Fannie Mae And Freddie Mac Common Shares Are Overvalued

| About: Freddie Mac (FMCC)
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The last dividend paid by Fannie Mae (NYSE: OTCQB:FNMA) and Freddie Mac (NYSE: OTCQB:FMCC) was back in the Spring of 2008. During 2012 and 2013, when the government sponsored enterprises (GSEs) began producing profits, the dividends were paid only to the Federal Treasury due to the "Sweep Amendment" Congress passed. I will attempt to stay focused on the value of the stock, and keep a less political view during my discussion.

Here are five reasons why Common Shareholders will not receive any compensation for their shares when the GSEs reach a final resolution.

1. Fannie Mae and Freddie Mac have no mechanism in place to repay their loans to the Federal government. Due to the initial agreement and follow-on government regulations the GSEs have no ability to end government control. Each quarter the GSEs produce billions of dollars in profit and pay their dividend into the general fund of the U.S. Treasury.

2. The new Chairman of the Federal Housing Finance Agency (Mel Watts) has not proposed any change to the current operational status of Fannie Mae and Freddie Mac's operations. Prior to taking office, he made several statements to stop the additional fees that were to go into effect on loans through Fannie and Freddie in 2014. There has been no policy direction changes from the status quo to this point. We do not want to polarize this point, just point out that Mr. Watts will be the catalyst for any change in the future. His agency will have to create a plan moving forward to create the organization that will manage the mortgage market with controls and guarantees for the government.

3. The change in federal law or regulation must occur from Congress and the agenda in both houses of Congress does not include addressing the GSEs. This is an election year and the political fever is not doable this year. Congress would have to rescind the "Sweep Amendment" or pass another bill and possibly over-ride the President's veto to change the current law. Currently, both parties are looking for topics of less political fire and will avoid this discussion publicly. The effect on the investors of common shares will include no resolution in 2014.

4. The Berkowitz Law firm has sued the federal government to protect the owners of the junior preferred stock. The law firm also proposed a deal that would kill the law suit if the junior preferred stock were used to recapitalize new companies and entitled as the common shares. We read this as a way to cut out the current common shareholders. If there is headway through the courts in 2014, there is no force representing the common shareholders, and they may not have a voice in the settlement discussion.

The Berkowitz proposal was quickly rejected by the White House, and it was clear the proposal would meet resistance in Congress, which wouldn't want to lose its GSE cash cow. Washington also perceived a lack of sympathy for the non-government shareholders of Fannie and Freddie, some of whom scooped up the shares at tremendous discounts in the hope of making a killing as the GSEs returned to consistent profitability.

5. I will not rehash the current position the GSEs are in after borrowing billions from the federal government, but the option the government holds to purchase 79.9% of common shares from the two GSEs at a strike price of $0.00001 per share. The government can purchase 10,000 shares for a penny. There are currently about 650 million shares and the government has the right to purchase 2.6 billion shares through the original rules. Any value left after the government pays itself (senior preferred shareholder), then the junior preferred shares will be dissipated to the common stock shareholders. With the amount of shares the government is able to purchase, the payout per common share will be insignificant.

Shares of Fannie Mae rose over the last year from near $0.26 per share on January 2, 2013 to close January (January 31, 2014) at $3.13. Freddie Mac last year traded at $0.29 on January 2, 2013 to close January (January 31, 2014) at $3.02. With no end state of resolution and the quarterly dividends going to the government, it is our recommendation that investors exit their positions and find other investments with growth and income potential. If and when the government does wind down the GSEs, there will be no value left for the common shareholder.

For an in-depth look at the details of the original loan and rules you can review my article here.

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.