Fannie (FNMA, Financial)’s and Freddie (FMCC, Financial)’s underlying earnings continued to progress modestly in the core mortgage guarantee business as the guarantee fee rate increased and credit costs declined. In addition, the non-core investment portfolio continued to shrink, resulting in a less risky and more capital-light business model. While underlying earnings improved, reported earnings remained volatile due to non-cash, accounting-based derivative losses in the non-core investment portfolio. As a result of the derivative losses and the Net Worth Sweep, the companies are at risk of requiring a capital draw from Treasury to maintain a positive net worth. As a result, there recently have been a number of proposals from policymakers, trade groups, and industry analysts that seek to have the GSEs retain capital so they are capitalized on a standalone basis.
In the Perry case in the D.C. Court of Appeals, new evidence came to light that shows Treasury entered into the Net Worth Sweep immediately after learning from Fannie Mae’s CFO that the company expected to soon realize ~$50 billion of profits from reversing a deferred tax allowance and expected to become sustainably profitable over time. We believe this new evidence further bolsters the Perry and Fairholme cases and our contention that the Net Worth Sweep is illegal.
From Bill Ackman (Trades, Portfolio)'s first quarter shareholder letter.
