Fannie, Freddie release likely. It’s just a matter of when

Although hedge fund manager Bill Ackman’s proposed plan to resolve the government-sponsored enterprise conservatorships is seen as unlikely, analysts believe the release of Fannie Mae and Freddie Mac remains a strong possibility.

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Rather than forgiveness of the senior preferred shares as Ackman suggested, the path out of conservatorship is more likely to be facilitated by the U.S. Treasury converting its senior preferred holdings to common stock in both Fannie Mae and Freddie Mac, said Bose George, an analyst at Keefe, Bruyette & Woods.

Since Ackman’s comments went live on X and especially following the Jan. 2 announcement of the agreement between the Federal Housing Finance Agency and the Treasury that outlined a process for exit from conservatorship, the common stock price of both GSEs has been soaring.

At 12:30 p.m. eastern time on Jan. 6, Fannie Mae was trading at $5.04 per share and Freddie Mac at $4.99. 

For Freddie Mac, this compares with a close of $4.33 per share on Jan. 3 and $3.27 on Dec. 31.

Fannie Mae closed on Jan. 3 for $4.47 per share, while ending the year at $3.28.

The Congressional Budget Office in December put out a report noting that 60% of its 250 recapitalization scenarios would provide enough funds for the GSEs to fully repay the Treasury within three to five years for the $190 billion in preferred stock it holds.

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That was up from 12% in a 2020 analysis.

But in comments about that report, George said privatization needs to be done so the implicit guarantee on their mortgage-backed securities remains in place.

In its statement on the Jan. 2 changes to the Preferred Stock Purchase Agreements, the Mortgage Bankers Association called for an explicit federal backstop for agency MBS.

The Community Home Lenders of America is looking to keep a level playing field between the small and midsized lenders and their larger competitors.

“The PSPA announcement is further evidence of rising expectations that the GSEs will be moving to exit conservatorship — so CHLA reiterates the critical importance of protecting smaller independent mortgage banks in the process — through a utility model with [guarantee fee] parity, a robust cash window and no new GSE charters going to Wall Street banks,” said Scott Olson, its executive director, in a statement.

The potential conversion of the preferred shares to common is what drove George’s post-election downgrade of both companies because the dilution risk for existing shareholders like Ackman is significant.

As of Jan. 3, Ackman owned 115.6 million shares of Fannie Mae, according to the KBW note.

“Under Trump 1.0, we believe that plan was to convert senior preferred to common, which would have meaningfully diluted the common shares, and we would expect that to be the case under Trump 2.0 as well,” George said. “However, the strongest argument in favor of forgiving the senior preferred investment is that it would end ongoing litigation.”

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That is important because under the Preferred Stock Purchase Agreements in their current form, neither Fannie Mae or Freddie Mac is able to raise the third-party capital they would likely need to meet regulatory targets.

But court battles are unlikely to cease if the government wipes out the common shareholders’ positions in a scenario where the Treasury converts its senior preferred shares. Because the net worth sweep was eliminated, the liquidation preference for those shares Treasury holds, which is on top of the value of those shares, has been growing every quarter. In the Nov. 19 report, George calculated the collective obligation at $341 billion, including $147 billion for the liquidation preference.

“We would also note that since Treasury owns [approximately] 80% of the shares, any forgiveness is really a forgiveness of the 20% of the equity value that is retained by private shareholders,” George said. “The Ackman post also assumed 2.5% minimum capital for the GSEs, which we believe is a reasonable level, but the current minimum is over 4%.”

As for the updated agreements between FHFA and Treasury, KBW considers the key point to be the requirement for a request for information that details the specific options for the termination of the conservatorship and then seeking input on how each would impact the housing market and the GSEs. It also keeps the minimum capital framework in place.

“Since these changes can be easily undone by the new administration, the purpose of this announcement appears to be to lay out some guidelines and tie up some loose ends before the expected attempt at GSE privatization under the new administration,” George said.

Morningstar DBRS takes a similar viewpoint in its report, subtitled “One step further on a long journey.”

“While these requirements would slow down any attempts at release, we don’t view them as substantial roadblocks, especially given that the new framework could potentially be amended under the second Trump administration,” said Eric Chan, vice president, North American financial institutions. “Nonetheless, the potential systemic repercussions of pursuing an ‘incorrect’ option would be meaningful, so any potential resolution will likely involve a long debate process.”

In addition, finalizing whatever approach the government were to take in releasing the companies would have to allow for sufficient implementation time to reduce the possibility of transactional disruptions to the housing market as well as to the “deep and liquid markets” for the GSEs’ debt.

“Although the upcoming Trump administration may attempt to move forward with a release, given a low margin for error and the complexities involved, our view is that the mortgage GSEs will likely continue in their current state for the medium term,” said Chan, pointing to comments made in an August research report.