FANNIE MAE AND FREDDIE MAC FMCC / FNMA

IS ACKMAN RIGHT
OR JUST TALKING HIS BOOK?

Every few years something comes around to bring Fannie Mae (FNMA – OTC) and Freddie Mac (FMCC – OTC) into the spotlight.

Usually nothing comes of it. But this time may be different.

Famous hedge fund manager Bill Ackman made special mention of these Government Sponsored Entities (GSE’s), naming them as his top picks for 2025.

Source: X.com

Ackman is bullish because he believes Fannie and Freddie will finally be removed from conservatorship in the next two years.

Source: X.com

Fannie and Freddie insure home mortgages. By doing so they allow mortgage rates to be lower than they would otherwise be. They also allow homeowners to buy homes that they wouldn’t be able to afford otherwise.

These are important companies. Which is why, when they were about to topple in 2008, the US Government stepped in.

Both have been under the conservatorship of the Federal Housing Finance Agency (FHFA) since 2008, when the US Government took over their business. Since then, they have been quasi-run by the US government.

If that is going to change under Trump, then Fannie and Freddie will once again become private companies.

It is Ackman’s assertion that this will be a boon for existing shareholders. He believes the companies will IPO at $30+ per share.

That’s a 5-bagger from the current price! It is nearly a 30-bagger from where the stocks were at before the election.

Source: Stockcharts.com

Of course, Ackman has skin in the game so he’s talking his book. Can we really believe that $30 is possible?

While Ackman is far from an unbiased opinion, there are other voices that affirm that the plan to make the GSEs private again is in the works.

The WSJ said as far back as September that something was in the works should Trump win.

“Former Trump administration figures and bankers have been discussing plans on ending U.S. government control of the mortgage-finance giants should Trump win the presidential election, according to people familiar with the matter,” the Journal reported. “The talks have been under way since at least this past spring and include reaching out to investment managers for advice on how to get the deal done.”

Just last week, the Trump Administration announced a framework for bringing them out of conservatorship.

So maybe there is something to this?

I’m certain there is. But whether its the big win for current shareholders of Fannie and Freddie is far from a sure thing.

BOILING IT ALL DOWN

Look, I spent A LOT of time on this. I reviewed Fannie and Freddie’s financials, I listened and read through briefings and opinion pieces on what may or may not happen.

Here is my conclusion:

Ackman might be right. But it is far from guaranteed.

You can boil it down to three questions:

1. How much capital does the government require?
2. How much money does the government want back for taxpayers?
3. What these companies are worth without a government guarantee?

These aren’t easy questions to answer, which is why saying Ackman is right (or wrong) is tricky.

HOW MUCH CAPITAL IS ENOUGH?

How much capital will the US Government require Fannie and Freddie have? To value the common stock, this is probably the biggest question that needs answering.

It is also a technical question, one that has to do with regulation and Government oversight. In other words, it is not an easy one to answer.

Let’s take a step back here and talk about capital.

Banks and other financial companies (like insurers, which is essentially what Fannie Mae and Freddie Mac are) are required by the US Government to hold capital on their balance sheet.

The required capital level is measured as a percentage of their assets. The idea is to make sure that the financial company is not taking on too much leverage.

When financial companies do take on too much leverage and loans go bad, they need capital to cover the losses. When Fannie and Freddie were put under conservatorship by the US Government, it was because so many of the home loans had gone bad they no longer had the capital to cover the losses.

Since 2008, both firms have been building capital. But let me be clear – by all accounts, neither company has enough capital yet for it to be considered to be enough.

The BIG QUESTION is simple – what is well capitalized?

Ackman believes that well capitalized is a capital ratio of 2.5% – in other words their capital is at least 2.5% of their assets. From his tweet storm:

Source: X.com

This 2.5% is an important number. If it turns out to be higher – if the US Government demands a higher ratio, that will have a big (negative) impact on the value of the common shares.

What may have emboldened Ackman’s tweet on December 29th was an update on Fannie and Freddie from the Congressional Budget Office on December 14th.

In this update the CBO outlined three possible scenarios for recapitalizing the GSEs.

The most positive scenario (Scenario 1 in the table below) is not too far off what Ackman suggests. It assumes a capital requirement of 3% and values the existing shares at ~$30 per share.

