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Bruce Berkowitz Reports New Buys for Fairholme Fund

August 02, 2013 | About:

Holly LaFon

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Bruce Berkowitz’s last five years can be summed up as initial losses on massive early bets on troubled financials and subsequent incredible gains on the same financials, but now he is finally making a slight change in direction. His second quarter portfolio, released today, shows that while he held on to most of his firm’s largest holdings, he bought three new ones for the Fairholme Fund: Fannie Mae (FNMA), Federal Home Loan Mortgage Corp. (FMCC) and Chesapeake Energy Corp. (CHK).

Berkowitz also notes in his first-half letter that his Fairholme Fund (FAIRX) returned 25.32% in the past year, versus 20.60% for the S&P 500.

Fannie Mae (FNMA)

Berkowitz purchased 7,042,000 shares of Fannie Mae in the second quarter. The stock had an average price over the quarter of $1.38, but the price fluctuated significantly:

1375474037421.png

Fannie Mae is a government-sponsored enterprise that was chartered by Congress in 1938 to support liquidity, stability and affordability in the secondary mortgage market, where existing mortgage-related assets are purchased and sold. Fannie Mae has a market cap of $1.8 billion; its shares were traded at around $1.55 with a P/E ratio of 11.30 and P/S ratio of 0.40.

Berkowitz commented on his Fannie Mae and Freddie Mac Investments in his second quarter letter:

The Fund's latest investments in the recovery of homeownership are in the preferred stocks of Fannie Mae and Freddie Mac. Your current mortgage may be backed by Fannie or Freddie – about 60% of new mortgages are. Millions of families depend on them to lower the costs and increase the availability of homeownership. In times of stress, Fannie and Freddie stand to ensure the continued functioning of our housing market. Their twelve thousand employees do yeoman's work helping to preserve a cornerstone of the American dream.

The Fund was able to purchase the preferred stocks of Fannie and Freddie near one-fifth of liquidation values – a significant bargain thanks to market predictions of U.S. Government agencies expropriating their assets. we see them differently. Fannie and Freddie are successful, publicly traded, shareholder-owned companies just like AIG and Bank of America. Shifting political winds can change their futures, but not alter their pasts.

The Fund has filed complaints in the court of Federal claims and the U.S. District court in washington. In our suits, we seek nothing more than the enforcement of existing contractual rights, which require the payment of dividends to Fannie and Freddie preferred shareholders. our arguments are based on fundamental principles. In America, property ownership is a
sacrosanct freedom, guaranteed by our Constitution. In America, we follow the rule of law, not the rule of the crowd. In America, profitable companies honor contracts.

Below is Fannie Mae’s revenue and earnings history:

1375474549198.png

Federal Home Loan Mortgage Corp (FMCC)

Berkowitz bought 7,218,200 shares of Federal Home Loan Mortgage Corp in the second quarter, representing 0.23% of the Fairholme Fund portfolio. The stock’s average price for the quarter was $1.30 per share.

1375474758076.png

Freddie Mac was chartered by Congress in 1970 with a public mission to stabilize the nation's residential mortgage markets and expand opportunities for home ownership and affordable rental housing. Federal Home Loan Mortgage Corp has a market cap of $942.6 million; its shares were traded at around $1.45 with a P/E ratio of 72.10 and P/S ratio of 0.30.

The company’s revenue and earnings history:

1375474773436.png

Chesapeake Energy Corp (CHK)

For Berkowitz’s largest new position he bought 3,194,200 shares of Chesapeake Energy for $20 per share on average, representing 1.1% of the portfolio. The stock has since gained 23% and trades for $24.95 Friday.



Chesapeake Energy Corp was incorporated on 1989. Chesapeake is a natural gas and oil exploration and production Company engaged in the exploration, development and acquisition of properties for the production of natural gas and crude oil from underground reservoirs and it provides marketing and midstream services. Chesapeake Energy Corp has a market cap of $15.5 billion; its shares were traded at around $24.91 with a P/E ratio of 27.10 and P/S ratio of 1.20. The dividend yield of Chesapeake Energy Corp stocks is 1.40%.

Cheapeake’s revenue and earnings history:

1375475172997.png

Fellow investor John Rogers of Ariel Investments who also owns Chesapeake shares commented on the company in his first quarter 2013 investor letter:

Specifically, Chesapeake Energy Corp. (CHK), a holding in some of our other portfolios, priced a joint venture at prices roughly 35% lower than recent transaction values for similar land. The deal implied low prices for deals across the space, hitting Contango's stock. Many believe the company's sale is imminent, and while it is reasonable to assume it could be, we do not believe management would sell its unencumbered assets on the cheap when they can afford to wait. As patient investors, that is what we would do, and we count their team as fellow travelers.

See Bruce Berkowitz’s second quarter portfolio here. Also check out the Undervalued Stocks, Top Growth Companies, and High Yield stocks of Bruce Berkowitz.


Rating: 4.0/5 (11 votes)

Comments

gorlickg
Gorlickg - 11 months ago
Why would Berkowitz buy the common stock----when the government says they will stop the program and the shareholders will get nada?.....I am confused. Any explanations? Thanks....



batbeer2
Batbeer2 premium member - 11 months ago
>> Why would Berkowitz buy the common stock----when the government says they will stop the program and the shareholders will get nada?

Simple, you assume shareholders get nada because government is stopping the program. Your assumption is wrong.

What happens to the income statement if Fannie Mae stops making new loans?

If anything, it improves. They'll still be collecting a lot of interest income on their HUGE portfolio.
gorlickg
Gorlickg - 11 months ago


Batbeer2:

I hope my assumtion is wrong. But is not the word in Congress that the program is to die and all the monies are to go to the government for the bail out ( there was no Bankruptcy as with GM ). Thus the shareholders get Nada? ( thus the law suits by Berkowitz et al). If you are right this equity has so much money and earns now so much money that EVERYONE would want to buy it hand over fist?

