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Sydnee Gatewood
Sydnee Gatewood
Articles (2814) 

Bill Ackman Comments on Fannie Mae and Freddie Mac

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August 28, 2020 | About:

Fannie Mae (FNMA) ("FNMA", or "Fannie") and Freddie Mac (FMCC) ("FMCC", or "Freddie," together "the GSEs")

Fannie and Freddie, along with their regulator and conservator FHFA, have continued to make substantial progress toward ending their conservatorships. While FNMA and FMCC common shares have declined 29% and 27%, respectively, year-to-date, possibly due to uncertainty created by the upcoming presidential election, we believe that both companies are now firmly on a path towards exiting conservatorship and raising substantial first-loss private capital.

Financial advisors for the eventual recapitalization of the GSEs are now in place, with FHFA hiring Houlihan Lokey in February, and Fannie and Freddie hiring Morgan Stanley and J.P. Morgan, respectively, in June. FHFA re-proposed the capital rule for the GSEs in May, which we expect will be finalized by the end of the year.

The re-proposed rule has been improved since the 2018 version, most notably with a clear goal of ending the conservatorships, and a reduction in pro-cyclicality, i.e., the requirement that the two GSEs raise more capital as housing values deteriorate, and hold less capital as housing values rise. We believe, however, that the newly proposed, substantially higher required capital ratio of 4.0% of assets and guarantees is far above what is required for the companies to comfortably withstand any future housing or financial crisis.

While banks are required to hold 4% of capital against the mortgages they hold on balance sheet, Fannie and Freddie hold only a fraction of the mortgages they guarantee on balance sheet. Rather, as mortgage insurers of whole mortgages, they guarantee only the timely payment of interest and principal on the mortgage securities they issue, which are backed by lower-risk mortgages than those typically held by banks. As a result, the GSEs do not have the same liquidity demands or mortgage risks as banks or other mortgage insurers that guarantee junior tranches of mortgages, which allows Fannie and Freddie to operate safely with substantially lower capital than banks.

We believe the recently proposed capital rule fails to balance the objectives of safety and soundness of the GSEs with the need to deliver affordable mortgage rates to consumers, and market returns to investors. In order to emerge from conservatorship, Fannie and Freddie must earn sufficiently high returns on capital to attract investors who can provide the tens of billions of equity capital for the companies to recapitalize. Earlier this month, we submitted a public comment letter on the re-proposed capital rule which addresses these issues.

In July, the U.S. Supreme Court agreed to hear appeals by both the plaintiffs and the Federal Government from the Fifth Circuit Court of Appeals' decision in the Collins case. The Fifth Circuit, sitting en banc, ruled in favor of the plaintiff-shareholders. On appeal to the Supreme Court, the parties will be arguing the legality of FHFA's structure, and, more importantly, the lawfulness of the net worth sweep, and the scope of various provisions under the HERA statute under which the Fannie and Freddie conservatorships were created.

We expect oral arguments to occur later this year or early next year with a decision by the Court around June of 2021. While we await further developments on both the administrative and legal fronts, Fannie and Freddie continue to build capital through retained earnings, with combined capital at both companies now approaching $28 billion, up from zero, two-and-one half years ago.

The Covid-19 crisis has further highlighted the critical role Fannie and Freddie play in the housing finance system. When the crisis hit, competitors withdrew from the market, leaving Fannie and Freddie among the only sources of mortgage capital for homeowners.

From Bill Ackman (Trades, Portfolio)'s Pershing Square 2020 semiannual shareholder letter.

About the author:

Sydnee Gatewood
I am the editorial director at GuruFocus. I have a BA in journalism and a MA in mass communications from Texas Tech University. I have lived in Texas most of my life, but also have roots in New Mexico and Colorado. Follow me on Twitter! @gurusydneerg

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