On Sunday, U.S. federal regulators outlined their takeover plans for the two GSEs, Fannie Mae (FNM) and Freddie Mac (FRE).  As part of the plans, the Treasury will acquire $1 billion of preferred shares in each company, and has also pledged to provide as much as $200 billion in capital and new credit lines. 

The Treasury plans to buy an unspecified amount of mortgage-backed securities in an attempt to lower mortgage interest costs for homeowners and in addition, it is also setting up back up facilities for the 12 Federal Home Loan Banks, which provide advances to its 8,000 members. The plans put the two companies under a conservatorship, giving management control to their regulator, the Federal Housing Finance Agency (FHFA).

While the move is expected to be positive for the housing market and the wider economy, and is also likely to help bring mortgage rates down, we do not expect it to lead to a housing recovery. The housing situation in the country continues to be quite grim as there is still a large supply of unsold homes in the market and an increasing number of foreclosures. Further, rising unemployment (now above 6%) and increased job losses will continue to worsen the situation.

The biggest losers so far have been shareholders of the two companies, with the shares falling more than 82% to below $1 a share on Monday from their 52-week-highs of $69 and $66, respectively. The shares had been declining sharply in the past few weeks based on the concerns that the companies did not have enough capital to withstand losses on their portfolios.

Despite the regulator’s assurances that the institutions were adequately capitalized, it was well known that the two were severely undercapitalized, and FRE in particular had used accounting methods to overstate the capital cushion. Now, as part of the bailout, the U.S. Treasury will receive warrants to buy up to 79.9% of the companies’ common stock, effectively wiping out the shareholder value. 

Further, the companies also face the risk of being delisted from the NYSE, as NYSE-listed companies whose shares close below $1, on average, over 30 days receive a letter from NYSE giving them six months to get their shares back above $1.

Though the markets reacted positively to the news, ultimately only time will tell how effective the plan will be in helping the housing market and the economy. We will look out for further details on the plan.

Read the full analyst report on FRE.

“FNM” Free Stock Analysis: Buy? Sell? Hold?
“FRE” Free Stock Analysis: Buy? Sell? Hold?
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