Fannie Mae (FNMA) / Freddie Mac (FMCC)
Fannie and Freddie reported continued earnings growth in their core single-family guarantee businesses in the second quarter. Guarantee fees charged on newly issued mortgage backed securities continued to increase along with the size of their guarantee portfolios, while underlying credit losses remained modest. Both enterprises have now increased their capital reserves to the $3 billion per entity limit imposed by Treasury in December, and plan to pay a combined $6.1 billion in dividends to Treasury under the net worth sweep by September 30th. Inclusive of these upcoming payments, Treasury will have received a total of $286 billion in dividends on its Senior Preferred Stock investment, which is $94 billion more than its cumulative cash investment of $191 billion. This represents an annualized cash-on-cash return to the government of nearly 11%, above the bargained for 10% interest rate. This return reflects no value for Treasury’s warrants to purchase 79.9% of the common stock of both entities, which we believe should be worth in excess of $150 billion if Fannie and Freddie exit conservatorship and are recapitalized.
In June, FHFA, Fannie and Freddie’s primary regulator, released draft proposed capital rules for the enterprises that would apply once they exit conservatorship. Overall, we are encouraged that FHFA is soliciting feedback from market participants regarding adequate capital levels for the entities, which have been near zero since conservatorship began nearly a decade ago. In order to raise the large amount of private capital that will eventually be needed to recapitalize the enterprises, we believe that all final capital rules should avoid complexity and procyclicality, as well as balance the requirement for a fortress balance sheet with the need to deliver market returns to investors, and affordable mortgage rates to consumers.
Other than the draft capital rules, the last three months were relatively uneventful with regard to housing finance reform efforts, but we expect activity to resume in earnest after midterm elections in November. Last week, the government filed an omnibus motion to dismiss in 12 cases asserting an unconstitutional taking and related claims. Given the lengthy briefing schedule, we would expect a decision sometime in the late spring or summer of 2019.
From Bill Ackman (Trades, Portfolio)'s second quarter 2018 Pershing Square shareholder letter.
