Inside Fannie Mae and Freddie Mac’s Billion-Dollar Machine

Often relegated to the pile of "financial blackboxes" among investors, Fannie Mae (NASDAQOTCBB: FNMA  ) and Freddie Mac (NASDAQOTCBB: FMCC  ) are incredibly profitable. But new changes coming down the pipeline could lead to even fatter bottom lines.

Fannie and Freddie's bread and butter
Fannie Mae and Freddie Mac's core business is simple; they insure the bulk of America's mortgages in exchange for a fee. These fees, known as guaranty fees, or G-fees, have been the subject of recent scrutiny by investors and the government alike.

Since the 2008 financial crisis, guaranty fees have become even more lucrative for Fannie Mae and Freddie Mac.

But the government is interested in raising guaranty fees even higher. The FHFA is currently accepting comments on a plan that would increase guarantee fees to encourage private insurers to take a greater share of the market.

Why guaranty fees matter
Guaranty fees are important for homebuyers and Fannie and Freddie Mac alike. Homebuyers silently pay the fee, first upfront, and then every single year thereafter as a percentage of their unpaid principal balance. Increasing fees simply adds to the spread that mortgage lenders need to underwrite a profitable, conforming loan.

For Fannie and Freddie, fee levels ultimately determine profitability. In a filing for comments, the FHFA detailed three alternative scenarios in which the GSEs held varying levels of capital, and sought a 9% annual return on capital.

The scenarios suggest the GSEs need to generate "G-fees" of anywhere from 0.67% to 1.36% on each new mortgage they back. Fees are currently lower than even the low range of the model at 0.55% in the fourth quarter of 2013.

A matter of policy
Given that Fannie Mae and Freddie Mac are currently in conservatorship, whatever fee level the FHFA deems appropriate will determine the profitability of the GSEs for the U.S. Treasury. This is, in some sense, a question of how much the U.S. Government can reasonably extract from the American housing market.

After all, increasing G-fees will naturally cut down on loan demand, since higher fees result in a higher interest rate for the borrower. Recent increases in mortgage rates have stymied some purchase and refinance demand, so it's a delicate balancing act between killing housing demand and operating profitable mortgage insurance companies.

In the end, analysts are calling for a 10 basis point increase in fees. This would be consistent with a 10 basis point increase that was mandated to help pay for the Temporary Payroll Tax Cut Continutation Act in 2011, which, among other things, held down the individual-level payroll taxes throughout 2011 and 2012.

Any increase in "G-fees" wouldn't happen until 2015 at the earliest, given the commentary period ends in August and the FHFA will review the idea for six months before choosing to act. Fee increases do tell us one thing: The government wants to run the GSEs as profitably as possible, and by raising fees, it's encouraging greater private competition.

Winding down Fannie Mae and Freddie Mac may be as easy as increasing prices on government-sponsored mortgage insurance.

Warren Buffett isn't betting on FNMA. He's buying this stock.
Imagine a company that rents a very specific and valuable piece of machinery for $41,000 per hour (That's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report details this company that already has over 50% market share. Just click HERE to discover more about this industry-leading stock... and join Buffett in his quest for a veritable landslide of profits!

 


Read/Post Comments (1) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Add your comment.

DocumentId: 2988900, ~/Articles/ArticleHandler.aspx, 7/24/2014 7:56:36 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement