Junior preferred shareholders sue for GSE payouts
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Junior preferred shareholders sue for GSE payouts

One of the most audacious punts in the market has been the bet by holders of junior preferred shareholdings in Fannie Mae and Freddie Mac that the liquidation of the agencies in their current form will translate into a payday for junior creditors. Junior preferred stock outstanding in the two entities totalled $33 billion in March this year, but there have been no dividend payments since the two government-sponsored enterprises were put into conservatorship in 2008. The preferred stock nevertheless jumped from a low of $1.50 (par value $25) to more than $6.50 in May this year in anticipation of GSE reform gaining traction.

Insult was added to injury when the Preferred Stock Purchase Agreement (PSPA) that was negotiated between the Treasury and the GSEs in August 2012 stated that all earnings from the GSEs should be distributed to the Treasury as dividends in a cash sweep. The sums involved are substantial; in June they amounted to the biggest dividend in US history: $66.3 billion. In May 2013, Fannie Mae announced first quarter pre-tax income of $8.1 billion and Freddie Mac recorded pre-tax income of $4.5 billion for the same period. According to Washington-based policy analysis and regulatory due diligence research firm Capstone, the combined earning power for the two GSEs of $5 billion to $6 billion a quarter means that they will deliver to the Treasury a sum greater than their combined bailout of $187.5 billion by late 2014.

The GSEs are making money out of their MBS holdings in exactly the same way that the discredited structured investment vehicles did before the crisis: funding long-term assets with short-term money. "The Fed has made roughly $250 billion in net income over the past three years, much of which has come from funding mortgages via maturity transformation," observes Jim Ahern, global head of securitization at SG CIB.

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