Last week, Dick Bove of Raffety Capital put out a research note stating that Fannie Mae (FNMA) and Freddie Mac (FMCC) could be reformed sooner rather than later. His justification for this was the fact that the companies may be forced to take losses due to new corporate tax law changes. In this matter Fannie and Freddie would be forced to take money from Treasury again if their capital dipped below zero.
Here’s the reality of the deferred tax asset mess. Fannie and Freddie lost billions of dollars during the subprime mortgage melt down crisis. This is partly due to congressional mandates that they purchase non-qualifying mortgage back securities from private label issuers. The mortgage meltdown was so intense, though, that it also affected their conforming mortgages.
Ironically, when a company loses money they build what’s called a deferred tax asset. This deferred tax asset is simply the net operating losses times the corporate tax rate with a few more details mixed in. So contractually a company should be allowed to retain this DTA and use it towards a future earnings. In the case of Fannie and Freddie, in 2012, the company’s were forced to change the way they accounted for earnings. Instead of keeping earnings for future periods of potential loss, the earnings were then swept to the government to pay for deficit reduction.
Thus, the contractual right to defer taxes was stripped by Treasury action. Indefinitely. Unilaterally. No other company has received treatment like this. (Well, there are some historical comparatives, but not exactly the same. The Supreme Court ruled in favor of shareholders in those cases.)
So this makes an interesting situation because they’ve sent all this money back treasury. Yet they have a DTA on their books. Â It just has no value because the equity has been swept away. Now if the corporate tax rate was to change from, let’s say, 35% to 30%, then 5% of that DTA would be worthless. The impact of making that asset worthless would be that a net loss which flow through the income statement to the balance sheet. Not ideal.
