Fannie Mae Preferred S (FNMAS)

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Speculators aim to milk Fannie and Freddie

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April 11, 2013 7:42 pm

Speculators aim to milk Fannie and Freddie

By Stephen Foley in New York

That mooing sound you hear in the distance is a cash cow. There has been quite the transformation in the market’s perception of the US mortgage finance groups Fannie Mae and Freddie Mac, which were taken over by the federal government at the height of the financial crisis in 2008.

From being a money sink, draining the US Treasury to the tune of $187.4bn so far, the pair suddenly look like they will make money for the taxpayer. Investors have piled in to the groups’ defunct preferred shares and common equity, taking a (very) long-shot punt that they might somehow get to milk the cow, too.

Payback time

Funds received from, and dividend payments to, US treasury

Small community banks are weighing in to demand a reversal of the 2008 wipeout of preferred shareholders, adding a further element of uncertainty to the task of reforming the US mortgage market.
For mortgage investors, resolving the future of Fannie and Freddie is vital to settling the US government’s role in the housing market, itself a prerequisite for the re-emergence of a private mortgage-backed securities market.

They fear the return to profitability will diminish the urgency of reform, potentially leaving the market in limbo.

“Record Fannie Mae profits could frustrate reform efforts,” Gennadiy Goldberg, strategist at TD Securities, told clients. “Politicians will have to agree on longer-term housing market priorities [and] reform could continue to take a back seat amid summer and fall budget negotiations, leaving Fannie and Freddie in their current forms for some time to come.”

For the time being, Fannie and Freddie remain the only major issuers of mortgage-backed securities.

Their regulator, the Federal Housing Finance Agency, aims to wind the MBS down and replace them. But in the meanwhile, they have been raising guarantee fees in the hope that banks will find it relatively more attractive to issue private MBS, without the government backstop.

The aim is to widen the pool of private investor money that is available to fund mortgages for US homebuyers. So far, though, just $5.3bn of private mortgage bonds have been sold since the start of 2013, according to Standard & Poor’s. That is strong compared with $6bn for the whole of 2012, but issuance topped $700bn in the peak years of 2005 and 2006.

Jeffery Elswick, director of fixed income at Frost Investment Advisors in San Antonio, Texas, is a potential buyer of private MBS, but he has stayed away from the market, both for new issues and existing securities, because of the uncertainty. “The rules on mortgages are just not clear yet,” he said.

Fewer homeowner defaults and better house prices are behind Fannie Mae’s record net income of $17.2bn for 2012, announced this month.
The Obama administration’s budget projections, released on Wednesday, see Fannie and Freddie handing $51bn more to the Treasury by 2023 than they took in aid.

A year ago, the projection was for a $28bn loss through to 2022.
But Fannie and Freddie are not formally paying back the Treasury; they will remain in hock to it in perpetuity. Instead, the government takes all the pair’s profits in the form of dividends on senior preferred stock held by the Treasury so that there is no way they can build up a cash reserve large enough to pay back anyone else. Yet the apparently worthless preferred shares in Fannie Mae have gone up sixfold since August; the common equity in Freddie Mac has more than doubled – an option on a miraculous restoration, a political volte-face.

Paul Merski, Congressional relations chief for Independent Community Bankers of America, pointed to a Fed study that found 600 banks took more than $8bn in losses when Fannie and Freddie were nationalised, and half the community banks that held preferred shares still have them on their books.

“The truth of the matter is that they are the rightful owners of these companies even though the government is stepping in with their super-duper senior shares,” Mr Merski said. “This goes beyond recovering value. This is more of a moral obligation. The government is playing with fire with the whole perception in the market for preferred shares. It says something about how they treat capital investors.”

Australian investor John Hempton, who with his Bronte Capital hedge fund has been profitably trading the preferred, is pinning his hopes on a well-funded pension fund or lobbyists for small banks or attorneys for anyone who still holds shares in the US.
They could have a legal claim under the US Constitution’s Fifth Amendment, which says private property cannot be taken for public use without just compensation.

“If you believe that change will stick, that Fannie and Freddie preferreds are worthless, there is no way to recapitalise them, since any capital just gets paid out to the government. But the current terms are theft; they will have to attract a Fifth Amendment claim, and that claim will be successful.”

The sound and fury, and the moral suasion, may or may not come to something in Congress, where lawmakers are also starting to take an interest in the future of Fannie and Freddie as part of a wider debate about mortgage rules and housing finance.
For speculators in the groups’ shares, the fight is over who gets to milk the cow while mortgage investors are impatiently waiting to?see?the landscape beyond.

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