Despite Courtroom Losing Streak, Legal Action Still Best Route For Fannie Mae, Freddie Mac Shareholders

After comments from newly-appointed Treasury Secretary Steven Mnuchin renewed investor optimism and lifted the share prices of Federal National Mortgage Assctn Fnni Me FNMA and Federal Home Loan Mortgage Corp FMCC in late 2016, investors have spent most of 2017 trying to identify the “least worst” path forward for Fannie Mae and Freddie Mac.

The Legal Backdrop

Back in February, Fannie and Freddie shareholders suffered a major blow in the courtroom when an appeals court ruled that investors could no longer pursue legal claims against the U.S. government related to the government’s “net worth sweep” of Fannie and Freddie’s profits. Shareholders have argued that the government illegally amended the terms of Fannie and Freddie’s conservatorship, and that shareholders have a legal claim to Fannie and Freddie’s profits.

After the ruling, shareholders turned their attention to Mnuchin and President Donald Trump in the hopes that the new administration would recapitalize Fannie and Freddie and turn control back over to shareholders.

Analyst Commentary

Unfortunately, Height Securities analyst Edwin Groshans believes shareholders have little reason for optimism when it comes to the Trump administration. Even if things take a positive turn in Washington, Groshans estimates that Fannie Mae and Freddie Mac would need $132 billion and $84 billion in capital, respectively.

“It would take almost 11 years for Fannie Mae to meet this requirement and close to 10 years for Freddie Mac, based on our earnings estimates and assuming 100 percent of earnings are retained and no dividend is paid to the Treasury,” Groshans explained.

In other words, the best-case scenario in Washington is that Fannie and Freddie shareholders would still have at least a decade of waiting ahead of them.

On the other hand, if Fannie and Freddie investors can somehow manage to win subsequent appeals in court, it could potentially create major instant value.

“It is our view that despite the string of court losses, legal action is the path that has the best chance of monetizing GSE preferred shareholder investments,” Groshans concluded.

As it stands today, Height Securities estimates a probability-weighted return of -68 percent for Freddie Mac investors and -70 percent for Fannie Mae investors.

Related Links:

2 Ways Fannie And Freddie Shareholders May Still Have A Chance In Court

Fannie And Freddie Shareholders Shouldn't Expect Resolution In 2017