It could be at least 15 years before Fannie Mae and Freddie Mac get fired from the conservatory, and even then the U.S. Treasury Department could keep its hooks on them, Keefe, Bruyette & Woods said.
The January amendment to the preferential share purchase agreement with the Treasury Department and the Federal Housing Finance Agency allowed state-sponsored companies to build capital through retained earnings.
But even then, FHFA director Mark Calabria said that relying on these alone would not be enough to adequately capitalize the GSEs according to his agency's guidelines for November 2020.
The GSEs' retained earnings for 2020 were $ 273 billion less than the $ 315 billion of capital they would need under the FHFA's final rule, said Bose George, an analyst at KBW. His calculations were based on Fannie's late 2020 disclosure that up to $ 185 billion in capital would be required. Freddie didn't make a similar disclosure, but George used Fannie's data to determine that Freddie would need $ 130 billion. As of December 31, 2020, the two had total capital of $ 42 billion.
If conditions stayed as they are now, with Fannie keeping the annual win rate between $ 10 billion and $ 12 billion and Freddie between $ 7.5 billion and $ 9 billion, it would be at least until 2036 for them to reach their minimum Capital requirement.
George isn't the only analyst who believes it will be a long time before the conservatories finish.
"We believe that the overarching considerations guiding GSE reform will be a moderate preference for moderate politicians on both sides of the political spectrum to avoid unduly disrupting the cost or availability of mortgages and the need for additional taxpayer support "said a report from KBRA Senior Managing Director Van Hesser. "To meet these conditions, the creditworthiness of the GSEs we believe is ongoing needs to be strengthened and the timeline for leaving the conservatory extended."
If it takes 15 years for the GSEs to raise enough capital, George believes the Treasury Department will likely exercise its rights under the PSPA to convert its senior preferred stock into common stock.
By 2036, the Treasury Department's liquidation preference will have grown in value to over $ 500 billion, so there will be little reason to freely give up the value of his position, George said.
"Based on KBW's earnings estimates and using a 10x price-earnings ratio, George calculates a combined market capitalization of $ 206 billion in 2036," a KBW press release said. "Treasury already owns 79.9% of that through its warrants. However, converting its senior preferred could add nearly 20% ($ 40 billion) to its ownership."
Given the potential valuation of Fannie Mae and Freddie Mac's shares in 2036, George downgraded both to underperformance with a target of $ 1 per share each. His previous goals were $ 2.50 per share for Freddie and $ 2 per share for Fannie.
On March 18, Freddie opened at $ 1.83 and Fannie opened at $ 1.88 per share.
While the GSE reform has so far been interpreted as a synonym for recapitalization and release, this term could take on a different connotation under the Biden administration, said Hesser of KBRA.
"A broader view of the reform could include any combination of measures that create a market that is stable and liquid, offers affordable housing and does not pose a significant risk to the taxpayer," said Hesser. "These goals could be achieved (and indeed partially achieved) through structures that create, encourage, and encourage strong underwriting criteria and quality processes."
These structures must take into account risk sharing in the private market and appropriate risk-based capital requirements.
Significant, explicit and unambiguous support from the federal government must be an ongoing component of every form of GSE reform, said Hesser: "At the moment, the conservatory outlined in the PSPA and the explicit support represent a high level of support from the federal government."