Fannie and Freddie's Shareholders Should Savor Their Latest Victory

Fannie Mae (NASDAQOTCBB: FNMA  ) and Freddie Mac (NASDAQOTCBB: FMCC  ) shareholders breathed a sigh of relief on yesterday as the Senate Banking Committee indefinitely delayed consideration of a bill aimed at overhauling housing finance. Under the bill, both Fannie and Freddie would be wound down over a period of five years, and the GSE's assets would be sold off with the proceeds going to the U.S. Treasury, which would most likely wipe out shareholders.

Source: www.futureatlas.com

Why the delay?
Of the 22 members on the Senate Banking Committee, 12 members (6 democrats and 6 republicans) publicly backed the Johnson-Crapo bill, but other democrats remained divided on several key issues. While this means the bill has the votes to make it through the committee, the bill likely wouldn't pass the entire Senate. In fact, Majority Leader Harry Reid would be unlikely to allow a vote on the bill without a significant increase in Democrat support.

What's next?
Many experts believe the delay is likely to kill the bill. There are six undecided Democrats on the committee, and some are seeking pretty significant changes before they'll throw their support behind the legislation.

Among the changes Democrats want to see are stronger protections for lending in disadvantaged communities. As the bill is currently structured, the new system of government mortgage insurance wouldn't kick in until private investors were wiped out. Many argue this is unfair, and would give lenders little incentive to finance mortgages in communities where the market is unstable, has a large amount of foreclosures, or any other undesirable traits.

They would also like to limit the ability of bigger banks to dominate the mortgage market, and to increase the sizes of loans allowable for government backing in high-cost cities.

If the bill does not get through the Senate before the summer recess begins in July, it is likely dead, and a new effort to overhaul Fannie and Freddie would begin during next year's session.

Shareholders still face an uphill battle
The delay is welcome news for shareholders, who during the proposed wind-down would be in line behind the government for any proceeds from the asset sale. Although both stock plummeted when news of the proposed bill was first released in March, shares of both companies rose 3% following the announcement of the delay, and are up more than 30% so far in 2014 on optimism of receiving some kind of profits from their investment.

FNMA Chart

Despite this good news, a lot more will need to happen before Fannie and Freddie's shareholders see any money.

Under the current terms of the government's bailout of the two companies, the U.S. Treasury keeps 100% of the agencies' profits as return on their investment. Shareholders are outraged by this arrangement, and with the companies' return to profitability, investors feel they should be rewarded. Major shareholders including Fairholme Capital Management have filed lawsuits to attempt to change the current arrangement, basically alleging it constitutes illegal self-dealing between the Treasury and the FHFA.

The gamble could pay off, but why take the risk?
If the shareholders win their lawsuit, they could indeed see tremendous returns on their investment. However, it seems at the current share price walking away isn't too bad of an option.  Many shareholders bought their shares for a small fraction of their current value of around $4.00. In fact, Fannie Mae's shares were trading below $0.30 for the bulk of 2012 and 2013, meaning shareholders who bought then already have more than a tenfold gain on their investment.

I'm not saying the Treasury is justified in what they're doing, but who knows how successful the lawsuit will be? All I'm saying is there is nothing wrong with taking gains off the table, especially in an investment as successful as this one has been for Fannie and Freddie's shareholders who bought during the bad times.

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  • Report this Comment On April 30, 2014, at 2:26 PM, Heisenberg2 wrote:

    Author stated: "However, it seems at the current share price walking away isn't too bad of an option. Many shareholders bought their shares for a small fraction of their current value of around $4.00. In fact, Fannie Mae's shares were trading below $0.30 for the bulk of 2012 and 2013, meaning shareholders who bought then already have more than a tenfold gain on their investment."

    To sell means someone else must buy your shares. Paradox.

  • Report this Comment On April 30, 2014, at 3:05 PM, smauney wrote:

    I can see you gave this a lot of while out on your boat.

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