Source: Congressional Budget Office

Here is how that math works.

Scenario 1 attributes the “Value of the Treasury warrants” at $206B.

The warrants Treasury has in both Fannie and Freddie total 7.2 billion. When the companies are released from conservatorship and become public, those warrants will be converted to common shares (Treasury would own about 80% of the common stock).

Effectively, the CBO is saying the shares in Scenario 1 are worth $206B/7.2B or a little under $30 per share.

Does that settle it? Is Ackman right and this is a shoo-in?

Not so fast. We’ve only looked at Scenario 1. There are two other scenarios and they aren’t quite so optimistic.

NOT ALL ROSES

Yes, the CBO does say that the common shares of Fannie Mae have the potential to be worth $30+ per share.

But they also say that the shares may be worth a lot less.

There are two additional scenarios in that table. Both value the Treasury warrants at $0.

Source: Congressional Budget Office

Why? Its the capital requirement.

All financial companies have to keep a certain amount of capital on their balance sheet. It covers losses when things go bad. To comply with the Basel accord, banks have to keep at least 6% of their risk-weighted assets in capital. In reality most banks have over double that.

I already pointed out that Ackman is saying 2.5% is sufficient. He says this, in part, because that is what other private mortgage insurers are required to have.

Source: X.com

While this is technically correct, in reality mortgage insurers have much more capital. The Radian Group (RDN – NYSE) has $4.4B of capital versus $7.6B of assets. MGIC Investment Corp (MTG – NYSE) has even more – $5B of capital for just $6.5B of assets.

Most importantly, the US Government has not outlined the capital requirement of Fannie and Freddie once they leave conservatorship. It could be 3%. Or it could be more.

In Scenario 1, the capital requirement of 3% (the GSE’s need 3% of their assets in equity), works out to $247B. As both Ackman and the CBO point out, this is manageable. The GSE’s may need a small capital raise on top of the capital they currently have and what they will accrue between now and 2027.

But in Scenario 2, the requirement is 4.5%. This corresponds to the GSE’s needing $370B. In Scenario 3, the CBO assumes that the GSE’s are required to hold 6% capital, which means they need $494B of capital!

The difference between #1 and #2 is $123B, in other words, a lot. The difference to #3, nearly $250B, is a TON!

If Scenario 2 comes to pass, the GSE’s would have to raise $162B in equity from the public markets. In scenario #3 they would have to raise over $300B!

While I’m sure there is going to be demand for a new Fannie and Freddie, these are still REALLY big equity raises. The biggest equity raise to date was Saudi Aramco, which raised $29B with its IPO. This is 5x to 10x that much.

You think of that in terms of a public equity raise, that sort of capital doesn’t typically come without a large discount to the stock price.

THE ART OF THE DEAL?

The second consideration when valuing Fannie and Freddie common is what the Government wants back.

That is going to depend on the man in charge of making the deal. Trump has said that he wants “a windfall” for taxpayers.

It comes down to this: how much of the “value” of Fannie and Freddie should accrue to existing shareholders and how much should accrue to the taxpayers?

The taxpayer stands to gain in two ways. First, there are the warrants owned by the Treasury that convert to common stock. Treasury owns 80% of the common stock of the GSE’s if all warrants are converted.

Second, there are the preferred shares that Treasury owns.

Both Fannie and Freddie have preferred shares outstanding. There are actually two levels of preferred shares. There is a junior preferred, which are publicly held securities. A lot of investors own these as a “safer” way to play the GSEs because these shares will be paid off before any value accrues to the common. These shares may actually not be a bad investment, though the upside is capped at their par value, which is $25 per share (they trade at around $11 right now), so they aren’t the moonshot the common is.

Second, there is the senior preferred shares, which are held by Treasury. These shares were given to Treasury at the time of conservatorship so that Treasury could collect dividends from Fannie and Freddie (once they turned their business around) and be the most senior holder of capital within the GSEs.

The face value of the senior preferred shares is $225M. They need to be paid off before any value accrues to the common stock.

So far, it’s straightforward. But here is where it gets tricky.

There is potentially extra capital that Treasury could demand for their senior preferred shares – for what is called the liquidation preference.

