With tax reform set to go into effect next year, Fannie Mae and Freddie Mac faced a possible one-time Treasury draw due to the change in corporate tax rate and the zero-capital mandate.

The Federal Housing Finance Agency announced each government-sponsored enterprise is entitled to a $3 billion capital reserve. This can be used as a cushion against expenses, should they occur, such as the scenario listed above.

More details may be found in the agreement letter.

Here are the details as laid out in an announcement from the Treasury:

  • Fannie Mae and Freddie Mac will be allowed to maintain a capital buffer of $3 billion each.
  • The dividend payment owed to Treasury will be calculated each quarter using the $3 billion capital buffer as a baseline.
  • To compensate taxpayers for the dividends they would have received absent these letter agreements, Treasury’s liquidation preference for the Preferred Stock held in Fannie Mae and Freddie Mac will increase by $3 billion as of December 31, 2017.
  • Any failure by Fannie Mae or Freddie Mac to declare and pay a full quarterly dividend will result in the automatic, immediate termination of its capital buffer.

“The Federal Housing Finance Agency, as conservator of Fannie Mae and Freddie Mac, and the Department of the Treasury have agreed to reinstate a $3 billion capital reserve amount under the Senior Preferred Stock Purchase Agreements for each Enterprise beginning in the fourth quarter of 2017,” said FHFA Director Mel Watt.

“While it is apparent that a draw will be necessary for each Enterprise if tax legislation results in a reduction to the corporate tax rate, FHFA considers the $3 billion capital reserve sufficient to cover other fluctuations in income in the normal course of each Enterprise’s business. We, therefore, contemplate that going forward Enterprise dividends will be declared and paid beyond the $3 billion capital reserve in the absence of exigent circumstances.”

Also in exchange for the capital cushion change, Treasury gets an additional $3 billion a piece in senior preferred stock as of December 31, 2017, according to Jim Vogel, analyst at FTN Financial.

“Bottom Line: This agreement delivers an acceptable win for both sides,” said Vogel.

“FHFA gets some capital flexibility and reduces the potential headache of GAAP earnings fluctuations that could cause unnecessary, annoying draws that are likely to be repaid shortly thereafter,” he added. “Treasury moves this 2-yr, nagging issue off its agenda and gets to focus on newly stirring congressional efforts at GSE reform in 2018.”

Vogel isn’t alone in declaring the announcement as good news overall.

“The FHFA Director could have chosen to create a $3 billion capital buffer on his own. He had such authority in HERA. The fact that Secretary Mnuchin and the UST worked with him on this initiative is a big positive and a proactive statement that Treasury is now focused on the issue,” said Joshua Rosner, an analyst with Graham Fisher.

“The FHFA and Treasury just, jointly, told Congress: ‘We have heard you say the GSEs don’t need capital and argue that UST lines of credit are capital, we don’t agree. We are reversing the Obama Administration’s direction that they have zero capital beginning in 2018’.”