There has been plenty of talk about Fannie Mae and Freddie Mac and the government’s proposal to recapitalize them and release them from conservatorship. However, not everyone may be familiar with the history of these two government-sponsored enterprises (GSEs) and the issues that face them. Bank analyst Dick Bove of Odeon Capital released a primer on Fannie and Freddie this week to help investors understand them and everything that’s happening with them.
Fannie and Freddie: the basics
According to Bove, Fannie Mae has 1.158 billion outstanding common shares owned by the public, and another 131 million shares could be issued related to a convertible preferred stock, which also trades publicly. He estimates that 4.6 billion additional shares could be issued if the U.S. government converts the warrants it holds. The warrants do not trade because they are owned only by the federal government.
Freddie Mac has 650 million outstanding common shares. He estimates that another 2.6 billion shares could be issued if the government converts the warrants it holds.
Fannie has 16 outstanding preferred issues. The government owns the senior preferred shares, which do not trade. Ten of the junior preferred shares have rates between 4.75% and 8.375%. The Preferred S shares yield 8.375% and trade more than all of the other preferreds put together. The Preferred S shares have ranged in price from $5.23 to $14.30 per share over the last 52 weeks. Four of Fannie’s preferred shares are variable rate, while one is a convertible preferred. Par value for nine of the junior preferreds is $50, while five have a par value of $25. The par value of the Preferred S shares is $25.
Freddie has 26 outstanding preferred issues, including a non-trading senior preferred issue owned only by the federal government. Twenty of Freddie’s junior preferred issues have rates between 5% and 8.375%. Like Fannie’s 8.375% issue, Freddie’s also trades more than all the other preferred issues put together. The 8.375% issue has been trading between $5.23 and $14.30 per share over the last 52 weeks. Five junior preferred issues are variable rate. The par value of six of Freddie’s junior preferreds is $25, while 18 of them have par values of $50 per share. There is no available data on one of the junior preferred issues, and the 8.375% issue has a $25 par value.
The U.S. Treasury’s role in Fannie and Freddie
Bove said Fannie Mae borrowed $119.8 billion from the Treasury and has paid $181.4 billion in dividends. The GSE has a $113.9 billion open line of credit with the Treasury. Freddie Mac has borrowed $75.6 billion and paid $119.7 billion in dividends. Freddie’s open credit line with the Treasury is $140.2 billion.
Both Fannie and Freddie guarantee mortgages originated by other firms. They both own mortgages, some of which are secured by the government, and they both own investment securities. Fannie reported $4.321 billion in pretax earnings for the second quarter, while Freddie reported $1.898 billion.
The U.S. Treasury recently released a list of its proposals to bring both GSEs out of conservatorship. The proposals include ending the collection of the current dividend based on sweeping earnings and establishing a plan to recapitalize and release them. The plan also includes guarantees on debt service payments on mortgage-backed securities they issue and some type of ETguarantee on payments for the 30-year fixed rate mortgages. The Treasury must also receive payment for the services it provided.
The Federal Housing Finance Agency agreed to end the profit sweep into the Treasury and wants to establish capital requirements for the GSEs which are well above current levels. The agency also wants to authorize more firms like Fannie Mae and Freddie Mac.
Congress could become involved at some point, but for now, the House of Representatives has no pending bills. While the Senate does have one outline for recapitalizing and releasing the GSEs, it doesn’t have any legislation in the works.
Court rulings on the GSEs
Complicating everything with the GSEs is some court cases filed over the net worth sweep of Fannie’s and Freddie’s profits into the Treasury. The Fifth Circuit Court in New Orleans ordered a lower court to reconfigure the basis of the Treasury dividends and declared the FHFA to be unconstitutional. The Supreme Court may step into this case.
The Federal District Court in Washington, D. C. has requested 70,000 documents from the government to be used in discovery. The court also requires a new trial on whether the FHFA and Treasury acted illegally by commandeering the GSEs’ profits. If so, then penalties should be established in this case.
The Federal Claims Court has scheduled a hearing for Nov. 19 to hear the case about the government taking private property without just compensation.
Bove has said in other reports that he recommends buying Fannie’s and Freddie’s junior preferred shares because he believes the courts will side with shareholders. Because of his expectations, he believes buying the preferred shares now will be like getting a discount on common shares because they will likely be converted as part of the recapitalization process. Several hedge funds have benefitted from the steady increase in Fannie’s and/ or Freddie’s preferred shares, including the top-performing hedge fund of last week.
This article first appeared on ValueWalk Premium