Is The Freddie Mac Bailout A Faux Bailout?
Summary
- Because both Fannie and Freddie reported net losses in excess of their capital buffer as of 12/31/2017, both had a negative net worth at that time.
- It is now two months later, and Freddie Mac has already likely made enough money to be net-worth positive, but the same isn't likely true for Fannie Mae.
- Why are we bailing out a company that doesn't need it with US Tax dollars?
Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are two companies slated for their second bailout later this month. Their first bailout took years, 2008-2011. This one will take just a month. The reason their first bailout took years is because FHFA used its discretionary accounting authority in conjunction with the Senior Preferred Securities Purchase Agreement to strengthen the government's control over the companies by writing down their assets under the implicit assumption that they would never make money again. This is in contrast to the cash profits they were making during that same time period. That's the past. The two companies have non-governmental equity shareholders who have effectively had their shares zeroed out. The net worth sweep makes it impossible for their shares to have any value unless there is a court victory or recapitalization settlement. The purpose of this article is to highlight that the bailout this month for Freddie Mac probably isn't even necessary.
Investment Thesis: If nothing changes or if the companies are put into receivership and the lawsuits are all lost, the equity shares publicly traded on the open market are worthless. The government's liquidation preference is by design insurmountable despite the fact that the net worth sweep eliminates any net worth being available for distribution to other equity shareholders. The court cases have raged on for years. There's even a new one Owl Creek v. U.S. If any lower court lawsuit were to be won by plaintiffs, it would be sent to appeals court, and recently we've even seen dismissed by the Supreme Court. The prevailing legal interpretation of HERA 2008 is that the government can do whatever it wants. Even the American Enterprise Institute acknowledges this in its advocacy to eliminate Fannie and Freddie. Their hope is to convince Trump to tell Mnuchin to eliminate the twins because so far his Treasury Secretary Mnuchin hasn't and instead has said that they need to get them out of government control. If the companies survive and exit government control, they would need to be recapitalized. In the event that they are recapitalized, the junior preferred would either convert to common or eventually resume dividends. Common shares would trade at a normal market multiple after raising capital. The Moelis plan, developed on behalf of the Trump administration insider John Paulson, recapitalizes Fannie and Freddie and puts the commons $8-13.
March Bailout
Freddie Mac came up $312M short in December. Assuming they are bailed out and not placed into receivership, that payment would be made by Treasury to Freddie Mac at the end of March. The end of March is also the end of Q1. If Freddie Mac reports Q1 with net income in excess of $312M they didn't need this bailout, to begin with. We're talking about an immaterial difference of a few reporting days at that point.
What this does, in my opinion, is highlight the pre-emptive failure at FHFA and Treasury to:
- Structure the SPSPA to provide bailout payments to the companies on a timely basis.
- Establish a capital buffer large enough to prevent a bailout they predicted.
Fannie Mae, however, is $3.7B short. It's possible but not likely that their income in Q1 exceeds $3.7B but if it does then that bailout would not have been necessary either.
The question here is why is the government structuring deals to bail out at least one company that doesn't need it? This bailout looks more like a blooper than anything, but the one in 2008-2011 was simply to take complete control which they now have. It sure is interesting that with the government in complete control over the situation, where they are taking all the money that they would make the preventable mistake of not letting them retain enough capital, forcing a bailout.
Summary and Conclusion
I own 4050 FMCCH, 8394 FMCCI, 8148 FMCCL, 400 FMCCL, 12608 FMCCP, 5042 FMCCT, 9085 FMCKP, 12934 FNMFN and 5 FNMFO. I own these preferred Fannie and Freddie shares because I think that they will appreciate significantly in value in the event that the companies are recapitalized. I've been overly optimistic about timing for the entire duration that I've owned GSE securities. Next year, the Trump administration gets to name a replacement for FHFA's Watt. If they can't do whatever they want now, they can then. I still think it's pretty clear-cut, just a matter of when:
As far as timeline goes, he suggested end of 2017, early 2018 around a year ago:
Later last year, he prioritized tax reform over housing reform, but his message was largely the same as it has been:
Right now the ball is in the Congress's court:
Senator Bob Corker leaked his draft bill and it hasn't gone anywhere. Rumor is that Representative Jeb Hensarling will push for something similar in the House of Representatives this month. The government hasn't been able to pass any legislation except GSE Jumpstart which delayed figuring this thing out for a few years. The good news recently is that even the AEI proposal acknowledges that almost anything can be done administratively and without legislation.
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This article was written by
Analyst’s Disclosure: I am/we are long FMCCH, FMCCI, FMCCL, FMCCN, FMCCP, FMCCT, FMCKP, FNMFN, FNMFO. 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.
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