Tuesday, August 25, 2009

Will Fannie Mae and Freddie Mac Earn Enough to Pay Back the Taxpayer (and turn a profit for the common shareholders?) FRE; FNM

UPDATE:"Fannie, Freddie soar on opportunistic day traders (FNM; FRE)"
Original post:
We started paying attention to Fannie and Freddie on August 5th, after basically ignoring them since we posted "Is Washington Mutual Going to be the Next Bank to Fail? FDIC Would Be Out of Money (WM)" on Sept. 15, 2008.

On August 7, FNM closed at 66 cents. Yesterday it closed at $1.70. This morning it is indicating a $1.90 open, just shy of a triple in eighteen days.
Freddie's trajectory has been a bit steeper, running from 74 cents to $2.22, exactly three times on the money.
Here are our posts over the period:
Aug. 5
Moody's Downgrades Fannie Mae, Freddie Mac to "Bleak" (FNM, FRE)

Aug. 6
Bullish Speculation Spikes as Fannie Mae Rumors Swirl (FNM; FRE)

Aug. 10
Freddie Mac Shares Surge After Firm Posts Profit. "Won't Tap Treasury Funds" (FRE; FNM)

Aug. 10
What’s Driving the Rally in Freddie and Fannie (FRE; FNM)

Aug. 11
Freddie Mac Says Its Loss From Taylor Bean May Be ‘Significant’ (FRE; FNM)

Aug. 11
Fannie's Failings (FRE; FNM)

Aug. 11
Options Update: Freddie Mac Short Strangled (FRE, FNM)

Aug. 11
Stocks: The latest Fed bubble (FRE; FNM)
You may have noticed the posts focused on what used to be called "Government Sponsered Entities", now more accurately referred to as Taxpayer Owned.
Fannie and Freddie are interesting not just for their trading appeal (FRE up 128% yesterday) but because the actual underlying companies are on life-support. Politically motivated life-support. As such they can give us a measure of the frothiness of the market as well as a direct read on the politically connected crapola sector of the economy. To see the recent FRE/FNM posts, scroll down or use the blog search box....
Here's the recent action vs. the S&P (via Yahoo Finance):
Chart for Freddie Mac (FRE)

We've been linking to John Hempton's ongoing series on the former GSE's (they're no longer "sponsored" they are majority owned subs of the U.S. government) since August 12.
To date we've linked to all eight of Mr. Hempton's posts, starting with parts I and II in:
"Modelling Fannie Mae and Freddie Mac – Part 1 (FRE; FNM)" and:

Aug 13
John Hempton's "Modelling Fannie Mae and Freddie Mac" Part III (FRE; FNM)

Aug. 17
Fannie and Freddie: More Defaults to Come (John Hempton's "Modelling Fannie Mae and Freddie Mac – part IV") FNM; FRE

Aug. 18
Fannie and Freddie: "I Will Survive" (alternatively: "Modelling Fannie Mae and Freddie Mac – Part V") FNM; FRE

Aug. 19
Fannie, Freddie and the Money Post-"Modelling Fannie Mae and Freddie Mac – Part VI" (FNM, FRE)

Aug. 21
Modelling Fannie Mae and Freddie Mac – Part VII (FRE; FNM)
Here'sMr. Hempton's latest:

Modelling Fannie Mae and Freddie Mac – Part VIII
In Part VII I did an “idiot check” on my credit loss numbers. They appear pretty robust. This post does an idiot check on the pre-tax, pre-provision profit estimate. Here I am less confident.

The massive rise in GSE pre-tax, pre-provision profits is one driving factor behind my assertion that the GSEs can recapitalise. In the Freddie Mac 10Q from the first quarter was this (often quoted) and profoundly bearish line.

Our annual dividend obligation, based on that liquidation preference, will be in excess of our reported annual net income in nine of the ten prior fiscal years. If continued to be paid in cash, this substantial dividend obligation, combined with potentially substantial commitment fees payable to Treasury starting in 2010 (the amounts of which have not yet been determined), will have an adverse impact on our future financial position and net worth, and will contribute to increasingly negative cash flows in future periods.

This line – or variants on this line are repeated multiple times in the recent 10Q.

This is a blunt statement that Freddie could never repay the government because it owed the government $5.2 billion per annum and that was more than the earnings in almost every prior year.

There is a little that is disingenuous about this statement – possibly deliberately. The statement compares the obligations to the Treasury to the post-tax, post provision income for the past decade. In most years the pre-tax, pre-provision income of Freddie was in excess of $5.2 billion (which would have allowed some repayment). But far more to the point – the current pre-tax, pre-provision income is in excess of $15 billion. After write-backs they dealt with over 8 billion of the 50 odd billion outstanding in one quarter in Q2 – but they are not permitted to make the actual repayment (more on that in a later post).

Here is a cut-down version of the profit and loss account from the last quarter...MORE