Here is the CATO Institute, quoting Trump’s former FHFA director Mark Calabria and talking about liquidation preference.

Source: CATO Institute Briefing Paper: The GSE Experiment Has Failed–Congress Should End It

The liquidation preference of the preferred shares is different than the face value. The difference is the interest on the preferred shares that was not paid.

Since they entered conservatorship, the GSEs haven’t fully paid the 10% interest they were originally supposed to pay. The amount they didn’t pay got added to the liquidation preference.

While the face value of the senior preferred is ~$190B today, the liquidation value is $312B and growing.

Technically, before any other investor gets paid (either the junior preferred holders or the common shareholders), the full liquidation preference should be paid back.

If Treasury follows through on this, that is another $120B before shareholders get anything. Which more than likely makes the common worth a lot less.

But wait, Treasury owns 80% of the common (through their warrants). Wouldn’t this hurt them?

No, it wouldn’t, because either way they get paid. It’s actually in the best interests of taxpayers to take as much cash via the senior preferred as possible because then you aren’t sharing it 80/20 with shareholders.

That doesn’t mean that Treasury will insist on getting the full liquidation preference. FWIW, the CBO estimate uses face value as the redemption value. Maybe Treasury plans to throw investors a bone.

But do we really know? It seems to come down to whether Trump wants to maximize the cash coming back to tax payers, or whether he wants to throw a bone to common shareholders. Which side wins out is anyone’s guess.

WHAT’S A GSE AND WHEN IT’S NO LONGER GS?

The last consideration is what happens once the Fannie and Freddie are no longer Government Sponsored Entities?

This is something that has been written about by Chris Whalen (here and here). His arguments are technical, but they are also valid, and they certainly play into what the “value” of the common stock of Fannie and Freddie is.

Whalen’s main point is to distinguish between what the Trump administration can do and what they can’t do.

Trump is fully within his rights as President to take the GSE’s out of conservatorship. BUT – what he can’t do is reassert the Fannie and Freddie of old – quasi-Government entities that have the fully backing of the US Government.

Before 2008, the GSEs were private/public entities. Yes they were private, but the understanding was that they were backed by the US Government if something went wrong. When something did go wrong (in 2008) the US Government did back them (they were taken into conservatorship).

But now that implicit guarantee can only go one of two ways. Either they become private companies with no government guarantee, or they get a guarantee, which can only happen if it’s voted on and approved by Congress.

If there is US Government backing of the mortgages they insure, it would need to be explicitly stated through legislation. Which isn’t really what we are talking about here when we talk about the Trump plan.

Not having that guarantee is kind of a big deal. Whalen points out that the reason the US can have a cheap 30-year fixed rate mortgage is because the government backs those mortgages.

That will no longer be the case if the Trump plan goes through without legislation from congress.

According to Whalen, a private issuer can’t have a AAA rating. It won’t matter how much capital they have. If the GSE’s are made private, their credit rating will have to go down, and mortgage rates will have to go up.

Of course, no one wants mortgage rates to go up too much. Which raises the question of whether 3% capital (or the 2.5% Ackman suggests) is going to be enough for the market?

Here’s the distinction – there is one level of capital that the Government requires, but another that the private market is going to require to feel comfortable investing in the stocks – especially stocks that are responsible for insuring much of the single-family homes in the country.

WHERE DOES THIS PUT US?

As usual, the deeper you dig, the more dirt you pull out. And the less black and white any position becomes.

Look, Bill Ackman is not necessarily wrong. There is a case that the GSE’s will be worth A LOT more in 2 years. If the cards fall right, Fannie and Freddie could be $30 stocks.

But it is far from a sure thing. There is an equally valid, maybe even more valid, case to be made that these stocks will end up being worth either what they are right now, or less.

The best thing you can say about Ackman’s position is that the guy seems to have an in with Trump. So it’s possible he knows what the administration is thinking. And its possible he can influence that thinking through the process.

Of course, that’s great if you are Bill Ackman but not really a strategy for the rest of us.

My advice? Decide if you like gambling.

At $4 this is a 8x bet with a downside of zero. The odds are probably less than 50%, more than one in ten. If you can handle losing it all, you could put some in and hope the cards fall in your favor.

Just don’t be surprised if they don’t.

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