Appreciate your follow up to these ponderings....

batbeer2
Batbeer2 premium member - 11 months ago
- Fannie and Freddie were doing dumb things, but it was perfectly legal.

- The treasury now has collected (almost) as much as they put in.

- The companies are in conservatorship. Now that they are profitable and seem solvent, any legal basis for keeping them in conservatorship disappears.

- The US isn't Venezuela.

- Congress is making a lot of noise but in the end they created this problem, not shareholders. That is probably why they are making noise. It detracts fro the main issue. They need to come up with a better system.

My bet:

1) The treasury collects dividends for another couple of years and oversees the wind down of the portfolio to manageable levels ($250B).

2) Congress changes the system, Fannie and Freddie are handed back to shareholders without their previous mandate but WITH their slimmed down portfolio.

If I'm wrong, Fannie Mae is worth 0. If I'm right, it's worth in excess of $10B.

The key point here is that for Fannie and Freddie to be worth 0, government has to outright disown shareholders of equity that is obviously worth something. Unlike say Enron... they weren't doing anything illegal so I see no clear basis for taking from shareholders what they bought under perfectly legal circumstances.

Just random thoughts from someone who has never been to the US.
fox10
Fox10 - 11 months ago
I am still baffled by this move into FNMAS. berkowitz has always said he tried as hard to kill an investment as possible - and if unsuccesful, they would start considering it. In this case though, politicians could kill his investment with the stroke of a pen?! Or maybe not. I can't imagine that he didn't consult the best lawyers available on this matter before putting half a billion $ into the preferreds of fannie and freddie. still, he may be wrong here...
spasm
Spasm - 11 months ago
Hi Guys,

I think this scenario is predicated on some basic principles of company law. For instance, no particular class of shareholders are to be prejudiced over other class of shareholders unless in the bankruptcy process whereby the recovery of assets are in the following order secured creditors, unsecured creditors, preferred shareholders and then common shareholders.

However, Fannie and Freddie and profitable now.

Whether it works or does not work depends on whether a court rules in favor of shareholders or dreams up a new legal precedent based on "extraordinary circumstances" to rule that government is allowed to misappropriate the assets of the shareholders.

The US government basically used Tarp funds rescue this Fannie and Freddie by buying the preferred shares in the company, similar to Warren Buffett's investment in Goldman Sachs and GE. In those deals, he was allowed dividend at a 10% yield. In the US Government case, it was supposed to be a similar investment. However, they started to overreach and declared (unilaterally and potentially illegally) that all profits now below to the US government.

My point is, if WB had done this (a private company) do you think he had any right to say that all dividends shall now belong to him or Berkshire? The obvious response is surely, no.

I think the fifth amendment of the US constitution states further: "
spasm
Spasm - 11 months ago
continued...

deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.". Thus, based on existing company law and the Constitution, the current circumstances in which the US government is taking ALL profits from Freddie and Fannie are an exception rather than the law.

I think Bruce Berkowitz is suing the government based on these principles.

Should he succeed, Fannie and Freddie are going to be worth a lot. Fannie alone has 3.2 trillion of mortgages on its balance sheet. It collects interest of about 127 billion (which i worked out was about 3.9% interest) but has to pay out about 107 billion in interest expense. With about 3-5 billion in SG&A, Fannie could earn about 15 billion put on a multiple of 10 (example JP Morgan) and fannie could be worth 150 Billion. With its market cap at 8.67 billion, this is a potential 20x.

But be warned, this is highly risky stuff and permanent capital loss is a higher than average probability. Having said this, it may be worth taking a small position of your portfolio 2-5% for a good risk reward bet.
gorlickg
Gorlickg - 11 months ago
Spasm: Thank you for the BEST commentary on FNMA to date. Your points are excellent.

batbeer2
Batbeer2 premium member - 11 months ago
@ Gorlickg

Seconded!

Also:

1) From where I sit it looks like the Treasury is collecting interest from homeowners meanwhile, through the Federal reserve, it is lending it to the banks at unsustainably low rates. This will stop.

2) Let's invert. Assume the Treasury collects all future profits forever. At some point, the same taxpayers that are yelling about the cost of the bailouts are going to wake up to the fact the interest they are paying on their mortgages is ending up in the Treasury's coffers.

The bailout was yesterdays problem. The Treasury collecting the interest on your mortgage is not. I just can't imagine how five years from now, the Treasury will still be collecting the interest form your mortgage as "compensation" for the fact that they bailed Fannie and Freddie out in '08. In fact, i don't think the Treasury has an interest in collecting that cash. I can see how the guys and galls in congress have an opinion but at the end of the day, the Federal reserve, not congress is at the helm of this particular ship. Congress handed them the keys in '08.

To me, the question is: If not the Treasury, who will be collecting the interest on those mortgages by 2018?


Just some thoughts.
vgm
Vgm - 11 months ago
According to the WSJ, it seems Bruce is reopening his fund and setting up to buy more Fannie and Freddie. And he does seem to have used his strategy of trying to (theoretically) kill them and has failed, in which case - for him at least - this is not a risky bet:

"We haven't found a way to disprove our thesis about Fannie and Freddie"

John Paulson is in too.

http://online.wsj.com/article/SB10001424127887324139404579015032274244954.html
vgm
Vgm - 11 months ago
Further to Spasm's interesting comments above, I thought this an insightful analysis and commentary:

http://seekingalpha.com/article/1492262-the-just-and-legal-way-forward-for-fannie-mae-and-freddie-mac

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