 billion. “Any additional draws from the Treasury under the agreement reduces a commensurate amount from the remaining funding under the agreement. Dividend payments made to the Treasury do not restore or increase the amount of funding available to them under the agreement,” Fitch said.
