In a big win for Fannie Mae and Freddie Mac preferred shareholders, the Supreme Court has decided it will hear the Collins case. It’s widely expected that the court will rule the net worth sweep illegal, which would mean preferred shareholders would finally receive the big payday they believe they are due.
Background for the Collins case and Fannie Mae/ Freddie Mac
In a note on Thursday, Odeon Capital analyst Dick Bove provided some background to explain the basis of the Collins case. He said U.S. lawmakers passed the Housing and Economic Act in 2008. One of the requirements of the law was that Fannie Mae and Freddie Mac would be placed in conservatorship.
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Congress also required that the conservator bring the government-sponsored enterprises into a solvent condition so they could function as they were intended. However, Bove said the Obama administration disagreed with that, so it started to work with the Federal Housing Finance Agency, which oversees the GSEs, to "bring these companies literally to their knees."
The Treasury Department and the FHFA signed an agreement in 2012 that's now known as the net worth sweep. It allows the Treasury to sweep 100% of Fannie and Freddie's earnings into the Treasury and take some of their capital. As a result, their common equity was brought so low that it couldn't defend their assets.
Bove said the FHFA and Treasury worked to bring the GSEs to a state of insolvency. However, we know that Fannie Mae and Freddie Mac are now in a very strong position compared to where they were before.
He believes that during the Obama administration, the FHFA and the Treasury rewrote the law created by Congress in 2008 to fit their own biases, ignoring what Congress demanded.
How the Collins case will impact Fannie Mae and Freddie Mac
Bove said dozens of lawsuits pertain to the net worth sweep and other events of 2012. He added that there are almost as many decisions by several lower courts.
Like most other analysts, he believes the plaintiffs will win on the issue of the net worth sweep. He said the GSEs' conservator not only failed to obey the law but did the opposite of what the law required. He also thinks the range of possibilities as far as what Fannie Mae and Freddie Mac shareholders will win in the Collins case is broad.
As far as the GSEs themselves, he believes the best-case scenario would be to have the payments they made to the government returned. At worst, he believes they could be sent back to the negotiating table to determine what harm has actually been done.
Bove speculates that the net worth sweep will be declared illegal and that the senior preferred shares held by the government will be declared paid, although he expects the government to keep the dividends it received. He believes Fannie Mae and Freddie Mac will receive tax relief for overpayment of dividends.
As far as Fannie Mae and Freddie Mac shareholders, he expects the Collins case to result in junior preferred shareholders starting to receive dividends again. He also expects the GSEs to make a large common stock offering, but much less than the $245 billion being suggested.
If the dividends are restored to the junior preferred shares, Bove expects them to return to par value, which is $25 per share. He expects them to be called and replaced with a new issue at much lower rates. If the stocks do return to par value, they would increase at least 200%.
Bove boosted his rating on the common shares of Fannie and Freddie from Sell to Hold. He believes the shares could increase in value along with the preferred shares.
However, if an offering is held, he expects the government to convert its warrants to common stock. The offering would also result in a large number of new shares being sold. He doesn't like the GSEs' business model, so he won't recommend purchasing the common shares.