Collins case involving Fannie Mae, Freddie Mac goes before Supreme Court

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The Supreme Court is set to hear one of the cases involving Fannie Mae and Freddie Mac. The Collins v. Mnuchin case goes before the court on Dec. 9, and whatever is decided will impact the valuations of the government-sponsored enterprises’ stocks.

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Range of possible decisions by the Supreme Court for Fannie Mae, Freddie Mac

In a note today, analyst Dick Bove of Odeon Capital pointed out that there is a range of possible decisions the Supreme Court could come up with on Fannie Mae and Freddie Mac. The government would win the entire case if the court rules that the government did what the Housing and Economic Recovery Act ordered it to do, which would mean there would be no legal action.

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It would also mean that the plaintiffs' claims should be dismissed, and the Fifth Circuit Appeals Court's rulings must be overturned. The Fifth Circuit Court ruled that the Federal Housing Finance Agency's structure and the net worth sweep are unconstitutional.

There could be a partial win by the plaintiffs, meaning that the FHFA director's position could be upheld as unconstitutional, but past actions taken by the director should not be overturned because they were in line with the president's witnesses. However, Bove noted that the addition of the senior preferred shares and the net worth sweep would be declared valid expressions of the agency's powers as conservator and regulator of the GSEs.

Finally, the plaintiffs could win it all, which would mean the FHFA director's position is declared unconstitutional, and the net worth sweep would have to be swept to the side.

What could happen to the GSEs' stocks?

In the event that the government wins it all, the FHFA would be allowed to continue with any path it chooses. The values of the junior preferred and common shares would be determined by investor sentiment. However, if the government wants to remove Fannie Mae and Freddie Mac from conservatorship, it will have to come to an agreement with the junior preferred shareholders.

If President Donald Trump is reelected, then Bove expects there to be no changes from what would occur if the government has a total win. He argues that if Joe Biden wins the presidency, nothing will be done to take Fannie and Freddie out of conservatorship or see that the junior preferred shareholders get anything.

However, Tim Pagliara of CapWealth Advisors told ValueWalk in a recent interview that he believes the GSEs could be past the point of no return with Fannie and Freddie exiting their conservatorships by the time inauguration day arrives.

If plaintiffs win the Collins case before the Supreme Court, the value of the common shares of Fannie Mae and Freddie Mac will remain based on investor sentiment. The value of the preferred shares should rise toward par value of $25 on the expectations that the dividends that were once paid on the stocks will be reinstated. There will be a chance that the government will negotiate a deal with the plaintiffs to eliminate the preferred shares.

Expected outcome of the Supreme Court case for Fannie Mae, Freddie Mac

Bove expects the plaintiffs to come away with a complete win in the Collins case. He noted that in order for that to happen, they will have to convince the Supreme Court that the government abused its powers as conservator of Fannie Mae and Freddie Mac. They will have to prove that they have suffered harm, the companies have suffered harm, and they can sue to correct the harm that has been done.

He explained that the plaintiffs will argue that the GSEs were cash flow positive in 2007 and 2008 and didn't need to be taken over. The plaintiffs also cite a 2012 report provided to the FHFA and Treasury Department in which Fannie Mae argued it was entering a "golden era" in which profits would rise for a lengthy period, which did happen.

They would also argue that the net worth sweep removed their rights as shareholders, causing them direct harm, which is why they can sue. Bove said the plaintiffs argue that "if a corporation rearranges the relationship of different classes of security holders to the detriment of one class, a stockholder in the disadvantaged class may proceed against the corporation as a defendant to protect his own legal interest."

The core of the Supreme Court case involving Fannie Mae, Freddie Mac

If the Supreme Court allows Fannie Mae and Freddie Mac shareholders to sue, then it is possible to get to the core of the complaint. The mission of the FHFA's conservatorship is to preserve and conserve assets and restore the GSEs to safeness and soundness. The net worth sweep prevents that from ever happening.

Further, none of the Housing and Economic Recovery Act's provisions allow the FHFA to forsake its conservatorship mission by sabotaging the companies' recovery "through a self-dealing transaction with Treasury," Bove quoted the suit. That is the foundation of the Supreme Court case.

The FHFA was supposed to help Fannie and Freddie get back into good health, even though that wasn't needed, but it "eviscerated, ravished, or robbed the companies instead," Bove declared.

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