Debate over what to do with Fannie Mae and Freddie Mac has reached fever pitch. The two government-sponsored enterprises (GSEs) have been hanging in the balance for the last 10 years, and investors are starting to get antsy. Well-known investors and hedge fund managers fully expect Fannie and Freddie to finally exit conservatorship this year, which should impact their valuations, but that’s not the only think that could change what they’re worth.
In a recent note, reputed bank analyst Dick Bove outlined a number of reasons both GSEs are necessary. The first is the economic necessity of Fannie and Freddie due to Americans’ dependence on 30-year fixed-rate mortgages for home purchases.
Private lenders don't want to offer such long mortgages with fixed rates, even though Bove said "numerous outside sources" indicate that they support 85% to 90% of home loans. This dynamic depends on Fannie and Freddie to guarantee these long mortgages with government backing. Bove also noted that even though Congress hasn't made any moves in the battle over the GSEs, it seems clear that lawmakers support the continuation of the 30-year fixed-rate mortgage.
In part due to America's dependence on the 30-year fixed-rate mortgage, Bove recommends Fannie and Freddie preferred shares. He said that at this point it's not possible to set a valuation on either of the GSEs due to the uncertainty about what their structure will look like when they finally exit conservatorship. He believes it would be logical to return Fannie and Freddie to the structures they had before the financial crisis, but he also notes that Washington often doesn't do what would make sense.
Three court cases to impact GSEs' valuations
Bove believes three pending court cases will have serious impacts on what happens to Fannie Mae and Freddie Mac—and what their stocks are worth. In fact, he thinks if the government loses any of these three cases, the preferred shares of both GSEs are "worth multiples of their present values." At this stage, he feels all three appear to be leaning in favor of the plaintiffs.
The first case is pending in the Federal District Court in Washington, which decided to allow a trial on the issue that the GSEs' shareholders never expected the government to take away their rights.
The second case is pending with the Federal Claims Court, which is now requiring discovery of documents which show the government misstated the facts concerning the health of the GSEs.
Bove finds the third case to be the most important. It's pending in the Fifth Circuit Court in Houston, Tex., and it questions the right of the Federal Housing Finance Agency to even exist. This case is key because the FHFA was created for the express purpose of overseeing the GSEs.
Bove believes any win in any of these cases would carry preferred shares of Fannie and Freddie "back to par of $25 per share."
This article first appeared on ValueWalk Premium