Why Fannie And Freddie Sellers May Be Misinterpreting Housing Reform Plan

After 11 years under government control, Federal National Mortgage Association FNMA and Federal Home Loan Mortgage Corp FMCC finally have a plan for exiting conservatorship. Unfortunately, the new Treasury Department plan unveiled by the Trump administration on Thursday is sparse on details, and Fannie Mae and Freddie Mac shares are taking a big hit.

What Happened

According to the new plan, the good news for Fannie and Freddie shareholders is that the administration’s goal is to make the two companies private once again. In addition, the administration wants to introduce more competition to the housing finance market and reduce the role of the federal government in guaranteeing mortgages. Part of the goal is to protect taxpayers from downturns in the housing market.

In the near term, Fannie and Freddie would be allowed to hold onto more of their earnings in an effort to recapitalize their balance sheets.

Why It’s Important

Fannie Mae and Freddie Mac have been under government conservatorship since they were bailed out during the housing market collapse back in 2008. Fannie and Freddie received $191 billion in bailouts following the crisis and have paid an estimated $300 billion in dividends to the Treasury in recent years as part of a government “net worth sweep” that Fannie and Freddy investors have challenged in court.

The government-sponsored enterprises’ share prices took off following Trump’s election back in November 2016 on hopes that he would finally tackle housing finance reform. Fannie and Freddie common shares plummeted on Friday after the report failed to address many of their concerns. Both stocks have doubled in value in the year-to-date period.

Unfortunately for investors, the plan does not end the net worth sweep, nor does it mention common shareholders. The plan does call for the FHFA to increase Fannie Mae and Freddie Mac’s capital buffer from its current $3 billion level.

Earlier this year, FHFA director Mark Calabria said it would take “years and years” for Fannie and Freddie to build up a safe level of capital even if they were allowed to retail 100% of earnings. Calabria also said a dilutive public stock offering has “got to be an option on the table if we need to build that large amount of capital.”

Experts Weigh In

Despite the negative market reaction, Odeon Capital Group analyst Dick Bove said the continued existence of Fannie and Freddie and a potential end to the conservatorship creates plenty of opportunity for “multiple winners.”

“Everyone could make money here including the taxpayers, the United States economy, the housing industry, holders of GSE preferred issues, and possibly even the investors in the GSE common shares,” Bove said.

Former Kase Capital hedge fund manager Whitney Tilson said Friday’s sell-off in Fannie and Freddie shares on lack of detail may be misguided.

“Not only does the government own 79.9% of the equity, but it also wants the GSEs to be able to raise a lot of capital so that taxpayers will never have to bail them out again. Both factors give the government a strong incentive to act in a way that leads to a higher share price,” Tilson said.

He said Fannie and Freddie shares are akin to extremely cheap options without an expiration date.

Benzinga’s Take

Fannie and Freddie common shares offer investors a classic high-risk/high-reward speculative opportunity. However, as the last 11 years suggest, investors shouldn’t underestimate how long it could take the privatization process to play out.

Do you agree with this take? Email feedback@benzinga.com with your thoughts.

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