With the volatile swings in Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) shares over the past week, many investors have been left scratching their heads. The biggest impetus for a stock rally appears to be the possibility that Fannie Mae will recognize its massive Deferred Tax Asset with its 4th-Quarter 2012 earnings. Earnings have been delayed as the accountants, regulators, and politicians deliberate. It's reported to be more than $60 billion and has been building up over the years with a valuation allowance against it to offset its value.
Outside of these facts, it's hard to imagine why Fannie Mae common stock would more than double. Last August 17, the Treasury instituted a dividend sweep of each GSE's net worth that will potentially pull every single cent of profit to the Treasury. However, with the recognition of the Deferred Tax Assets in each GSE, there is a possibility of wiping out $90 billion of the net investment made in their bailouts. Freddie has a valuation allowance of $31.7 billion on its Deferred Tax Asset.
According to a press release issued by Jeb Hensarling's (R-TX) office, the House Financial Services Committee may be meeting in late April to discuss the historic wind-down of Sallie Mae (SLM) and lessons learned. This little tidbit of information points investors in a new direction. For years, the discussion around Fannie Mae and Freddie Mac has been elimination through wind-down of their operations. Investors have taken this to mean death.
By comparing the wind-down to Sallie Mae's 1990s restructuring, one can then begin to draw parallels and predict outcomes. In 2006, the Treasury released an analysis on the Sallie Mae wind-down, which can be found here.
The wind-down of Sallie Mae included the creation of a new private sector holding company. Shareholders of the old Sallie Mae voted to exchange their shares of stock for the new Sallie Mae shares and a reorganization was made effective August 7, 1997. Over time, assets and operations were transferred to the new entity, which was free to operate as a private company and eventually dominated the student loan market.
Investors may be drawing parallels between Sallie Mae and Fannie Mae and Freddie Mac. It is very easy to do, especially with the recent announcement that the GSEs would be forming an operational merger to bring their securitization businesses together. Very few details for shareholders have been made public. These key facts are known:
- GSE securitization operations will be merged,
- the new entity may possibly be made private,
- the new entity will be owned by Fannie Mae and Freddie Mac.
All this sounds very similar to the Sallie Mae "wind-down" with the exception of the part about shareholders getting a chance to vote on the changes and exchanging their shares from one company to the new company.
However, there is the very real possibility that a takings issue will occur if the U.S. Government takes one penny more than what is owed. After all, it is transferring operations from one entity to the next without providing any type of compensation at this point. This is enough to create a speculator's rally.
The GSE preferred stocks have been moving higher for months, but today, several broke $10 per share, touching as high as $17 for brief moments. Federal National Mortgage Association $50 preferred shares traded between $6.95 and $17 a share before settling at $11.20. FED HOME LN PFD $50 preferred shares traded for $10.01.
There's a lot to be hopeful about. Shareholders will be eagerly awaiting more details of the wind-down and new company, as well as the possible recognition of the massive deferred tax assets.
Additional disclosure: Various preferred stocks.