While proposed corporate tax cuts by the Trump administration would largely be good for Fannie Mae and Freddie Mac, they would be required to make an initial adjustment that could force a draw from their line of credit with the Treasury Department.
Such a move would likely alarm members of Congress, who have been anxiously watching the government-sponsored enterprises' dwindling capital levels as they continue to debate housing finance reform. If the GSEs must take a draw from the Treasury, lawmakers are likely to speed efforts to reform the system or put pressure on the firms’ regulator to allow them to rebuild capital.
"If Congress enacts such a reduction, it would negatively affect the value of our deferred tax assets and, we expect, result in a significant net loss and net worth deficit for the quarter in which the legislation is enacted," Fannie Mae President and CEO Tim Mayopoulos said Friday during the company’s first-quarter earnings call. "Such a deficit would require us to draw addition funds from Treasury.”
Long term, a reduction in corporate tax burdens would likely be a positive for earnings at the GSEs and other companies.
"It would be a boost to our net income going forward," said Dave Benson, Fannie Mae's chief financial officer.
But there is an initial adjustment to the cut because under current rules, a move to a lower tax rate would require a one-time downward revision for certain deferred tax assets now held under a higher tax rate.
"In the one period where we had to revalue the tax assets, we would have to put through that one-time loss," Benson said.
The GSEs' deferred tax assets are substantial. Fannie had more than $36.2 billion on its books at the end of the first quarter. Freddie had $15.8 billion in deferred tax assets at that time.
While there are different types of deferred tax assets and some would not be affected by a tax cut, the value of the assets would be reduced by roughly the same percentage as taxes are, Benson said.
Trump administration proposals could cut the corporate tax rate to 15% from the current 34-35%.
While most companies will have both earnings and capital buffers with which to absorb that shock when it occurs, the GSEs have directives to shrink their capital buffers to zero by the beginning of next year.
To be sure, that directive could change before a tax reform proposal took effect. Moreover, Treasury Secretary Steven Mnuchin has said he plans to act on GSE reform within the next year.
"I am glad to see that policymakers are starting to refocus on housing finance reform, including the lack of capital," Mayopoulos said.
Despite its shrinking capital buffer, Fannie in the first quarter generated $2.8 billion in net income, and it expects to pay a dividend equal to that amount to the U.S. Treasury.
That represents an improvement over the $1.1 billion in net income and $919 million in dividends Fannie recorded for the first quarter a year ago, but it is a decline from $5.04 billion in net income and $5.5 billion in dividend payments made during the fourth quarter of 2016.
Fannie attributed the differences in quarterly results to the effect of interest rates on valuations recorded in earnings. There was an unusually large run-up in rates in the fourth quarter of last year.
Both GSEs have been carefully expanding their credit boxes and encouraging lenders to originate loans to the full extent those credit boxes allow, including loans for single-family rental properties.
"It’s a big market. It's one that I don't think we have served as well as we might," Mayopoulos said.
But he was noncommittal when it came to prospects for participation in more institutional deals, such as one Fannie recently tested.
"I won't speak as to whether we'll do additional transactions or not, and how many," Mayopoulos said.
Despite the expansion of their credit boxes, both GSEs have recorded declines in their serious delinquency rate.
Fannie's single-family guaranty book of business had an average 1.12% serious delinquency rate in the first quarter that was slightly higher than Freddie's. Freddie saw its 90-day-plus delinquencies drop below 1% for the first time since 2008 in the first quarter.
Fannie's delinquency rate has fallen for 28 consecutive quarters, Mayopoulos said.
"We don't see any change in that overall trend" but the extent of the decrease could moderate over time, he said.