Out of the ashes, a phoenix shall rise. But, unlike that creature from Greek mythology, the resurrection of Fannie Mae ("Fannie" (FNMA.OB)) and Freddie Mac ("Freddie" (FMCC.OB)) was not due to a miracle. No, these two companies recovered through a combination of 1) an improving economy, 2) effective management decisions, and 3) prudential stewardship by their conservator, the Federal Housing Finance Agency (the "FHFA"). And now these firms are experiencing robust earnings, with Fannie and Freddie reporting pre-tax income of $8.1 billion and $4.5 billion, respectively, for the first quarter of 2013; and they are expected to remain profitable for the foreseeable future.
Yet the FHFA has not taken any steps to prepare Fannie and Freddie for release from their conservatorships and for their return to the shareholders, even though it has become obvious to most interested observers that these companies have regained tremendous financial health. In fact, the FHFA did just the opposite when in August 2012 it agreed to the 3rd amendment to the Senior Preferred Stock Purchase Agreements (the "Agreements"). Beginning January 1st of this year, the enterprises are required to pay dividends to the U.S. Treasury (the "Treasury") in an amount by which their net worth at the end of the immediately preceding fiscal quarter exceeds zero, less the applicable capital reserve amount. As a result, the two companies are essentially imprisoned in their conservatorships, since they are unable to build capital in order to regain their solvency classification status under the Housing and Economic Recovery Act of 2008 ("HERA") and thereby qualify for release 12 U.S.C. § 4614(a)(1)(A-B).
This action by the FHFA is in stark contravention to its mandate as conservator under HERA that empowered the agency to take any and all actions as may be "necessary to put [Fannie and Freddie] in a sound and solvent condition" 12 U.S.C. § 4617(b)(2D)(i)-(ii). Moreover, this act is a deliberate attempt by the FHFA, and possibly the Treasury, to avoid the covenant to the shareholders that states, "Upon the Director's determination that the Conservator's plan to restore [Fannie and Freddie] to a safe and solvent condition has been completed successfully, the Director will issue an order terminating the conservatorship[s]" (Pg.2). This situation is something I wrote about last month.
A Change in Narrative
Up until now, the narrative has focused on aspects based primarily on the premise that the fate of Fannie and Freddie rests in the hands of Congress and the president, and that they and they alone will decide the future, if any, for these two entities without regard for the common and preferred shareholders. This is a theme that has been advanced by many financial and non-financial journalists and pundits who simply repeat what they have been told by lawmakers and the Obama Administration. But there is an overarching principle that is conspicuously absent from the discussion -- the FHFA has a fiduciary responsibility as conservator to the shareholders of these companies. Through the enactment of HERA, a commitment was made to restore these companies, if economic conditions allowed, and return them to their owners. And although the two companies are federally chartered, they are publicly traded, for-profit enterprises tasked with, among other things, providing liquidity and stability for America's housing finance system. So, after having kept the two companies in conservatorship for almost five years, the federal government is left with three basic options for the disposition of Fannie and Freddie.
The first option is for government officials to direct the FHFA to comply with the original intent of the conservatorships and amend, retroactively, the Agreements with the Treasury to allow the companies to use funds in excess of the 10.0% annual dividend amount for the rebuilding of their capital structures and the repayment of their debt to the Treasury, effective January 1, 2013. Additionally, the two firms are to be released from their conservatorships and returned back to the shareholders when each company has achieved certain risk-based capital requirements, as provided by law 12 U.S.C. § 4611(a)(1).
Furthermore, Fannie and Freddie are to be relisted on the New York Stock Exchange, with any remaining amounts owing on the Treasury's aggregate liquidation preferences to be satisfied by exercising whatever portions of the warrants are necessary to retire the debts and unpaid interest (dividend). Also, through a prudent mix of debt and unused Treasury warrants, the two companies could hasten the process of full recapitalization beyond the basic regulatory requirements. Consider, too, that conservative estimates indicate that on a fully diluted basis, the initial values of the common shares for Fannie and Freddie could be approximately $37.00/share and $29.00/share, respectively. And finally, if Congress still wishes to reform the enterprises, the Congressional Research Service has provided several alternatives in their February 2013 report to Congress that are not contrary to the conservatorships, the taxpayers, or the tax-paying shareholders.
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