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Fannie and Freddie: 80% Dilution

by: Tim Plaehn September 07, 2008 | about stocks: FNM / FRE    
Tim Plaehn

Tim Plaehn

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A quick look through the Treasury plan to take over and prop up Fannie Mae (FNM) and Freddie Mac (FRE) shows that although common and preferred shareholders will not be completely wiped out, their holdings will be seriously devalued and diluted:

  • First, dividend payments on both the common and preferred shares will be suspended.
  • Second, in exchange for a $1 billion capital infusion, the Treasury will get senior preferred shares with a 10% coupon to be paid quarterly.
  • Third, the government will receive warrants representing 79.9% ownership of each company.

You can see where the 80% dilution for the common shareholders comes from. With the current share prices down 90% from a year ago, this effectively, completely wipes out the market value of the two companies. Will either or both of these stock trade under a $1.00 tomorrow? Or has this devaluation already been accounted for by the market?The WSJ stock quote shows both down over 20% in Friday’s after market. This reminds me of the bailout that Thornburg Mortgage (TMA) was forced to accept from private investors to save the company and dilute the common shareholders by over 90%.

The ongoing future of Fannie and Freddie will be up to the new Congress and President in 2009. At this time I hope these actions are positive for the housing market and a result in a significant decrease in mortgage rates. This would be a positive for the economy as a whole.

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This article has 15 comments:

  •  
    Sep 07 02:08 PM
    Tim, and what about the taxpayers?
    Reply
  •  
    Sep 07 02:12 PM
    sounds like a Thomburg Mortgage story to me except that private senior bond holders investors cannot make margin calls. The common stock and preferred are out to cents of a dollar.
    Reply
  •  
    Sep 07 02:23 PM
    They are going to need a lot more than that 1 billion. But the plan should cheer the rest of the financials and boost the broad market.
    Reply
  •  
    Sep 07 02:36 PM
    Tim,

    Why would as you say " I hope these actions are positive for the housing market and a result in a significant decrease in mortgage rates. This would be a positive for the economy as a whole." Be positive.

    Since when is extending credit to overvalued real estate guarantied by tax payers a good idea? Are you a communist or something like that?
    Reply
  •  
    Sep 07 02:37 PM
    When government enters,speculators die.
    Only those with bonds,secured debt,preffered stock are respected,Chapter 11 or 8 means common stock holders must be canceled completely.
    Bad news for FRE,FNM good news for my longs for tomorrow DJIA futures,I will sell those for 250-500 points profit since Friday's close at 11220.Check,mate.
    Reply
  •  
    Sep 07 03:05 PM
    Why is this good for the general market??? The government is running out of our tax dollars to support marrket losses. Leverage is going to continue to contract, and the ability of the banks to raise money has ended along with the prefered payments. Also what about all the banks that own the prefered as part of their capital base? When will they write down the the value? How much will the have to shrink their balance sheet to stay afloat. Long or short this is not a good day for anyone in America as we are "ALL" taxpayers in the end.
    Reply
  •  
    Sep 07 03:14 PM
    The treasury is going to make a killing on this. Borrowing at the risk free rate and buying nearly riskless securities at nice spreads. Ultra low risk preferred paying 10%, financed with borrowings at under 4%. 80% of both co's at likely zero cost, co's will probably have earning power of $2 a share each in a couple of years after the dilution. The warrants are the kicker-probably will be worth over $100 billion collectively in a few years.
    Reply
  •  
    Sep 07 03:35 PM
    Please explain how a takeover of the GSE's will fix the rest of the banks mortgage portfolio's and stimulate the markets. They still have the same issues they had Friday. Look at LEH, MER, WM, WB... How are they going to clean up their books so they can free up capital? Until that's done, nothing has changed. I can't see them lowering their spreads while they are still hemoraging money, so nothing has changed except the GSE's are now the most stable entities in the financial market.

    These are government sponsored enterprises, not corporations. They actually work for the agency that just "took them over". This is like LEH taking over Neuberger Berman. This little show today was just a move to behead the companies CEO's to apease Wallstreet's call for blood. Hank even said they were staying on to help with the transition and this was in no way their fault. That's the only way this thing didn't go to the courts because these guys are solvent, even if Wallstreet wants everyone to think otherwise.

