Remember This About Fannie And Freddie's Common Vs. Preferred Shares

Federal Home Loan Mortgage Corp FMCC and Federal National Mortgage Assctn Fnni Me FNMA shareholders took a beating on Tuesday when an appeals court rejected shareholders’ case that the government-sponsored entities’ (GSEs) net-worth sweep is illegal. With every dime of the two GSEs’ profits going to the Treasury, Fannie and Freddie are a lottery ticket trade at best.

However, investors may be able to up their odds of hitting the jackpot by opting for preferred shares such as FED HOME LOAN MTG 5.79% PFR PERP USD50 FMCCK and FED NATL MORT ASSC 7.625% PRF CON-DUM SER’R’ FNMAJ.

Silver Lining

The silver lining of Tuesday’s ruling was that, while the court ruled shareholders can not challenge the illegality of the net-worth sweep, it also ruled that certain shareholders can continue to pursue damages related to breach of contract.

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“It barred claims against the Federal Housing Finance Agency (FHFA) because the agency succeeded to all rights, powers, and privileges of the stockholders under HERA,” Height Securities wrote of the decision. “It remanded contract claims regarding liquidation preferences and dividend rights to the lower court for further proceedings (i.e., certain shareholders can sue for damages).”

When it comes to matters of liquidation, preferred shares are higher on the priority list of claims on liquidation proceeds, and they have fixed liquidation values that protect them from the same type of dilution risk the common shares have.

Of course, these preferred shares understandably trade at a high premium to common shares, meaning they likely have less upside in the event of a favorable outcome.

Investing in Fannie Mae and Freddie Mac is a big risk no matter what. Traders choosing between common and preferred shares simply have to determine exactly how much risk they’re willing to take.

Image Credit: Carol M. Highsmith [Public domain], via Wikimedia Commons