GSE’s: Backstop or Bailout- Implications Aren’t All Bad – Citigroup
Citigroup is out positive (or semi-positive) on the GSE’s Fannie (NYSE:FNM) and Freddie (NYSE:FRE) noting the recent sell-off has been surprising. This is especially true since the only catalyst appears to have been a press report suggesting that federal officials are likely to recapitalize (“nationalize”) the GSEs soon. The market reaction indicates that a government seizure of the GSEs is imminent and that common and preferred shareholders would likely suffer. This view has prevailed despite the recent public comments of the Treasury secretary and other policymakers in support of the GSEs in their current form (as shareholder owned institutions).
Citigroup believes the GSEs are not entirely without options. First, policymakers could reassert the benefits of the backstop plan that became law last month. Second, the GSEs’ regulator could ease the arbitrary capital surplus requirement further. Third, the GSEs could free-up capital by allowing portfolio assets to run down over time. Fourth, given firm’s analysis, which shows that both FNM and FRE should have sufficient capital through (at least) year-end 2008 under a variety of negative credit scenarios, all parties could wait-it-out until market conditions calm.
Firm is not convinced that Treasury needs to take any action over the near-term. While the decline in the GSEs’ stock prices, if they persist, may pose challenges to any capital raising efforts down the road, the short-term stock price performance does not have any bearing on the success of the “Paulson Plan.” In fact, they believe Treasury Secretary Paulson’s plan to provide a backstop for the GSEs in order to ensure their market access for debt issuance (included in the recent mortgage legislation, see below) is working. As evidence, the recent notes issued by FRE, which were oversubscribed and included 40% participation from non-U.S. investors (30% Asian) showed the success of the backstop plan, regardless of the price paid (which is more of a business issue than an access to funding issue).
Accordingly, they explore a possible scenario for a government “bailout”, such as a Chryslerlike federal loan with warrants and discuss implications for investors. In this unique situation, the impact on stakeholders was generally positive over the long-term.
Citi maintains Buys on both FNM and FRE with $9 and $6 tgts, respectively.
Notablecalls: Was going over this call with a tier-1 trader this AM. This is what he had to say:
"As the only semi positive note I’ve seen in weeks, I think it should generate some interest, if not from longs, then from shorts… but any price action to the upside will prob be limited."
I must agree here. I like FNM more here as it’s just somewhat bigger in mkt cap. It’s being offered @ $4.80 (down 5%) in pre mkt which looks like a solid initial entry. Keep it small and tight. Let’s see if this Citi call puts some fire under the shorts.
