GSEs Face Speed Bumps on the Road to Recapitalization
Fannie Mae and Freddie Mac made news this week with word that they’d hired Morgan Stanley and J.P.Morgan, respectively, as underwriting financial advisors. According to the GSEs, the investment banks will assist in developing and implementing a plan for recapitalizing the companies and ending conservatorship, helping to evaluate different business and capital structures, valuation and market impacts, and available capital raising alternatives.
The hiring of underwriters was expected after the GSEs issued RFPs to start the process in May, notes Keefe, Bruyette & Woods. While the shares of both companies could respond positively to the announcement, KBW’s Bose George continues to believe there are meaningful hurdles to recapitalization.
Further, even if recapitalization is successful, it’s likely to result in significant dilution for current common shareholders. Accordingly, George remains cautious on the value of the common shares, although there are scenarios in which the preferred shares could have upside.
In terms of the hurdles, George notes that the Federal Housing Finance Agency recently issued proposed capital standards for the GSEs, and the comment period is ongoing. He believes that, under the newly-proposed capital rules, it would be difficult for the GSEs to generate acceptable returns on equity without raising guarantee fees (which Bose doesn’t see as a desirable outcome for the mortgage market).
Morgan Stanley and J.P.Morgan will also have to address several other important issues, including the size of the commitment fee, notes George. Further, the recent economic downturn has meaningfully increased market concerns about mortgage credit risk.
“Until there is better visibility on the economic downturn, it is likely to be difficult for investors to be comfortable about normalized earnings,” George writes. “Finally, the short timeline to the election suggests that many of these decisions will not be made until after the presidential election. So, a change in the White House could potentially change how the recapitalization process plays out.”
For comments, questions or concerns, please contact Paul Bubny
- ◦Financing
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