The Third Amendment Net Worth Sweep is Illegal
I recommend listening to Charles J. Cooper's interview with The Federalist Society to better understand the illegal nature of the Third Amendment Net Worth Sweep. The law was broken. Discovery is happening. This will be retroactively fixed. Until it is fixed, the way that the sweep works is very bad business and forces bad internal decision making and capital allocation.
Paid Back More Than They've Borrowed
The two businesses in aggregate have paid back more than they've borrowed at this point in time. Ironically, because of the above, in this case the debt that was once $187.5B is now considered infinite. That is to say that with the way things currently are, it is impossible to ever pay back what they have borrowed because the Treasury 'said so.'
There are a lot of people who stop their analysis here, give up and find the two businesses worthless. It is true that these businesses are worthless if the government can take them over without compensating shareholders. It is also arguably true in this context that no business has any value in the United States of America. As such, I enjoy throwing that argument into the garbage can. Swish.
The Largest Investor in Fannie Mae and Freddie Mac is American Taxpayers
The terms as they stand today leave the American Taxpayer with 80% of the two businesses. This would be accomplished by exercising the warrants at a price that is basically $0. Who loses the most by winding two of the most profitable businesses in the world down? American taxpayers lose.
The Largest Beneficiary of Fannie Mae and Freddie Mac is the American Taxpayer
These two businesses make billions of dollars providing significant value to all Americans by providing our friends and family the ability to afford their own homes. The proposals to wind down these two increase the cost of home ownership. The proposals are only in the best interest of the big banks.
Other People's Views On Upside Valuation
The following views are in the context that the Net Worth Sweep is Illegal.
William Ackman noted on February 23, 2014 that Fannie and Freddie are worth 10-15x their current price. That puts his target between $30 and $50. If you listen to his interviews, you can a base assumption, that the warrants are executed, diluting the current common shareholders by 80%.
Dick Bove put out price targets on Fannie Mae suggesting that $18/share was reasonable. Looking at his assumptions, he expects a continuation of the senior preferreds. If those can be resolved in a few years, the valuation starts lining up with Ackman's. He also notes that the multiple is 'easily 10-12x' normalized earnings. Recently, he has declared victory saying that Fannie Mae is worth over $20 after Watt's latest remarks that effectively imply that Fannie Mae is here to stay.
My View On Upside Valuation
I think that Dick Bove's estimate is the most conservative. I don't think that it is reasonable to assume that the senior preferreds are never paid down and they continue to accrue at 10%. If you assume that they will be paid down per the original agreement, then I get a run rate EPS of $2.62. The difference between my estimate and Dick Bove's estimate is that my estimate matches putbacks against the principle that was borrowed, interest included. I also estimate that the GSEs have minimum net capital requirements of $50B. By 2017, this expands to $3.40 per share. With a 12x multiple, you get $40. I can wait a few years. This doesn't even take into consideration the possibility that the warrants are canceled.
It's really kind of sad what is going on here. You have two amazing American companies that make billions of dollars being treated as if they are a political football. The reality is that congress can't wind them down because they can't find a better solution. This is the best solution. In fact, this is how the system is supposed to work. The way I see it, the two businesses came in and saved the American economy when people needed money most.
And how do we treat our heroes? We blame them for things they didn't even do. Look at the lawsuits that resulted from Banks illegally trying to push toxic assets to Fannie Mae and Freddie Mac. Look at who is winning them.
I realize that you may not agree with me. You may not understand. If that is the case, please share your reasoning, and I will try to understand your assumptions. I do encourage you to read the comments across the articles for and against mortgage reform. Where are the supporters? Just saying. What exactly is the good that comes from hopelessly winding down two of the most profitable companies in the world that saved America during a time of crisis?
The risks are simple:
- Laws are not followed and the U.S. Government succeeds in getting away with robbing private investors.
- The GSE's print the occasional loss and the way that this is currently structured would dig the hole deeper.
- Congress passes legislation that benefits the big banks at the expense of everyone else in America.
- The companies are never able to capitalize under the way that they are currently structured and are effectively worthless.
I think that this list of risks is a joke, and that is the premise behind my long position in both private companies.
Disclosure: I am long FNMA, FMCC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.