The clock may finally be counting down on the end of conservatorship for the government-sponsored enterprises. However, some analysts are not convinced that Fannie Mae and Freddie Mac will be released so quickly, despite the market’s enthusiastic reaction to the prospect this week. Renown bank analyst Dick Bove said in a note this week discussed GSE junior preferred shares and that the process could take much longer than what investors are expecting—possibly months or even years.News outlets reported this week that the first draft of the Treasury Department’s plan to move Fannie and Freddie out of conservatorship was sent to the White House for approval. Investors reacted enthusiastically, expecting an end to the decade-long situation. In theory, Mark Calabria, director of the Federal Housing Finance Agency (FHFA), has the power to immediately enact the plan.
However, Bove said that in practice, there are three other groups that must agree before it can truly be enacted. They are the courts, the mortgage and housing finance industry, and investors.
Several lawsuits related to the government's handling of the conservatorship are now underway, and Bove said if they aren't resolved, no one will make new funds available to Fannie Mae or Freddie Mac. Investors simply won't buy shares in companies with "hundreds of billions of dollars in penalties unresolved," he explained.
The plaintiffs in the case want the so-called "Net Worth Sweep" to be eliminated because it took all the GSEs' profits and gave them to the Treasury. The senior preferred shares would have to be considered paid and no longer exist. Plaintiffs also want payments on their junior preferred shares. Dividend payments would have to be resumed, and preferred shares would have to be redeemed so they no longer exist. Common shares would have to be traded on par for the junior preferred shares. The lawsuits will end if the holders of junior preferred shares are paid. Bove believes the Treasury report discussing the end of conservatorship must provide a solution to the issue.
In the case of the mortgage and housing industry, Bove sees two requirements. The first is that 30-year fixed rate mortgages will remain viable with the U.S. backing them in exchange for some payment made to the U.S. government for the protection. The other need is for the GSEs to continue being able to avoid the Qualified Mortgage Rules. Fannie Mae and Freddie Mac would also have to keep making contributions to trusts which fund low-income housing.
Bove noted that the political issues involved in the housing finance industry are "meaningful." Conservatives want the government to exit the industry, but liberals want the government's support of housing at all levels to remain non-negotiable.
"The failure to bring these two sides together over the past decade has prevented Congress from passing any bill related to these companies," he explained.
The last group that must agree with the Treasury's plan is investors. Bove said Fannie Mae and Freddie Mac must be able to attract funds from the private sector in order to be successful. However, in order to do that, the major issues involved in mortgage origination must be fixed. For example, originators must be able to make a profit from their efforts, which isn't possible now, and the Qualified Mortgage Rules must be adjusted.
Additionally, big banks can't be eligible for the same government benefits as the GSEs. If they were, they would greatly reduce Fannie's and Freddie's market share and reduce their profits dramatically. Bove also believes the plan to rebuild both GSEs "cannot assume massive dilution of the common stock 'out-of-the-gate.'"
In short, investors must see a path to making a profit, and that isn't clear with the way things are right now.
Bove expects it to take quite some time for all these issues to be resolved, but he will be watching for a sign from one place.
"My belief is to continue to relay on the Fifth Circuit Court in Houston," he wrote. "If this court finds for the plaintiffs in some meaningful way, the debate on the Treasury Report will begin in earnest. Some resolution that makes all constituencies happy will be put in place. If the Fifth Circuit Court does not find for the plaintiffs, the debate on the Treasury Report will not begin in earnest until April of 2021.
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