Sunday, August 17, 2014

My sincere best wishes to Bill Ackman: Fannie Mae and Freddie Mac edition

Bill Ackman is suing the Federal Government over the Fannie Mae and Freddie Mac bailout terms.

It is clear that the US Government will make a profit over that bailout and yet they are still suspending payment on Fannie Mae and Freddie Mac preferred securities. These securities are potentially money good.

Long-time readers know that I purchased a lot of these securities from 0.7c to 2 cents in the dollar - and I wrote a ten part blog series on this purchase. 100 cents in the dollar would be quite fine.

Bill is late to the trade - but in all sincerity I wish him well.


For the record here is my ten part series on Fannie and Freddie. I have cross checked the numbers that I guessed - some are high, some are low - but in the end it is roughly a wash. [Defaults are higher than I would have guessed, severity lower for instance...]

Part 1, Part II, Part III, Part IV, Part V, Part VI, Part VII, Part VIII, Part IX, Part X.

The series took a while because I broke my collarbone in the middle of it.


David Sims said...

Hey John. I read your analysis on Fannie and Freddie years ago and it impacted my decision to buy GSE preferred. Thanks!

Have you considered filing a lawsuit in an international court like the Hague?

John Hempton said...

We did the Frannie trade when we opened (June 2009). I was depserate to open in part so I could put it on.

I did it personally in March-to-June - but I kept silent until the clients were filled to.

We have sold some one the way- the aggregate position is too small to justify a law suit.

Besides well funded people like Billy Bob - who are lawyer-driven - are going to do it for me.


Anonymous said...

Are you planning on commenting on the Lamberth decision? It pretty much shoots down all of Fairholme's legal arguments. TIA.

Michael Meyer said...

The earnings of a combined Fannie Mae / Freddie Mac are approx. $15 Billion per annum. At a 12 to 1 P/E ratio, the value of 15 Billion times 12 equals $180 Billion. Multiply this 180 number times 79.9% and the result is $143 Billion dollars in equity value recovery through the sale of equity warrants for the US Government. If the US Government closes the GSE's this amount is lost to the US Treasury. If the US Government creates another entity from scratch to support the mortgage market, they would have to raise several hundred billion in private capital so that the US Government would not have capital exposure in the future and the US Government could walk away from the current implicit / explicit backstop. This $143 Billion number does not take into account additional tax revenue from gains that current private capital / shareholders would realize which could also be recovered by the treasury. The alternative of capitalizing on the value of the warrants would value the remaining equity of the company at a value not less than $37 Billion amount. This $37 Billion could be used to satisfy preferred and / or common equity stock holders. Also, the cost the US Government may incur for selling new securities in order to capitalize a new entity may be as much as 1% to 3% of the funds raised charged by the Investment Banks selling the new securities as well. Sooner or later, I believe the US Government and Congress will need to sign off on this solution, either through court victory for plaintiffs or US Congress taking advantage of equity markets to gradually 'sell' their 79.9% stake. If you remove all the lawsuits from the equation and remember the US Government needs private capital for mortgages to be funded and liquid in the US market, the need for the GSE's is substantial and thus private capital should be valued. Also, if you can get past the statements by Senate members against Hedge Funds profits and simply accept that the preferred stock and common stock would need to be honored as part of the corporate balance sheets, some hedge funds would make money but the US Government would recover multiples above any of these amounts recovered by shareholders. The value of the $143 Billion is well above total amount of the junior preferred securities face amount of $33 Billion; the exercise of these warrants may need to be done sooner rather than later in order to avoid declining US stock market valuations.

Whether the US Government chooses to continue to support or leave their involvement in the mortgage market, a market valuation of the equity stake at a 12-1 multiple provides significant return to both the US Government and private capital (common shareholders and preferred shareholders) and could go a long way towards the companies recapitalization.   If treated fairly, the current private capital shareholders would most likely put additional funds up to assist with a necessary recapitalization for future ongoing operation of Fannie Mae / Freddie Mac.  I don't believe that the US Government will walk away from their stake and neither should you.

How to Fix the GSE's:

Shapiro Plan

Fairholme Funds statement on GSE's

Former CFO Tim Howard on GSE'S

Amicus curiae brief - Tim Howard

GSE Actual Loan Losses and Losses Under GAAP:

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