(Editors' Note: This article covers micro-cap stocks. Please be aware of the risks associated with these stocks.)
Our assessment has been and continues to be that for the near-term, the next 2-3 years, the investors in Freddie Mac (OTCQB:FMCC) and Fannie Mae (OTCQB:FNMA) will see their quarterly profits go into the U.S. Treasury. This is clearly defined by the latest agreement between the federal government and the leadership of both FMCC and FNMA. Investors are exerting pressure for change, but it is unclear at this time if they will be successful to win any court battles to force the federal government to relinquish control of the Government Sponsored Enterprises (GSEs) and allow their investors to benefit from the profits.
Freddie Mac on August 7, 2013 announced second-quarter earnings of $5.0 billion, increasing from $4.6 billion the previous quarter. Freddie also announced it would pay the U.S. Treasury a dividend of $4.4 billion in September.
Fannie Mae on August 8, 2013, announced second quarter earnings of $10.1 billion, and said it would pay the government a dividend of $10.2 billion in September. This was Fannie Mae's sixth-consecutive quarter of profits. Every profit has resulted in the dividends being paid to the federal government.
Under the modified bailout agreement, neither Freddie Mac nor Fannie Mae are allowed to repurchase any of the government-held preferred shares, no matter how profitable the GSEs become and no matter how much in dividends they pay the government.
The government's senior preferred stake in Fannie Mae totals $117.1 billion, and following the September payment, the company will have paid the Treasury cash dividends totaling $105 billion.
The government has a $72.3 billion senior preferred stake in Freddie Mac, and once Freddie's September dividend is paid, the company's dividend payments to the Treasury will total about $41 billion.
Both individual investors and large financial institutions have challenged the modified bailout agreement through a series of lawsuits with the hope of recapturing some value. Several of the law suits include the Berkowitz Group in federal court of the District of Columbia, the Police Retirement System of Austin, Texas, and a bank from the state of Washington, Perry Capital, one of the largest U.S. hedge funds invested in the GSEs.
One possible solution, which seems remote, is for the government's preferred stake to be converted to common shares, as was successfully done as part of the epic bailout of American International Group (NYSE:AIG). That bailout resulted in a profit to the U.S. taxpayers of $22.7 billion dollars.
Senators Mark Warner (D. Va.) and Bob Corker (R., Tenn.) introduced legislation to wind-down Fannie and Freddie over five years, privatize most of the U.S. mortgage market, while putting in place a limited government backstop in the form of a "Federal Mortgage Insurance Corporation (FMIC), modeled in part after the FDIC." The Federal Deposit Insurance Corp. insures bank deposits by charging premiums to all U.S. banks and savings and loan associations. There has been little movement on the topic and the way ahead is very political, and with a Republican House and Democratically controlled Senate, this is not a topic that both parties will come together on easily.
On August 6, 2013, during a speech, President Obama supported the striping of assets and dismantling both Freddie Mac and Fannie Mae. The most likely process would include selling off a combined $5.2 trillion in assets, which would be an astronomical amount to sell to private investors. The private sector does not have that much cash available for the amount of risk the government plans to shift. If the plan includes a limited government backstop in the form like "Federal Mortgage Insurance Corporation (FMIC), modeled in part after the FDIC." The Federal Deposit Insurance Corp. insures bank deposits by charging premiums to all U.S. banks and savings and loan associations. Currently, there is no public support, no financial organizations, investors or companies interested in participating and no political gains other than the rhetoric to the media.
The real positive that has taken place is the Federal Reserve Chairman Ben Bernanke told members of the House Financial Services Committee on August 7, 2013 that they, the policymakers, should first decide on the government's role in housing as they attempt to shape the future of housing finance. He clearly encouraged lawmakers that they must define the path ahead for governments participation in oversight, and/or, participation in the market place. He was clear that private investment must become a larger player, but the government should be firmly rooted in oversight and enforcing regulations and standards in the markets.
In the near future, the third and fourth quarters of 2013, both Freddie Mac and Fannie Mae will earn profits and the federal government will sweep them into the U.S. Treasury as approved by the current agreement. Investors will fight court battles, but any change through legal proceedings will take an expected 2-3 years. The federal government has a multi-billion dollar cash-cow paying billions of dollars to the U.S. Treasury four times a year. They will not give that up without a fight.
Our recommendation is two-fold. If you believe the investors will win the lawsuits over the next few years, then you are welcome stick it out. Some comments on my previous articles claim $20 to $50 stock prices after they win court cases. Right now in the market, there are solid investments that are earning over 10% a year. I like several that pay dividends over 10% that I can take the cash and keep the principle of my investments.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Information collected for this article are from the public release of information, the President's speech and Federal Reserve Chairman's visit to Capital Hill. Our analysis is driven from most likely courses of action and investment concerns of our readers. We recommend every investor conduct your due diligence on every investment to ensure it meets you investment criteria.