Much stock analysis of Fannie Mae and Freddie Mac has focused on the preferred shares, with many saying the common shares hold no value. However, Tim Pagliara and Grant Stark of CapWealth Advisors argue that the common shares do hold value.
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Value in Fannie Mae, Freddie Mac common shares
Preferred shares in Fannie Mae and Freddie Mac have a par value of $25, but they're currently trading much lower than that. Many of those who have invested in the government-sponsored enterprises believe the preferred shares are the only ones with value because they are tied up with what's happening in the lawsuits that have been filed over them.
On the other hand, the value of Fannie Mae's and Freddie Mac's common shares is tied to what will happen to the companies when they leave their conservatorships. CapWealth holds both common and preferred shares of Fannie Mae and Freddie Mac, although the firm does have a preference for the preferred shares. About 90% of CapWealth's holdings in the GSEs are preferred shares, while the other 10% are common shares.
Fannie Mae common share value is linked to strength
The value in the common shares of Fannie Mae and Freddie Mac lies in the strength of the two companies.
"I think no one argues they are very strong companies," Stark told ValueWalk in an interview. They're making sure these companies will be on a sound footing. Nobody wants to kill the companies. "
Consensus on the difference between the common and preferred shares has changed a bit in recent years. The gap between them was once much wider than it is now, but it has gradually narrowed.
Pagliara notes that the GSEs have recurring revenue and pretax earnings of about $30 billion a year, which demonstrates just how strong they are. He based this amount on a $6 trillion mortgage market and 0.5%, which is the fee Fannie and Freddie take on the mortgages they package and sell. He added that the GSEs are two of the most profitable companies in the world. Together, they form the bedrock of the mortgage industry. They keep the mortgage market going in both good times and bad.
He also notes that the GSEs are very stable. He believes no other company can provide the services Fannie and Freddie provide and do it better than them.
Release from conservatorship
Investors who are considering either common or preferred shares of the GSEs may want to lean in one direction or the other, depending on their level of comfort.
"There's reasons to love both, and I think it comes down to your appetite for owning a contractual security that you can hold, a piece of paper, and know there's a contract, or your appetite for owning and equity," Pagliara told ValueWalk.
Pagliara and Stark note that the investors who currently own preferred and common shares of Fannie Mae and Freddie Mac are probably the same investors who will be providing the capital they will need when they are reprivatized. Pagliara said this means the pool of capital currently funding the GSEs is the same source of capital they will rely on when they are reprivatized.
Pagliara also emphasized that there is no conspiracy about nefarious things going on at Fannie and Freddie. He said the common shares of Fannie Mae and Freddie Mac do hold value because the effort to recapitalize and release them from conservatorship must be successful.
"Everybody has to win, so the 20% of non-government shareholders have to win," Pagliara said. "The government and taxpayers have to win. Preferred shareholders have to win. When you put it in that kind of context and you try and say the government is going to be bad with accounting or trying to trick somebody, it's like shooting yourself in the foot."
Disclosure: No positions