Summary
- A framework for the recapitalization and release of Fannie Mae and Freddie Mac from conservatorship is on Treasury Secretary Steven Mnuchin's desk.
- Wall Street bankers have been meeting with Treasury and have seen that the framework has input from FHFA's Mark Calabria.
- After years and tens of thousands of man hours in the making, it seems that the only thing that is missing is final signatures executing the GSE Big Bang.
- Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are two companies that are in conservatorship that have been retaining their earnings since September of last year when Treasury and FHFA began implementing Treasury's Housing Finance Reform Plan:
Treasury's Housing Finance Reform Plan was put together at the request of President Donald Trump via a White House Memorandum with the primary objective being to see to the:
(i) Ending the conservatorships of the GSEs upon the completion of specified reforms;
Investment Thesis: With the capital rule finalized, it sets the end zone out clearly for what is to happen next. Mnuchin's chief concern with Fannie and Freddie lately seems to be their ability to raise third-party capital, which is necessary given the grand canyon of a gap between their current capital level and the amount of capital that they would need to hold to meet their newly finalized capital rule. Before the companies can raise money, they need to have their equity restructured. In order to be attractive to new investors, the new investors need to be able to buy securities that have earnings that accrue against them.
The government currently takes everything above and beyond the capital buffers and has an insurmountable liquidation preference along with warrants for 79% of the companies. Investor-backed lawsuits have been filed in courts around America and have recently been argued in front of the Supreme Court. Wall Street bankers have been meeting with Treasury and there is now a recapitalization framework on Mnuchin's desk.
According to Craig Phillips, who put together Treasury's Housing Reform plan, the PSPA amendment should result in reclassifying payments to Treasury as liquidation preference paydown. Junior preferreds would be exchanged for common stock to help facilitate the recapitalization and Treasury would exercise its warrants. The major question for me regarding the valuation of the common stock is the possibility of a retroactive commitment fee in lieu of being declared paid back. As such I recommend owning preferred stock and figure preferred stock is worth par in the next year and common stock is worth $3-7 as the companies are restructured and move forward to raise third-party capital.
