An updated analysis from the Congressional Budget Office suggests that recapitalizing Fannie Mae and Freddie Mac is more financially feasible than it was four years.
However, an analysis from Keefe Bruyette & Woods puts the dampers on that possibility occurring in the next three-to-five years for other factors.
The investment banker agrees with the CBO’s reassessment but it believes other factors, primarily the mortgage industry’s concerns about potentially higher rates, are likely to be bigger impediments to privatizing the government-sponsored enterprises.
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The CBO analysis was released on Dec. 13 and was conducted at the request of Rep. Patrick McHenry, R.-North Carolina, chairman of the Committee on Financial Services.
“CBO’s updated analysis concludes that the potential value of the GSEs to investors is greater now than it was at the time of the previous analysis, resulting in more scenarios in which the GSEs could be recapitalized through the sale of common stock and could repay the Treasury for its stake in the enterprises,” the report said.
The Federal Housing Finance Agency, which is the regulator for Fannie Mae and Freddie Mac, said in a statement that it “is currently reviewing the CBO’s findings internally to form a thoughtful analysis.”
In the 2020 analysis, CBO used three- and five-year timelines where Fannie Mae and Freddie Mac would retain their earnings and then sell new common stock to investors in order to repay the Treasury.
Through the Preferred Stock Purchase Agreements, the Treasury provided financial support to Fannie and Freddie after they were placed in conservatorship. Those agreements were modified at the end of Pres. Trump’s first term to end the net worth sweep and allow Fannie and Freddie to retain earnings.
However, that shift increases the liquidity preference for the shares held by the Treasury. That would have to be repaid. The Treasury does hold warrants to purchase Fannie and Freddie common stock, but the report notes those expire on Sept. 7, 2028, the potential 20th anniversary of conservatorship.
The new analysis updates the start time for the three- and five-year windows to Jan. 1, 2024.
“Under current conditions, nearly 60% of CBO’s 250 recapitalization scenarios would raise enough funds to allow the GSEs to fully repay the Treasury for its roughly $190 billion in outstanding preferred shares issued before the GSEs’ conservatorships,” the report said. The prior analysis found that to be the case in just 12% of those circumstances.
The change was because the GSEs’ combined capital of $125 billion at the end of 2023 was over five times the $24 billion used in the prior analysis; the first analysis was done shortly after a policy change that allowed Fannie and Freddie to retain some of their earnings.
The combined capital has since grown to $147 billion at the end of the third quarter, KBW’s Bose George pointed out.
“A 2027 IPO assuming a minimum capital of 3% (which is the lowest level assumed in the CBO analysis) would allow for the government to fully recoup its investment,” George said. “While a recap in 2029 is easier because of the greater level of retained capital, that timeline is unlikely, in our view, since it would be after the Trump term is over.”
But George added alternatives exist to raising enough funds through an initial public offering in order for both companies to be adequately capitalized on the first day they are out of conservatorship.
“One option would be to conduct an IPO and allow Treasury to sell down its stake while setting a timeline for the GSEs to be adequately capitalized, while keeping restrictions on capital use in place until that occurs,” George said. “The final level of capital will also be key since it would need to be set at a level that allows the companies to generate [returns on equity] that are at least in the 12-13% in order to attract private capital, in our view.”
Even though it is financially feasible, George is of the view that the biggest impediment to GSE privatization will be the market for agency mortgage-backed securities. The U.S. government provides an implicit guarantee for those investments.
“Privatization needs to be done in a way that keeps the implicit guarantee intact,” George said. “Market concerns on this issue could result in widening of agency MBS spreads, and if that happens in a meaningful way, we think it could derail the privatization effort.”
A Fitch Ratings outlook on community development and social lending for 2025 is subtitled “uncertainty and downside risk rise amid federal policy shifts.
It is also of the view that ending the conservatorships does not have a high probability of occurring.
“Ending GSE conservatorship would have a direct negative rating effect on GSEs, which in turn would have an adverse impact on a substantial number of affordable housing debt ratings that have direct linkages to Fannie Mae and Freddie Mac, based on guarantees provided by these GSEs,” Fitch said.
Winding down the GSEs could reduce liquidity in the mortgage markets, as well as raise long-term housing market volatility, and adversely affect pricing and underwriting standards.
Others that could be affected in a negative fashion would be the homebuilders, building supply companies and multifamily real estate investment trusts, Fitch said.
