Despite the public uproar over the bailout of the financial industry, the U.S. Treasury is no pushover when it comes to demanding stiff terms on its loans.
The returns on some of the loans made to various banks and financial institutions would make a payday lender blush. For example, when the U.S. completes the sale of its remaining warrants of Citigroup, the Treasury expects a profit of over $12 billion on its original investment of $45 billion for a fat return of 27%.
The Treasury lent money to banks under the TARP Capital Purchase Program (CPP). The terms under the CPP involved the Treasury purchasing preferred shares that pay a 5% annual dividend which increases to 9% after five years. In addition, the U.S. Treasury received warrants to purchase stock in the companies it invested in. In many cases, the value of the stock warrants increased considerably as the shares of companies recovered from panic lows.
When the giant government sponsored enterprises (GSE) Fannie Mae and Freddie Mac collapsed, they were given unlimited government aid, but at double the cost charged to major banks. The Treasury’s preferred stock investment in Fannie and Freddie requires a dividend payment of 10%.
In the case of Fannie Mae, total investments of $87.6 billion have been made by the U.S. Treasury. Fannie Mae to date has paid the U.S. Treasury over $8 billion on the Treasury’s preferred stock investment.
As noted in Fannie Mae’s third quarter earnings report, the required dividend payment to the U.S. Treasury was almost twice the company’s losses. “The company’s net loss attributable to common stockholders was $3.5 billion, including $2.1 billion in dividend payments to the U.S. Treasury. To eliminate the company’s net worth deficit of $2.4 billion as of September 30, 2010, more than 85 percent of which is the dividend payment to Treasury, the Federal Housing Finance Agency has requested $2.5 billion on the company’s behalf from Treasury. Upon receiving those funds, the company’s total obligation to Treasury for its senior preferred stock will be $88.6 billion. The company has paid a total of $8.1 billion in dividends to Treasury.”
Fannie Mae is therefore required to borrow more funds from the U.S. Treasury, also at 10%, to pay the dividends due on the original debt. Borrowing costs on the additional loan of $2.1 billion loan will amount to another $210 million per year. Unless Fannie Mae can suddenly start generating large profits to repay the original debt to the Treasury, it will remain in the absurd position of borrowing ever larger amounts from the Treasury to return to the Treasury in preferred stock dividends.
The Financial Times of London reports that Fannie and Freddie have been lobbying the U.S. Treasury to reduce the dividend payments due on the preferred stock. The U.S. government also effectively owns 80% of the common stock in Fannie and Freddie under stock warrants granted as part of the original financial rescue.
The odds of Fannie and Freddie getting a break on their bailout funds are low given the political overtones involved. In addition, until there is a framework in place for restructuring the GSEs, the dividend rate will probably remain unchanged.
From the Treasury’s standpoint, there is nothing to be gained by reducing the dividend. The funds borrowed from the Treasury by Fannie and Freddie to pay the dividend are returned to the Treasury. If Fannie and Freddie eventually recover, the return to the U.S. Treasury from its high rate preferred stock will make the large gains on Citigroup seem like small change.