Steven Mnuchin May Now Be Fannie Mae And Freddie Mac Investors' Last Hope

Federal Home Loan Mortgage Corp FMCC and Federal National Mortgage Assctn Fnni Me FNMA shares are each down more than 22 percent on Tuesday after an appeals court upheld a ruling that hedge funds may not sue to challenge the legality of two government-sponsored enterprises (GSEs) net worth sweeps. Together, Fannie Mae and Freddie Mac reported $9.8 billion in Q4 income, all of which will be turned over to the U.S. Treasury as part of the terms of the net worth sweep.

Fannie and Freddie shareholders' hopes now lie with President Donald Trump and new Treasury Secretary Steve Mnuchin. Shareholders are hoping Mnuchin will opt to begin the process to recapitalize Fannie and Freddie and return the GSEs’ income to shareholders. According to Height Securities analyst Edwin Groshans, the window for favorable GSE reform is closing fast.

Related Link: A Reformed Fannie And Freddie Will Be Worth 'A Multiple Of Their Current Price'

Groshans believes Congress will likely not tackle housing finance reform prior to the 2018 midterm elections. Instead, they will focus on higher-priority issues such as the fiscal 2017 budget, the Affordable Care Act, the fiscal 2018 budget and corporate tax reform.

“These issues, along with rolling back regulations under the Congressional Review Act and continuing to confirm President Trump’s cabinet nominees, mean that taking on a complicated and divisive issue like housing reform is unlikely to occur,” Groshans explains.

He believes the time between now and the 2018 elections is Mnuchin’s chance to stabilize the GSEs.

“Both companies are critically undercapitalized and making cash payments on noncash earnings affects the GSEs liquidity,” Groshans writes.

Groshans projects it would take Fannie and Freddie more than a decade to build capital positions large enough to meet federal capitalization requirements. If Mnuchin eliminates the net worth sweep, Fannie and Freddie could begin the slow process of building capital.

Groshans cautions investors that news of an amendment to the terms of the Preferred Share Purchase Agreements isn’t necessarily an indication the two GSEs will be released from conservatorship.

“FHFA as the regulator will have to release the companies from conservatorship and we do not see that as an outcome that can 1) happen in the intermediate or 2) under the watch of Director Watt,” Groshans concludes.

Even in a best-case scenario, Height sees a long road ahead for Fannie and Freddie shareholders.

Despite Tuesday’s selloff, shares of Fannie Mae and Freddie Mac have roughly doubled since Election Day.