Earlier this month, famed investor Bruce Berkowitz disclosed that he is once again placing an enormous bet on the recovery of the U.S. financial infrastructure. This time he purchased a stake valued at approximately $2.4 billion par value of Fannie Mae (FNMA) and Freddie Mac preferred stock. Previously in 2009 and 2010, Berkowitz invested the majority of his Fairholme Fund (FAIRX) into crippled financials, after which his returns nosedived, though his fund recently reached an all-time high
Fannie Mae and Freddie Mac are secondary mortgage market government-sponsored enterprises that entered government conservatorship in 2008 on fear that they would go bankrupt due to defaulted mortgage assets from the U.S. housing crisis. Fannie Mae in 2012 was the largest single issuer of mortgage-related securities in the secondary market.
As of March 31, no gurus besides Berkowitz have purchased shares of Fannie Mae. In fact, 14 gurus tracked by GuruFocus sold out of their holdings in 2008, and more followed in 2009. The last to exit their positions were Brian Rogers in the fourth quarter of 2009, and Richard Pzena in the second quarter of 2012.
Several firms lost substantial sums on Fannie Mae, as they bought shares in the first three quarters of 2008 when the price plunged to $27 and $8 per share on average. Then, by the fourth quarter of that year, the stock traded for under a dollar. It remained there for the next several years.
The stock suddenly sparked to life, however, in mid-March. That month, Fannie Mae reported $58.7 billion in net income and $8.1 billion in pre-tax income for the first quarter of 2013 – the largest pre-tax income in its history. It compared to pre-tax income of $2.7 billion in the first quarter of 2012.
The year-over-year improvement largely resulted from rising home prices, higher average sales prices on its properties, a decrease in delinquent loans and a resolution agreement between it and Bank of America (NYSE:BAC).
In the fourth quarter of 2012, the company also reported its first annual net income since 2006.
Fannie Mae five-year price, revenue and net income history:
Fannie Mae also continued to the government for its massive bail-out this year. It plans to pay $59.4 billion to the Treasury by June 30, 2013. Including that payment, it will have paid the government $95 billion in cash dividends in total since conversatorship began on Sept. 6, 2008. The Treasury held $117.1 billion in senior preferred stock as of March 31, 2013, as well.
It seems to be “déjà vu all over again,” as Berkowitz’s comments about Fannie Mae and Freddie Mac echo those he made about other investments that raised eyebrows in recent years.
“Privately owned Fannie Mae and Freddie Mac are critical to our nation’s economic security, lowering the cost and increasing the availability of homeownership,” he said in a release on June 3. “There are no substitutes. Fannie Mae and Freddie Mac currently purchase or insure 6 out of every 10 home mortgages in America. Today, they are stronger than ever – enabling the United States Treasury to rapidly recoup its temporary emergency investments in both entities.”
Berkowitz said similar things in defense of his major purchases of financials such as Bank of America (NYSE:BAC), CIT (NYSE:CIT) and AIG (NYSE:AIG). For instance: “So this is why we’re in financials; a group essential to the country, essential to the world,” he told Bloomberg in March 2012. “They are the financial system of the United States and a good chunk of the world’s financial system.”
Berkowitz himself drew the comparison to his financial stocks in his June 3 letter. "The time to restructure Fannie and Freddie is upon us,” he wrote. “Sustaining our nation's economic recovery requires it. On behalf of the hundreds of thousands of Fairholme shareholders who helped to rebuild American International Group, Bank of America, CIT Group, General Growth Properties (NYSE:GGP), MBIA Inc., and others after the Great Recession – we stand ready to do our part."
Though it took longer than expected, Berkowitz has made excellent returns on most of the mentioned holdings. Of those he still holds, he has made 50% on AIG, 59% on MBIA (NYSE:MBI), but is still down 9% from the average price he paid.
But Fannie Mae and Freddie Mac carry unique risks. Namely, Congress is currently discussing legislation introduced by a bipartisan group of senators for the companies to remain under government control until they can form a plan to replace them, Politico reports.
In his letter, Berkowitz seemed to brush off this possibility:
“Taxpayer dollars expended by the government during a time of national crisis will be fully repaid,” he said in a release. “And equitable treatment of taxpaying shareholders, including community banks, insurance companies, and mutual funds holding Preferred Stock, must be restored with dividends reinstated. Repaying taxpayer investments, restructuring government guarantees, and restoring shareholder property are not mutually exclusive. This is the American way.”
The statements mark a change in opinion from February 2013, when he suggested to Bloomberg that he expected Fannie Mae and Freddie Mac to be liquidated. “For example, as government-sponsored enterprises Fannie Mae and Freddie Mac run off/wind down, who will take their essential roles?” he asked. “Could it be the big banks that at one time funded 100% of home loans? Could it be AIG to insure residential mortgages?”
On the other side, hedge funds that hold preferred shares, such as Paulson & Co. and Perry Capital, are lobbying Congress to allow the companies to go independent again, and shareholders are seeking $41 billion in damages from the government, who they believe should not have taken over the companies.
Additionally, the prices of Berkowitz’s other investments imparted confidence. Many of them were trading at half of shareholders’ equity or half of book value when he bought them. Fannie Mae, however, has not reported positive book value since 2008.
- Warning! GuruFocus has detected 4 Warning Signs with FNMA. Click here to check it out.
- FNMA 15-Year Financial Data
- The intrinsic value of FNMA
- Peter Lynch Chart of FNMA
FNMA data byGuruFocus.com
The Peter Lynch Chart, however, is indicating that the stock was significantly undervalued on a fundamental basis until the price popped recently:
Fannie Mae Preferred shares are down 3.53% on Thursday, at $5.27 per share.
See Bruce Berkowitz’s portfolio here. Also check out the Undervalued Stocks, Top Growth Companies and High Yield stocks of Bruce Berkowitz.