GSEs Fannie Mae & Freddie Mac March Toward Cicada Exit

Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are two companies retaining earnings on their path out of conservatorship. They are unable to raise capital because the government currently lays claim to all of their earnings via the Senior Preferred Stock Purchase Agreement (SPSPA). Sandra Thompson recently met with the Bipartisan Policy Center for a Fireside Chat where she spoke about the possibility of the exiting conservatorship (37:40):

If the enterprises ever get out of conservatorship, everybody knows it’s going to be the largest IPO ever.

In addition, Sandra Thompson said the enterprises are being prepared to exit conservatorship:

We are preparing the enterprises to adjust to the supervision in a way that they would be regulated outside of conservatorship.

At around 44 minutes into the Fireside Chat, an audience member who started HUD 50 some years ago and worked on the legislation creating the regulator predicted that Fannie and Freddie would be a cicada event, that’s 17 years, that Sandra Thompson will be confirmed, see them get out of conservatorship. 17 years of conservatorship would put their exit in 2025, aligning with the end of the Biden presidency.

Investment Thesis

Fannie and Freddie were on track to raise capital to exit conservatorship by the summer of 2021 if Trump had been re-elected. Biden won the election, however, and fired Calabria after the Supreme Court ruled that HERA 2008 permits the government to do whatever it wants with GSEs in conservatorship and that the FHFA director is a political position. Biden elected to continue following the path of the Trump administration with Fannie and Freddie continuing to retain earnings instead of restarting the net worth sweep upon firing Calabria. This means that this is moving towards an eventual equity restructuring. The government has a huge and growing liquidation preference that is equivalent to multiple years of earnings for both GSEs as well as 79% warrants equivalent to 80% of the common stock whenever it decides to exercise them. As such, I don’t think that there is security in the common shares especially since there is no litigation path to reverse the net worth sweep now that SCOTUS has blessed it, a true tragedy. Nevertheless, there is no way to get around the junior preferred stock in a restructuring and they still have legal claims that are alive and well and moving to trial. I expect the strong junior preferred legal claims to be mooted or settled by pending restructuring Treasury actions that are all waiting for Sandra Thompson to get confirmed at the earliest.

Biden Treasury’s Involvement In GSE Reform

Treasury has released their Strategic Plan for FY 2022-2026 where they outlined their strategy for Fannie and Freddie. Specifically, Treasury has a measure and indicator of success on page 16:

Developed administration positions on Government Sponsored Enterprise (GSE) reform issues to facilitate progress towards a desired future state for the GSEs

At the Fireside chat, Sandra Thompson said she is talking with Treasury:

I think that there are a number of things that need to take place. One, there’s the big ticket items, the things that are obvious to everybody — certainly conversations with Treasury as a significant shareholder have to take place. I know that lots of people have views on that, but those conversations are not as easy as they could be. The nice thing is we’ve had precedential conversations given what happened in the great recession. So the issues, while they’re specific to Fannie and Freddie are not necessarily new to the federal government at large.

So we know that Sandra Thompson is talking with Treasury, that Treasury has identified this as an issue to solve, and that after having precedential conversations with Treasury, Sandra Thompson is still talking about Fannie and Freddie retaining capital on their way to the “largest ipo ever.”

Summary and Conclusion

At the Bipartisan Policy Center Fireside chat, Sandra Thompson talked more about working with Treasury than working with Congress. Junior preferred trade at 12 cents on the dollar. If they get par in 2025, that is about 100% return per year until the exit conservatorship. This opportunity has been created because no one thought the Biden administration would do anything with respect to ending the conservatorships of Fannie and Freddie, but they appear to be doing just that. I don’t think that these prices make any sense aside from the stark reality that Fannie/Freddie junior preferred investors have just the worst case of investor fatigue I’ve ever seen.

Lastly, there was a motion for summary judgment filed by plaintiffs under seal in Lamberth’s court. That is expected to surface with potential redactions in any day now. That motion included the fruits of 3-4 years of discovery that started back in 2018 and got delayed and the trial pushed back because of COVID and because the government’s document production took longer than expected. Trial is set for this summer, but this motion for summary judgment should be fireworks.