Fannie Mae-No Politics (FNMA)

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Perry Capital Still Believes Its GSE Shares Have Upside

Sep. 29, 2016 8:06 AM ET| Glen Bradford

..... Summary .....

-- Richard Perry believes so strongly in his fund's GSE preferreds that he's keeping them for a while longer even though he's liquidating his fund.

-- Many large financial institutions paid billions of dollars to settle lawsuits brought against them for defrauding Fannie Mae and Freddie Mac.

-- The acting director of FHFA admitted the law was trumped. Evidence supports this admission.

Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are two companies that have been run by a conservator that claims no fiduciary duty to shareholders since 2008. As such, the government has self-negotiated into its current position of having a $187B liquidation preference and 79% warrant coverage. This is on top of taking out over $100B of net cash since conservatorship commenced. The Senior Preferred Securities Purchase Agreement was designed around the government having discretionary accounting authority which was then used to issue stock to itself. If you look closer, FHFA had the discretionary accounting authority and Treasury was the proverbial money man.

The government's interpretation of the law that is supported by several legal rulings all revolving around a district court opinion by Lamberth permits FHFA to effectively transfer Fannie and Freddie's money to whomever it chooses without judicial review. I've read the applicable law and I'm not a lawyer but I don't think I need to be to understand the implications of this interpretation. The implications are that insolvency law as we have come to know it would be uprooted according to former FDIC Chairman William M. Isaac. There, he oversaw approximately 303 failure or assistance transactions. It's clear to me that the actions that the government has taken against Fannie Mae and Freddie Mac if left to become settled law would undermine my discounted cash flow analysis of any large public company that may be at risk of nationalization as well as any company that may be acquired by one.

Investment Thesis: If the government gets to take all the money of Fannie and Freddie for nothing, then the shares I am writing about are worthless. I find it difficult to find anything of worth in such a scenario so I've bet everything I have. My credit cards are maxed out. I have personal loans. I have college loans. I have a Bachelors of Industrial Engineering from Purdue University and a Masters of Business from their Krannert School of Management. The point is as follows. Richard Perry is one of the smartest hedge fund managers in the world. He's closing down his fund. I've closed down a fund before and sometimes things go in such a way where you have to make choices:

While he'll be returning much of their money next month, Perry has told clients that he probably won't be ready to sell a few of his investments for a year or more. Chief among them are preferred shares in Fannie Mae and Freddie Mac.

In the same spirit, Michael Burry who was played by Christian Bale in the movie The Big Short faced redemptions before his predictions came true. I own preferred shares in Fannie Mae and Freddie Mac and I wanted to provide the insight of someone who has liquidated a fund before as I have to demonstrate that what Richard Perry is doing amounts to a cute, "I told ya so" and is a rather ingenious way to exit stage left. Right now the preferreds are trading at less than 20 cents on the dollar of par value leaving significant upside on the table.

The Reality Of Liquidation

If Richard Perry didn't have confidence that the government was not only wrong but broke the law and misrepresents the law in court to judges then he would be getting out of Fannie and Freddie preferreds. Liquid or not, when it's closing time, there's no shame in getting out before the knife drops if you're not confident in order to save face. I'm sure Richard Perry is well aware that Fairholme's Motion To Compel was Ordered by Judge Sweeney in favor of plaintiffs. Those facts, once produced for plaintiff lawyers, will be used to amend the lawsuits in at least the court of claims. Assuming Perry Capital's lawsuits is remanded then those facts would make it impossible for Lamberth to rule in favor of the government if he is ordered to assume that a conservator has fiduciary duties and can't liquidate the enterprises to one shareholder without judicial review.

The question that I have is at what point in time would Perry Capital be more willing to sell the preferreds it has and return capital to shareholders. Considering that the accounting fraud lawsuits are still in play I would argue that it wouldn't make sense for him to begin selling on just a remand or even an Injunction declaring the government's actions ultra vires. If the accounting is restated without the influence of FHFA trying to funnel GSE assets to Treasury by writing down assets using overly pessimistic soon to be reversed assumptions, the preferreds are worth at least par as a going concern in the current interest rate environment. This doesn't even take into consideration the potential for payment for the breach of contract claims brought by class plaintiffs.

Key Points In Fanniegate History

For starters, the Federal Housing Finance Agency initiated litigation against 18 financial institutions involving allegations of securities law violations and, in some instances, fraud in the sale of private-label securities (PLS) to Fannie Mae and Freddie Mac. These lawsuits produced billions of dollars for plaintiffs of settlements. This supports the general notion that the problem was never Fannie Mae and Freddie Mac, but it was the large financial institutions that defrauded them. This money has all been swept to US Treasury.

Secondly, the printing of non-cash losses between 2008 and 2012 to the benefit of Treasury at the expense of taxpayers was signed off by Deloitte in the case of Fannie Mae and PwC in the case of Freddie Mac. We now know that on October 9, 2008 PwC met with FHFA to help them figure out how to implement capital draws. We also know that the government has been withholding documents from plaintiffs in the Court of Claims as evidenced by the plaintiff favorable ruling on the motion to compel along with the expectation that the government has to explain why it shouldn't pay plaintiff legal expenses.

Thirdly, the current acting director of FHFA Melvin Watt says the law got trumped:

I think the law got trumped when they went into conservatorship...

Even thought the law got trumped, here's how he reconciles it:

An agreement was made that was before I got there. I didn't negotiate the agreement.

And he's right. That being said, he admits that an agreement between one agency and another department of government was made that trumps the law and that typically these sorts of agreements cannot trump the law.

Summary & Conclusion

Richard Perry knows exactly what he is doing and recent performance has effectively put him into a position where he is making the best choice possible. Even though he is liquidating his fund, he continues to hold his GSE preferred which is a testament to his conviction that they are undervalued and that court rulings will benefit preferred shareholders like himself. I have 27,225 FNMFN, 500 FMCKO, 6,585 FMCKP, 9,714 FMCCT, 4,050 FMCCH, 2,600 FMCKI, 9,340 FMCCP and 5 FNFMO. What's good for Perry is good for me. Note that there are several other court cases filed under the same theories of law that have been consolidated alongside Perry inn the DC Circuit Court of Appeals as well as similar cases filed elsewhere that would subsequently be revived upon remand.