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Why Fannie Mae and Freddie Mac’s shares, and their preferred stocks, all fell today

By on June 23, 2021 0

What happened

The shares of two government-sponsored entities were skimmed today after the Supreme Court dismissed part of a case that could have brought shareholders tens of billions in profits. The stock of National Federal Mortgage Association (OTC: FNMA), or Fannie Mae, fell more than 32% today, while shares in the Federal Mortgage Company for Real Estate Loans (OTC: FMCC), or Freddie Mac, fell almost 37%.

The preferred shares of Freddie and Fannie were hit even harder, for no obvious reason as far as I know. For example, the actions of Federal National Mortgage Association 7.625% non-cumulative preferred stock fell 60% today.

So what

Fannie Mae and Freddie Mac buy mortgages from banks and other lenders in order to provide liquidity to the mortgage market, so these lenders have the money to keep lending. The two then bundle the mortgages they buy into securities and sell those mortgage-backed securities to investors. The big difference is that Fannie buys her mortgages from large commercial banks, while Freddie buys them from small banks.

During the Great Recession, Fannie and Freddie took too much exposure to subprime mortgages and had very little capital reserves to cover their exposure. As losses began to mount, the government concluded that it should intervene to protect liquidity in the mortgage market. The Treasury Department has agreed to provide up to $ 100 billion each in taxpayer funds to Fannie and Freddie in exchange for first preferred stock.

The deal also involved placing the two companies under government supervision under the direction of the Federal Housing Finance Agency (FHFA), which regulates entities now sponsored by the government. In 2012, Fannie and Freddie had withdrawn $ 187 billion from the treasury. Initially, the two were supposed to pay the fixed interest back to the Treasury, but eventually this deal was changed to simply hand over their profits – above the capital reserves they needed – to the Treasury.

Image source: Getty Images.

And that’s where the trial comes in. From 2013, Freddie and Fannie’s financial situation improved, and the two began to hand over a lot of money to the treasury. Between 2013 and 2016, Fannie and Freddie returned more than $ 200 billion to the treasury and paid a total of $ 300 billion to the department. Shareholders say this is $ 124 billion more than they should have been in initial fixed interest payments over those four years.

Shareholders in Fannie and Freddie claimed in their lawsuit that the FHFA overstepped its statutory authority as the corporate registrar by essentially agreeing to turn all profits over to the treasury. Shareholders also claimed that the structure of the FHFA is unconstitutional because it has a single director whom the president can only remove “for cause”.

The Supreme Court rejected the shareholders’ first request for statutory authority, but left an opening for the second request. Judge Samuel Alito wrote that “the possibility that the unconstitutional restriction on the president’s power to remove an FHFA director may have such an effect cannot be ruled out”.

But perhaps another disappointment for shareholders is that the lawsuit now allows the White House to remove FHFA director Mark Calabria from his post, which it did quickly following the ruling. Supreme Court. Calabria had been in favor of getting Fannie and Freddie out of control quickly. This would likely have benefited both of their stocks, which haven’t touched $ 5 per share since 2008.

Now what

Given the market reaction, it looks like the move came as a bit of a shock. The case is not completely finished and has been referred to the lower courts, where investors can still make their second claim regarding the difficulty of removing the director of the FHFA from the president. But Elliot Stein, analyst for Bloomberg Intelligence, said the Supreme Court ruling actually means shareholders “can’t get back most of the overpayments they’ve asked for.”

The Calabria pullout is also likely not good for Fannie and Freddie shareholders, as it could make a full exit from trusteeship less likely, or at least much slower.

At the start of the year, the FHFA concluded an agreement with the Treasury allowing the two entities to keep all of their profits in order to comply with the new capital rules set by the FHFA. But it might take a while. Meanwhile, Fannie Mae and Freddie Mac are still unable to raise private capital or issue a dividend to shareholders while the Treasury has preferred shares and both are under trusteeship – two factors that are not attractive to investors.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.