    What is the true value of their portfolio'? Exactly, no one really knows. Last week, the companies, congress (Barney Frank), analysts and the fed all said they are well capitalized and didn't need a capital infusion. Now????

    Speculators might run the market up for a couple hours, but when reality sets in, the market is going to go down fast. SDS is cheap after Friday's AH sell off. Buy, buy, buy!!!
    Reply
  •  
    Sep 07 04:01 PM
    Reactions today....
    "This is a stop-gap measure," said Peter Kenny, managing director of Knight Equity Markets in Jersey City. "It's not going to address the credit crisis."

    In the short term, the U.S. government's action should buoy financial stocks by lifting concerns that Fannie and Freddie could be left insolvent, analysts said.

    The government action also reassures banks that trade with the companies that their trading agreements and debt will be honored.

    "Hopefully the capital injection will allow (Fannie and Freddie) to get out there and buy mortgages and create some liquidity," said Peter Goldman, principal at Front Barnett Associates, which manages about $600 million in Chicago.

    "That could help the housing market put a bottom in, which would put one stable leg back into the economy."

    Reply
  •  
    Sep 07 04:04 PM
    FED said they'd NEVER EXERCISE WARRANTS, so the warrant are a cap on the preferred, AND, a cost free "gift" to FNM/FRE--in "payment" for Paulson's woeful last minute decision that after 70 years, the "business model is flawed".

    Rubbish. The mortgage granting model was deregulated to liar ninja loan status, the reserves these two firms fine, if regulatory guidance was enforced and in place. They said as much, their fault, their mess to get us out of.

    The taxpayer pays, and the shareholders scapegoated for management incompetence, which escapes witht their millions. Japanese and our buddies the Chinese (!) get to continue to fund our wars, and the small investor continues to emulate Barney Frank, whether so disposed or not.

    Paulson wisely left it to the markets to conclude the wipe out scenario this article incorrectly surmizes. S&P, those great harbingers of truth, downgrade the preferred and common to junk AFTER CONSERVATORSHIP?

    Now that's the kind of forward thinking analysis we pay for....

    In truth, this speculative stock will be all over the place the next three days. What a farce. Daytraders delight.
    Reply
  •  
    Sep 07 05:04 PM
    Another reaction:
    BASEL, Sept 7 (Reuters) - Hong Kong welcomes moves by the U.S. government to seize control of mortgage finance firms Fannie Mae (FNM:$7.04,00$0.62,009... and Freddie Mac (FRE:$5.10,00$0.15,003... as this should stabilise the stressed market, its central bank chief said.
    Speaking to Reuters, Joseph Yam, who heads the Hong Kong Monetary Authority, said the bailout of the two government-sponsored Enterprises was an unusual and "possibly controversial" step but necessary given the circumstances.
    "As investors in debt issued by the two GSEs, we of course welcome the measures," Yam said.
    "It should have a useful, tranquillising effect on the very stressful market," he said on the sidelines of a bi-monthly meeting of central bank governors at the Bank for International Settlements.
    Reply
  •  
    Sep 07 06:33 PM
    What is the author's position in FRE / FNM? Full disclosure please.
    Reply
  •  
    Sep 07 06:37 PM
    The opening market reaction: S&P 500 futures rose 30.30 points. Dow Jones industrial average futures rose 239 points and Nasdaq 100 futures gained 35.25 points.
    Reply
  •  
    Sep 07 06:38 PM
    I have no position in FRE or FNM. Never have. I do own a few shares of TMA. I am more interested if this move by the Fed will lead to lower mortgage rates and an improving housing market. Strong housing is a much better positive for the country than anything that can happen to Fannie or Freddie.
    Reply
  •  
    Sep 08 12:17 PM
    A minor technical point. Treasury did not advance any money to the GSE's with the agreement. If you read it you will see that the Treasury gets $1 billion of preferred and the warrants for 79.9% of thecompany in exchange for providing the facilities. Not to say that money won't be advanced just that none has been advanced so far.
    Reply
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