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http://online.wsj.com/article/SB10000872....
August 17, 2012

The Treasury Department is preparing to revamp the terms of its nearly four-year-old financial backing of Fannie Mae and Freddie Mac FMCC -6.67% in a bid to allay investor concerns that the companies could one day exhaust their federal lifelines, according to government officials familiar with the plans.

The renegotiated agreements, which could be announced as soon as Friday, would change the way the firms pay the government for its support, these people said...

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Under the new arrangement between Treasury and the companies' federal regulator, all the firms' quarterly profits would be turned over to the government as a dividend payment; the government wouldn't require such payments in periods when the firms are unprofitable.

The revised terms would also accelerate the reduction of the firms' mortgage portfolios, these people said. The firms will have to shrink those portfolios by 15% annually beginning next year—a change from the currently required 10% annual reduction. That means the portfolios, which can be no larger than $650 billion for each firm at the end of the year, will fall to the final cap of $250 billion by 2018, four years earlier than previously scheduled...

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The changes are designed to avoid the prospect that Fannie and Freddie could one day exhaust their Treasury support simply because they might not generate enough profits to pay back those dividends. They will also prevent the companies from rebuilding capital, which should tamp down any hopes—or fears—that the firms would one day re-emerge from conservatorship in their old forms...

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The changes could spoil hoped-for returns for investors who bought the companies' preferred shares on the cheap on the assumption that the companies might one day generate profits, even after the firms pay their government dividends.

Any losses generated by the Treasury dividend payments haven't been a concern until now, in part because the Treasury in 2009 amended its agreements with the firms to provide unlimited support through 2012. Previously, the companies had been provided up to $200 billion each in support from the government.

At the end of this year, the existing agreements return the companies to a limited amount of support, which adds up to $200 billion less any funds that had been injected through 2009. The Treasury will be able to inject up to $125 billion into Fannie and $150 billion into Freddie.

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But with the companies returning to a fixed amount of aid that they could receive from the Treasury beginning next year, investors had begun to pencil out how long that support might last—particularly for Fannie, which stood to pay back nearly $12 billion to the government every year in dividends. That is more money than it ever made in one year. "Mathematically, $125 billion is not enough to cover snowballing dividends indefinitely as Fannie or Freddie shrinks its balance sheet," said Jim Vogel, an interest-rate strategist at FTN Financial in Memphis, Tenn.