The Treasury Department on Friday said it is restructuring the terms of its investment in Fannie Mae and Freddie Mac, which could render them more dependent than ever on the government.

Instead of paying a mandatory 10% quarterly dividend, an arrangement which at times has forced the government-sponsored enterprises to borrow more from the government to pay the government, the Treasury will now capture all of their profits. When Fannie and Freddie aren't making money, they won't have to pay.

"By removing virtually all concerns about standalone credit and appropriating all future profits, the government is signalling what most market participants already know: that [Fannie and Freddie] are essentially off-balance-sheet government entities,"said Barclays Capital is a research note on Friday.

This distinction means that investors could also stop differentiating between Treasury/GNMA and FNM/FRE securities.

The new terms accelerate the shrinkage of the GSEs' portfolios of MBS to 15% annually beginning next year, from the current required pace of 10%. The catch is that forking over all their earnings will make it harder for Fannie and Freddie to build capital.

The now, more accelerated pace of annual shrinkage of the GSEs portfolios means that the retained portfolios could be a marginal source of agency MBS "supply," going forward, said the Barclays analysts.  

The the current pace of liquidations, however, will be enough for the GSEs to comply with the new limits in 2012 without "resorting to outright sales", according to Barcalys. The analysts also anticipated that the FHFA will likely ensure that the portfolios are wound down in a non-disruptive way.

"We are taking the next step toward responsibly winding down Fannie Mae and Freddie Mac, while continuing to support the necessary process of repair and recovery in the housing market," Michael Stegman, the Treasury' official overseeing housing finance.

The Treasury said it wants "to make sure that every dollar of earnings each firm generates is used to benefit taxpayers, and support the continued flow of mortgage credit during a responsible transition to a reformed housing finance market."

The government is reworking the terms because the open-ended financial commitment to the GSEs that the administration announced on Christmas Eve 2009 is set to expire this year. Absent any change, Fannie and Freddie would have been limited in the amount of additional capital they could get from the Treasury.

Though Edward DeMarco, the acting director of the Federal Housing Finance Agency, oversees the GSEs, the Treasury has provided unlimited financial support, injecting a combined $188 billion into the GSEs since they were put into conservatorship in 2009. In exchange, the government took senior preferred shares that pay the 10% dividend.

But the concern has been that Fannie and Freddie would exhaust their capital and default on bond payments, says Jaret Seiberg, a senior policy analyst at Guggenheim Partners. That fear could drive up their borrowing costs, which would require them to seek government capital more quickly and create a vicious cycle that Treasury wants to forestall.

The Treasury has been advancing funds to the GSEs simply to have them pay the funds back to the Treasury.

"The borrow-to-repay problem is only going to worsen as the enterprises shrink their retained portfolios," which are their key profit drivers, Seiberg wrote in a research note Friday.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.