Royal Bank of Scotland (RBS) analysts said in a report released today that they disagree with the speculation that the redirection of the GSE fees to pay for non-mortgage related expenses makes a credit rating downgrade is likely.

"While this is a clear case of redirection, the GSEs do not have any standalone credit quality as continued operations are fully reliant on the U.S. Treasury," analysts said. "In addition, the redirection of the guarantee fees utilizes the GSEs in a way we have not really seen before, bringing them closer to the government."

They project that the 10 basis points in added fees can generate $20 billion in 9.5 years, which is low versus the $183 billion the GSEs currently owe to the Treasury.

Analysts do not anticipate both agencies to be downgraded based on the government’s increased reliance on the GSEs. However, they think that the GSEs will underperform Treasurys, swaps and FHLB as buyers reassess the risk of owning agencies beyond the 2012 unlimited Treasury support period.

Payroll Tax Cut Act

Last Dec. 23, the Temporary Payroll Tax Cut Continuation Act of 2011 was signed into law. The Act increased GSE guarantee fees by no less than 10 basis points from the average of about 20 basis points charged last year  to pay for the tax cut.

On Dec. 29, the Federal Housing Finance Agency announced a 10 basis point rise in the fee effective April 1, 2012 with further hikes possible in the two-year implementation time period.

The Payroll Act as stated that the increased fees are effective through October 1, 2021. The GSEs need to remit the amount of the increase to the U.S. Treasury. The Act does not allow the fees to be considered a reimbursement to the government for the $183 billion in support given to the GSEs from the Treasury via the Preferred Stock Purchase Agreements. The purpose of the fee hike is not to increase GSE profitabiliy limit the Treasury draws, analysts stated.

The redirection of the GSEs fees to pay for non-mortgage related expenses has caused some speculation that a credit rating downgrade is likely. S&P’s approach to rating the GSEs stated that extraordinary government intervention increases the GSEs relationship with the government, but that the credit quality could be weakened if GSE resources were redirected to the government.

According to RBS analysts, although this is a clear case of redirection, the GSEs do not have any standalone credit quality as continued operations rely fully on the U.S. Treasury. The GSEs, they said, have been entirely reliant on the Treasury support to avoid the mandatory triggering of receivership since September 2008. The GSEs have lost over almost all the earning that they had ever made. Profitability or the potential to operate as standalone entities is not the basis for the Standard & Poor's and Moody’s Investors Service debt ratings of Fannie and Freddie. The ratings are based on the GSEs relationship to the U.S. government.

RBS analysts cited the fact that last September, Moody’s said that it would perceive a rise in the guarantee fee as negative for bondholders if it showed that the government was decreasing its reliance on the GSEs without offering clear bondholder protection. This is not what is occuring here. RBS analysts said. Instead, the government is increasing its reliance on the GSEs. 

The redirection of the guarantee fees used the GSEs in a way analysts have not seen before, bringing them closer to the government. Both agencies had not raised the guarantee fee in a meaningful way since they were being directed to keep housing finance costs low to stimulate U.S. housing. Congress now thinks that economic stimulus in the form of a payroll tax cut in an election year financed by a “buried” tax on new home owners is more significant than improving GSE profitability, which would help to lessen the number of Treasury draws. 

The revenue from the fee increase will not be sufficient to pay back Treasury, RBS analysts said. The Congressional Budget Office estimated that the added fees would make roughly $37 billion in  the 9.5 years while RBS agency MBS strategist Jeana Curro projected that a 10 basis point fees hike would generate only $20 billion in the same time period.

Both numbers are low versus the $183 billion in Treasury support already given to the GSEs and the $32 billion in dividends that the GSEs have paid to Treasury, RBS analysts clarified. The GSEs will have to increase the guarantee fee by multiples of 10 basis point to make the fee  have a true dent in Treasury support. It is more probable that any repayment will be sourced from different sources, both within and outside the GSEs, RBS analysts stated.


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