What should Fannie Mae junior preferred shares be worth?

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Fannie Mae and Freddie Mac junior preferred shares could increase by at least 100% if one analyst is correct. Dick Bove of Odeon Capital said Josh Rosner of Graham Fisher & Co., who has testified multiple times in front of Congress about the government-sponsored enterprises, discussed them with the Odeon team.

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Among the talking points was the likelihood that negotiations on what to do about the GSEs will have to begin, leading to a resolution by the time of the inauguration date of the winner of the presidential election. Bove believes the end result for holders of Fannie Mae junior preferred shares is at least a 100% increase in the value of the stock.

Fannie Mae junior preferred shares and the Collins case

Rosner said it is in the government's best interest to settle with the plaintiffs before the Supreme Court in the Collins case. If the government loses, it could own Fannie Mae and Freddie Mac $130 billion. Additionally, the Federal Housing Finance Agency could be declared unconstitutional, and the next president could fire FHFA Director Mark Calabria. However, these last two points have already effectively happened due to the impact of the Seila case on the government-sponsored enterprises.

If the government wins the Collins case, it will still have to eliminate the senior preferred shares and the net worth sweep if it wants to recapitalize and release Fannie and Freddie from their conservatorships. The government has already spent more than $100 million on legal fees and achieved nothing but "maintenance of the status quo," Bove added.

Also if the government wins, it will create a precedent in which the federal government can take whatever it chooses from possibly any company whenever it chooses to do so, striking at the heart of private property rights.

Bove believes the president, the Treasury secretary and FHFA director are united in their belief that Fannie and Freddie must be recapitalized and released from conservatorship. To do this, the lawsuits over the Fannie Mae and Freddie Mac junior preferred shares will have to be settled. The senior preferred shares and the net worth sweep will also have to be eliminated.

Here are the negotiables

In the negotiations over the Fannie Mae and Freddie Mac junior preferred shares and the Collins case, the government will want clear indications that both GSEs are truly safe and sound. Bove believes the government will also want some control over the companies.

He also expects the government to want a commitment fee of possibly 10 to 15 basis points for any government guarantees on 30-year fixed-rate mortgages. Additionally, the government will want freedom from a political problem "no one wants to deal with." He believes Joe Biden, if elected, would probably be happy if he never had to deal with Fannie and Freddie.

In exchange, investors will want the standing and rights of Fannie Mae and Freddie Mac junior preferred shares to be restored along with their lost dividends. They will also want to see value created for common shareholders.

Issues with the Fannie Mae junior preferred shares that must be resolved

In order for both sides to agree on the matter, several issues must be addressed. For example, Bove said the FHFA's failures to meet certain requirements of the Housing and Economic Recovery Act of 2008 will have to be corrected. He also said some internal government issues must be corrected, and a capital rule must be put in place.

Fannie Mae and Freddie Mac will have to hold public offerings, and the GSEs may have to acquire government warrants.

Bove doesn't expect to see dividend payments on the Fannie Mae and Freddie Mac junior preferred shares. He also doesn't expect the junior preferred shares to be converted into common shares or full payment of par value on preferreds.

He also gave an expected timeline for the recapitalization and release process. By late September, all comments on the proposed capital rule will have been received, and the rule will be in place by late October. By mid-November, he expects a resolution of the senior preferred shares, possibly eliminating the Supreme Court decision.

Also in November, he expects the GSEs to submit their required capital data. Then in December, he expects the resolution to begin ahead of a target date for the resolution in mid-January.

Not So Fast: Fannie Mae, Freddie Mac May Still Be In Conservatorship In 2021

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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.

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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.

Are you bullish or bearish on regular, senior and junior preferred shares of the GSEs? Tell us in the comment section!

This article first appeared on ValueWalk Premium

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