The battle over Fannie Mae and Freddie Mac continues, but a new court hearing has prompted an upgrade on the GSEs‘ shares from bank analyst Dick Bove of Odeon Capital. He now rates the preferred shares of both government-sponsored enterprises at Buy, while he rates their common shares at Hold.
“Thugs in a mob”
In a note today, Bove highlighted a hearing in front of Federal Claims Court Judge Margaret Sweeney on Tuesday. The hearings focused on the Federal Housing Finance Agency’s creation of a third amendment for its senior preferred shares in Fannie Mae and Freddie Mac.
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According to Bove, the judge made comments like, “The United States government has acted like thugs in a mob in this situation.”
She also said once again that the net worth sweep isn’t valid. She has asked the Appeals Court to certify her views, and Bove noted that Tuesday’s hearing isn’t a final result. The Appeals Court and the Supreme Court might have to weigh in on the issue, but he believes Sweeney’s rulings will be upheld. Because of this, he upgraded both the preferred and common shares of Fannie and Freddie, although he noted that he still has a Hold rating on the common shares and would not buy them at this time.
Preferred versus common shares
Bove noted earlier this week that there was a sharp sell-off in both the common and preferred shares of Fannie Mae and Freddie Mac in response to a press announcement about a GSE capital rule. He said the sell-off made sense for the common shares, but not for the preferred shares.
At that time, he still rated the common shares at Sell because he didn’t think the government would be able to remove the GSEs from conservatorship without three things. The first is an act of Congress guaranteeing their debt, while the second is Congress’ willingness to view the senior preferred shares as paid. The third is for both companies to be able to raise capital based on both their balance sheets and business models.
He noted that the value of the preferred shares doesn’t depend on the GSEs exiting conservatorship, which makes them a better bet than the common stock. Additionally, it’s up to the courts whether the junior preferred shares have any value, although court rulings so far have been in favor of shareholders.
Delay hurts Fannie & Freddie common shares
FHFA Director Mark Calabria said this week that he will rewrite the capital rule for Fannie Mae and Freddie Mac and that it might not happen until 2020. However, given that 2019 is nearly over, that isn’t a huge surprise.
“What is off-putting here is the estimates that the likely release and recap of these companies from their conservatorship may be a 2021 or 2022 event,” Bove wrote. “Further, if the Democrats gain the Presidency, it may never happen.”
Bove also said the market believes that if the Democrats gain control of the Presidency and the FHFA, the junior preferred shares will never be repaid. He said that assumption was based on the Democrats’ view of the junior preferred shareholders under former President Barack Obama as never “obtaining anything from their investments.” However, he said that assumption also assumes the courts will rule that junior preferred shares have no value, which is unlikely. He also pointed out that Fannie’s and Freddie’s balance sheets indicate that the junior preferred shares have an equity value rather than no value at all.
“The government wants everything its way,” Bove wrote. “1. It wants the companies to issue senior preferred stock, as they did in the third quarter, and not show it on their balance sheets. 2. It wants to list the junior preferreds on its balance sheet as having value while arguing that they have no value. I may be the most naïve individual in the country, but I do not believe that these contradictions will be allowed to stand.”
This article first appeared on ValueWalk Premium