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Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are two companies in conservatorship regulated by the Federal Housing Finance Agency (FHFA). The companies currently are retaining their earnings on their path out of conservatorship, but if they want to raise money, they need to have their balance sheets restructured. Before any of this can happen, FHFA needs to get everything else in place, and things could be in place sometime early this year should the administration want to reap any additional profits from its equity stake in Fannie Mae and Freddie Mac, while simultaneously tackling the affordable housing crisis.
Investment Thesis
Fannie and Freddie currently have balance sheets that are structured where Treasury lays siege to their ability to raise capital. From 2008 to 2019, FHFA and Treasury pumped Fannie and Freddie full of accounting losses and then drained them of cash when the losses never materialized; but, in 2019, put an end to this and began letting Fannie and Freddie retain earnings on their path out of conservatorship. The government's senior preferred equity stake in Fannie Mae is $163.7B and $98.0B in Freddie Mac. In addition, the government has 79.9% warrant coverage that it can exercise at a nominal price to take the bulk of the common stock. The senior preferred stock is what makes the companies unattractive to new capital. An investment in these company's common or preferred stock is a bet that that the government restructures its equity in such a way where there is value left over for existing junior preferred shareholders and common shareholders or a resolution in the courts where the government is forced to pay shareholders money for the imposition of the net worth sweep. I own preferred shares and largely expect they are converted to common in an equity restructuring where the lawsuits are settled and the companies move forward to raise capital to exit conservatorship. Common could be worth $4-8 in such a scenario, but take a backseat to the junior preferred equalization because they are junior in the capital structure.
Biden Announces Nominee For Director of FHFA
Sandra Thompson has been acting director of FHFA since Biden fired Mark Calabria after the Supreme Court ruled that he could. Now, Biden has nominated her to serve as the Director:
Her hearing has now been scheduled for Thursday January 13 at 10 AM at Dirksen Senate Office Building 106. It will be interesting to see what sorts of questions she gets asked regarding her thoughts about the conservatorships and how long they have gone on.
FHFA Proposes Capital Planning Rule for Fannie Mae and Freddie Mac
FHFA put together an Enterprise Capital Planning rule for Fannie and Freddie. The document references the word 'capital' 357 times. The rule addresses the fact that the companies are in conservatorship and that it is not yet applicable but argues that it will allow the Enterprises to proceed with figuring out how much capital they need, what kind of capital they need, and when to raise it:
This proposed rule, along with the continued retention of earnings during the Biden administration, is further evidence that Fannie and Freddie will eventually be restructured to raise money to protect taxpayers. Raising capital appears to be where this is all going.
Prior FHFA Director Mark Calabria Suggests 2008 Approach to GSEs Was Illegal
Mark Calabria was the prior director of the Federal Housing Finance Agency. He recently wrote his first commentary on the GSEs since leaving office:
This isn't the first time that Mark Calabria has spoken out against the agency that he directed. Previously, in 2015, Mark Calabria wrote a paper on the law that he wrote that governs FHFA saying that it broke the law when it implemented the net worth sweep. This paper is what likely put him first in line to head the agency under Trump who seems to agree with the governmental stealing of Fannie and Freddie narrative.
To his credit, Mark Calabria did stop the net worth sweep in Sept. 2019.
Summary and Conclusion
Fannie and Freddie are retaining earnings on their path out of conservatorship. Since leaving office, now Trump and Calabria have put out statements about prior administrations' actions being illegal and got work started to try and fix it but didn't get everything done. Sandra Thompson seems to be taking this and going with it, and all comments are due on her Capital Planning proposed rule by February 25, 2022. I think the next major step is to wait for Sandra Thompson to get confirmed, at which point I think we'll see these rules that she has been working on be put to use. Really looking forward to her conservatorship comments next Thursday.
Happy new year 2022!
