That’s good. Now the question becomes: what will the companies do about the write-downs of their deferred tax assets (DTAs) that will be done in the fourth quarter of 2017, given passage of the tax bill.
Fannie has the bigger problem–its net DTAs are twice the size of Freddie’s. At September 30, Fannie had $30.5 billion in net DTAs. Fannie’s net DTAs have been dropping by about $1.0 billion per quarter this year, so for the fourth quarter one could expect them to be around $29.5 billion. If that’s correct, a cut in the corporate tax rate from 35 percent to 21 percent will cause it to have to write its DTAs down by $11.8 billion.
Year to date, Fannie has been averaging about $4.5 billion in pre-tax net income per quarter. With an $11.8 billion net DTA write off, that would leave it with a pre-tax loss of $7.3 billion. Is there some way Fannie could make that up, and not have to take a draw?
In a post I did this February (“Deferred Reform, and Deferred Taxes”), I noted that all of Fannie’s DTAs stemmed from timing differences between when it paid taxes to the IRS and when it accrued them on its books. (I’ve read in other places that Fannie’s DTAs are the result of net operating loss or capital loss carry-forwards; that’s simply not correct–Fannie said in its 2016 10K that it had no NOL or capital loss carry-forwards.) Since these timing differences stem from accounting implementations that push income back and accelerate expense (beyond the thresholds used by the IRS), I argued that Fannie should look at changing some of those implementations to treatments that still were GAAP-compliant (and approved by its outside auditor), but would allow it to reduce its DTAs, and thus reduce the post-tax reform DTA write-off. So far Fannie hasn’t done that. I wonder if it will this quarter. If I were CFO at Fannie I would make every effort to. If the company doesn’t figure out some way to get about $8 billion in pre-tax net income this quarter through a combination of lower net DTAs and one-time revenue gains, it will need to take a draw. (Freddie’s problem is more manageable, but it still will need some DTA reduction, or extraordinary income, to avoid a draw.)
We’ll know how this plays out in late January, when both companies publish their fourth quarter and full-year 2016 results.
TimelessInvestor
GSE to retain capital
Here are slew of breaking news on GSE to retain capital,
Key takeaways:
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.
Detailed news:
“The Federal Housing Finance Agency (FHFA), 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. 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.”
Fannie Mae Letter Agreement
Freddie Mac Letter Agreement
“Sufficient to cover other fluctuations in income”
That’s good. Now the question becomes: what will the companies do about the write-downs of their deferred tax assets (DTAs) that will be done in the fourth quarter of 2017, given passage of the tax bill.
Fannie has the bigger problem–its net DTAs are twice the size of Freddie’s. At September 30, Fannie had $30.5 billion in net DTAs. Fannie’s net DTAs have been dropping by about $1.0 billion per quarter this year, so for the fourth quarter one could expect them to be around $29.5 billion. If that’s correct, a cut in the corporate tax rate from 35 percent to 21 percent will cause it to have to write its DTAs down by $11.8 billion.
Year to date, Fannie has been averaging about $4.5 billion in pre-tax net income per quarter. With an $11.8 billion net DTA write off, that would leave it with a pre-tax loss of $7.3 billion. Is there some way Fannie could make that up, and not have to take a draw?
In a post I did this February (“Deferred Reform, and Deferred Taxes”), I noted that all of Fannie’s DTAs stemmed from timing differences between when it paid taxes to the IRS and when it accrued them on its books. (I’ve read in other places that Fannie’s DTAs are the result of net operating loss or capital loss carry-forwards; that’s simply not correct–Fannie said in its 2016 10K that it had no NOL or capital loss carry-forwards.) Since these timing differences stem from accounting implementations that push income back and accelerate expense (beyond the thresholds used by the IRS), I argued that Fannie should look at changing some of those implementations to treatments that still were GAAP-compliant (and approved by its outside auditor), but would allow it to reduce its DTAs, and thus reduce the post-tax reform DTA write-off. So far Fannie hasn’t done that. I wonder if it will this quarter. If I were CFO at Fannie I would make every effort to. If the company doesn’t figure out some way to get about $8 billion in pre-tax net income this quarter through a combination of lower net DTAs and one-time revenue gains, it will need to take a draw. (Freddie’s problem is more manageable, but it still will need some DTA reduction, or extraordinary income, to avoid a draw.)
We’ll know how this plays out in late January, when both companies publish their fourth quarter and full-year 2016 results.
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About Timeless Investor
My name is Samual Lau. I am a long-term value investor and a zealous disciple of Ben Graham. And I am a MBA graduated in May 2010 from Carnegie Mellon University. My concentrations are Finance, Strategy and Marketing.