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feature se r v ic i ng Or ig i nat ion SECONDARY MARKET Moving Past Codependency The GSEs once counted on the Treasury for their survival, but now that the roles have been reversed is it prudent to use them as the Treasury's shoulder to lean on? s e c on da r y m a r k e t a na ly t ic s By Brian Montgomery, Chairman, The Collingwood Group T he much-improved financial performance of the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, has offered bright spots on the Treasury's balance sheet, welcomed infusions to the Treasury's operating budget, and have served as an optimistic counterpoint to the larger and more pessimistic fiscal deficit debate in Washington. The reinvigoration of Fannie Mae and Freddie Mac has generated renewed interest in their future and calls to maintain their current operations to capitalize on their apparent profitability. The first quarter of 2013 marked the first full year since their conservatorship began, during which neither GSE required draws from the Treasury. But, the story does not end there. Not only have the GSEs stabilized their finances enough to make payments to the Treasury, Fannie Mae and Freddie Mac have actually boasted record profits. Most prominently, with the help of $50.6 billion in recovered valuation allowances on deferred tax assets, next month Fannie Mae will make a massive $59.4 billion dividend payment to the Treasury with respect to 76 | The M Report its profits for the first quarter of 2013. This is in addition to Fannie Mae's already impressive $17.2 billion profit for all of 2012. Freddie Mac has performed strongly as well: Its net income for the first quarter of 2013 was $4.6 billion, which represents its second highest ever. Freddie Mac's gross mortgage portfolio increased at an annualized rate of four percent while Fannie Mae's increased at a rate of 12 percent. The bulk of these profits has been devoted to making payments to the Treasury with respect to the $187 billion bailout funded by American taxpayers. As of Q 4 2012, Freddie Mac had repaid a total of $23.8 billion in dividend payments to the Treasury Department, and Fannie Mae another $35.6 billion. In addition to impressive profits, the GSEs also boast improving credit quality in recent books of business, including sharp declines in loss reserves and delinquency rates. In Q 4 2012, Fannie Mae's loss reserves dropped to the lowest levels in over two years at $63 billion, down from $76.9 billion in December 2011. Fannie Mae has also seen two years of continued declines in delinquency rates. By the end of 2012, Fannie Mae's single-family serious delinquency rate was a mere 3.29 percent. Freddie Mac's single-family serious delinquency rate dropped even lower to 3.25 percent. As those rates fell, the GSEs also reduced their loss reserves by nearly 24 percent, from $116.4 billion in December 2011 to $88.8 billion in March 2013. Given these indications of improving credit quality and profitability, which Fannie Mae President and CEO Timothy Mayopoulos, "expects to remain ... for the foreseeable future," it is no wonder that people are getting excited about the future of the GSEs. Just five short years ago, Fannie Mae and Freddie Mac were the poster children for too big to fail government institutions and unwanted government bailouts. But today, via legislative diversion of guarantee fees and dividend payments to Treasury, they have now become a rich source of funding for a cashstrapped federal government. The housing market and mortgage lenders cannot seem to get enough of the GSEs either. Since 2008, Fannie Mae and Freddie Mac have accounted for a strong majority share of the mortgage securitization market, while (notwithstanding recent increases) private-sector mortgage capital has remained nearly absent. When Fannie Mae and Freddie Mac volumes are combined with Federal Housing Administration (FHA) and other government-supported entities, publicly-backed housing loans have a nearly 95 percent market share. As the GSEs' future remains uncertain, this dramatic and unexpected turnaround has many in the industry and inside the Beltway scratching their heads as conclusions once taken for granted, such as the policy goal of winding down the GSEs, come into question again. The