Why the capital rule may prevent an offering from Fannie Mae, Freddie Mac

Fannie Mae and Freddie Mac have now officially said that they oppose the capital rule proposed by the Federal Housing Finance Agency. The government-sponsored enterprises agreed with critics of the rule who said the capital rule would increase costs for borrowers.

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Q2 2020 hedge fund letters, conferences and more

Fannie Mae, Freddie Mac oppose FHFA’s capital rule

In a note over the weekend, analyst Dick Bove of Odeon Capital pointed out that Fannie Mae Chief Financial Officer Celeste Brown said recently that she had reservations about the FHFA’s capital rule as it was proposed. He also argued two more points, although his views are controversial.

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Bove argued that FHFA Director Mark Calabria “is a highly intellectual, honest, and committed Libertarian who is adamant that the GSEs are not good for the government or the economy.” However, others like Tim Pagliara of CapWealth Advisors believe Calabria supports Fannie and Freddie, based on his actions and comments.

Bove also argued that the FHFA “has continued to institute rules that cannot be overturned by anyone from the President on down, that are making Fannie Mae and Freddie Mac unappealing investments” without growth. Pagliara has also disagreed with this view, stating previously that the market needs the GSEs, and the FHFA and Calabria know this.

Unprecedented step

Bove called Fannie Mae’s and Freddie Mac’s opposition to the FHFA’s proposed capital rule “an unprecedented step” because they officially disagree with the agency that oversees them. Both GSEs wrote comments about the capital rule, and they both said they will have to increase mortgage costs if the rule is established as it is currently written.

Fannie and Freddie are asking that the capital rule be “dialed back.” They agree with former Freddie Mac CEO Don Layton and Phil Swagel of the Congressional Budget Office, both of whom have raised the same question about the proposed capital rule.

The GSEs said if the capital rule is put in place as currently written, they would have to increase their mortgage fees by 15 to 35 basis points. They also said this would cause their businesses to shrink and force borrowers and lenders to tap other sources for mortgage funding.

Calabria has said previously that he wants more competition in the mortgage space. However, Pagliara and Grant Stark at CapWealth have said they don’t believe other lenders want to compete for 30-year mortgages, especially while interest rates are low because they don’t want to keep low-rate loans on their books for 30 years.

Other problems with capital rule for Fannie Mae, Freddie Mac

Bove also argued that there are other problems with the capital rule that’s been proposed for Fannie Mae and Freddie Mac. He said increasing the cost of mortgages would also decrease home values. And by decreasing home values and shifting mortgages to other lenders and insurers, the GSEs would see their revenues decline at a time when they will have to raise at least $200 billion in capital.

Bove believes the capital rule is unlikely to be changed because Calabria’s rulings “cannot be overturned by anyone other than an Act of Congress.” However, he also pointed out that the Fifth Circuit Court of Appeals has ruled Calabria’s position unconstitutional, and the Supreme Court is now reviewing that ruling.

He added that Fannie and Freddie have never officially opposed anything Calabria has ever done, which he believes suggests the issue with the capital rule is extremely serious.

“Their opposition cannot be taken lightly, because they may be forced to follow a rule that could lower the price of every house in the United States, and the ability of these companies to increase their earnings.”

There may be no stock offering from the GSEs

He continues to believe that the FHFA “is crippling” Fannie and Freddie, which is why he wouldn’t buy their common shares. He does expect the Supreme Court to rule in favor of the plaintiffs in the Collins Case, which is why he rates the preferred shares at Buy.

Bove said in a subsequent note that he believes if the capital rule is enacted as it is written, it would keep Fannie Mae and Freddie Mac from having a successful stock offering. He noted that the FHFA would have to count on the GSEs to “make pitches and do road shows arguing that investors should buy $200 billion worth of stock.”

He added that they wouldn’t be able to do that if they believe the deal is uneconomic for investors.

“Bottom line, you cannot sell stock in a company if that company tells you that it is not a good deal,” he wrote. “… The FHFA is going to have to change its proposed rule if it ever wants these companies to sell more stock. I assume that this must happen. We will not find out until December.”

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