A stock for the courts to decide

Fannie Mae was put into conservatorship with the Federal Housing Finance Agency on Sept. 6, 2008, due to the $187 billion bailout from the federal government that they and Freddie Mac received. Because of the indebtedness and level of government support, the stock had pretty much flatlined until early 2013.  

Earnings reported in March 2013 revived the stock and it has been on an upward trend ever since. As of March 14, 2014, the stock had returned 1,300 percent for the rolling 12-month period and, year-to-date, the stock was up around 37 percent to $4.13 per share.  

So, why the huge turnaround in Fannie Mae stock? It came down to the discovery that there could be potential value in the corporation when it appeared profitable. According to Bloomberg compiled data released in late February 2013, the fiscal year 2012 financials revealed Fannie Mae beat Wal-Mart, GE and Berkshire Hathaway with record profits.  

It reported the largest annual profit in company history with the housing rebound. The net income of $17.2 billion outpaced the profits of many other large companies that year. This was a dramatic improvement from the loss that was incurred in 2011 to the tune of $16.9 billion.  

But nothing could have prepared investors for the news that Fannie Mae would post an even larger unexpected profit of $84 billion in 2013. With that, it marked the eighth consecutive profitable quarter for the company. Fannie Mae President and Chief Executive Officer Timothy J. Mayopoulos said on a conference call with reporters,  

“We expect to remain profitable for the foreseeable future.” Further, a recent press release by the U.S. Office of Management and Budget said that “Fannie Mae and Freddie Mae could return $179.2 billion in profits over the next 10 years to taxpayers if they continue to operate under federal conservatorship.”  

The rub for preferred stockholders and stock investors is that all profit has been going back into the federal coffers. Fannie Mae and Freddie Mac have paid back $202.9 billion, as of March month end, which is more than the $187 billion they had received in Treasury support.  

The question on investors’ minds is who the assets of the company, the profit, and the future profit belong to since the company was put into conservatorship as opposed to receivership for bankruptcy or nationalization.  

Many savvy investors with a high degree of tolerance for uncertainty and volatility see the distinction and have been buying up the stock as well as the preferred shares. Some of these investors have taken up huge positions, such as hedge fund manager William Ackman. In November 2013, Ackman’s Pershing Square hedge fund purchased nearly a 10 percent stake in Fannie Mae.  

His stated goal is to persuade the stakeholders to allow Fannie Mae to continue operations and to work with the stockholders to an amicable conclusion.  

With Congress working on legislation to wind down and replace the two companies, investors are fighting back. Hedge fund Perry Capital and mutual-fund firm Fairholme Capital Management have both sued the U.S. and challenge an arrangement in which the government takes all of the companies’ quarterly profits, leaving nothing for stockholders.  

The Treasury owns the senior preferred stock and has an unexercised warrant to purchase 79.9 percent of the common stock. As a result of Fannie Mae’s senior preferred stock purchase agreement with the Treasury, the company is not permitted to retain its earnings. Furthermore, under the terms of the senior preferred stock purchase agreement, dividend payments do not offset prior Treasury draws.  

As such, the company expects to continue to make dividend payments to the Treasury and that prior payments do not effectively pay down the amount previously provided by the government. The argument by the stockholders is that the government does not have the right to retain all the profit since the company was not officially bankrupted. Instead, it was pseudo-nationalized or temporarily nationalized.  

This is where the problem stems from. If Fannie Mae had been bankrupted, it would have followed an orderly liquidation process. From there it would have been easily calculated after all senior creditors were paid back how much, if any, money would be allocated to subordinate debt holders, then preferred and then common stock holders.  

Even if the company had been nationalized, the U.S. government, per the Fifth Amendment, would have had to provide “just compensation” to holders of the company. Instead, Fannie Mae was left to operate with preferred and common stockholders holding an interest in the company, and those stockholders are not going to relinquish their rights without just compensation.  

As it stands now, stockholders have very little power or influence over the company. Stated in the latest 10-K report with the SEC, “Our directors do not have any fiduciary duties to any person or entity except to the conservator and, accordingly, are not obligated to consider the interests of the company, the holders of our equity or debt securities or the holders of Fannie Mae MBS unless specifically directed to do so by the conservator.”  

The terms of the conservatorship states “there is no termination date and there is no current adopted plan on how the conservatorship will terminate or what changes to the business structure will be made during the course of the conservatorship”. Following the conclusion of the conservatorship, what ownership interest, if any, will the current common and preferred hold?  

It is unknown what will transpire between today and when the courts decide the conclusion of the conservatorship. Big money, such as hedge funds, are speculating that they will either be able to negotiate or sue to have their voice heard, while U.S. politicians are skeptical of any plan that will be viewed as lining the pockets of hedge funds managers with a windfall profit at the cost of the American taxpayers.  

In the end, the variation of the payout provided to stockholders could be considerable.  

Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Ltd. The Bank accepts no liability for errors or actions taken on the basis of this information.