Bill Ackman owns many Franklins. This Alpha article may have unleashed the fantasy receivership minds of Preferred children.
Below is my letter sent to Bill Ackman of Pershing Square Management in February 2015 regarding his long investments in the GSEs, Fannie Mae (OTCQB:FNMA) & Freddie Mac (OTCQB:FMCC), and why I believe private investors should reap very little of any value accrued of these firms going forward. Although written in February, it is still as pertinent today as it was then. He did not respond to my certified letter.
To: William Ackman, Pershing Square Management L.P.
RE: The Future Value of the GSEs: Fannie Mae & Freddie Mac
Dear Mr. Ackman,
I am writing you this letter in regard to your long thesis on the common and preferred shares of Fannie Mae & Freddie Mac. I have read both your comments in the press as well as your case for the GSEs at the Ira Sohn Conference in May 2014 and presentation, "It's Time to Get Off of Our Fannie."1
As a potential long investor myself, I wanted to write you in order to try to square what I believe is the single largest fundamental obstacle precluding any type of reasonable long investment into Fannie & Freddie.
Before I do that though, I just wanted to state, that like many others (including yourself), I believe that Treasury and the US Government cannot and will not fully nationalize the GSEs. I agree with you that it simply would not be feasible nor practical for the government to fully privatize and run these two gigantic firms while at the same time adding over $6 trillion of US mortgage debt to an already overstretched Federal balance sheet.
Rather, the likely future scenario for the GSEs is some type of public/private hybrid entity with the government (and taxpayers) providing an ultimate guarantor of last resort backstop for principal and interest payments on mortgages.
It is this implicit (though virtually explicit) guarantee provided by the government that leads me to assign little if any value to private, common GSE investors. Without the almighty weight of the US Government guarantee the market would hold little faith in these firms to fully insure millions of Americans' homes. You know as well as I, that there is simply nowhere near the amount of private capital awash in the world to guarantee the GSEs massive books and the historical data on private mortgage insurance (PMI) issuance bears this fact out.
Thus any real economic value attributed to FNMA & FMCC is almost solely derived by this implicit guarantee. Without it, these companies are like the proverbial 'emperor without clothes.' Were the GSEs to be deprived of Uncle Sam's good faith & credit backing up American mortgages, private mortgage insurers would be forced to charge orders of magnitudes above the current 60bp or so Fannie Mae g-fees. Furthermore, private insurers would in all likelihood unilaterally retreat from offering the 30-year fixed mortgage in fear of duration risk. Finally, any real stress in the system would likely see a wholesale withdrawal from the mortgage market in panic by consumers without the steadfast reassurance of the US government.
Having said all of this - if it is Uncle Sam doing a majority of the heavy lifting, providing the backstop capital on millions of mortgages, why should any of the benefits reaped of the implicit guarantee accrue to private shareholders? Even if we attribute 80% of the value to the government safety net and a liberal 20% to private capital, using your future value estimates on slide 104 of your presentation1 assuming an eventual 80pb g-fee and 15X FP/E multiple, one would arrive at a $35 share price. If only 20% of that value would be attributable to non-government private capital, we would derive at $7 a share. This is still about 3x the current $2.32 (2/11/15) FNMA share price, but definitely not the Grand Slam many private investors are betting on in the event of a Net Worth Sweep dissolution. Once again, my 80/20% government-private split assumption is both arbitrary, and one could argue, very optimistically skewed on the private side (95/5% is more realistic).
All this being said, I cannot make any type of good faith argument in favor of significant value accretion towards non-governmental private shareholders when it is the US Government providing the very bedrock upon which these firms were created and continue to operate. Can you?
Ultimately I agree with both your points that the 5th Amendment and Net Worth Sweep should be dissolved and that the true equity value of Fannie and Freddie are much higher than at present levels. Yet, at the same time, the current share levels of the GSEs most likely accurately reflect the appropriate value attributable to private, non-US government shareholders contribution towards these iconic American firms.
If you could argue otherwise Mr. Ackman, I would very much be interested in listening to you or someone on your staff at Pershing Square.
Thank you.
Pershing Square Capital Management LP - Fannie & Freddie Holdings
In a previous Seeking Alpha article published on 8/17/15, "Tracking Bill Ackman's Pershing Square Portfolio - Q2 2015 Update," author John Vincent cited Pershing Square's last 13D file mentioning the firm's GSE positions.
A 13D filed in November 2013 showed that Ackman's fund held 115.57m shares of Fannie at a cost-basis of $2.30 and 63.5m shares of FMCC at a cost-basis of $2.14. This equates to a position just over $400m.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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