Ticker | $FNMA

Very rarely do we outright buy stock on the open market. Our acquisition strategy has always been to reduce acquisition costs by selling put options in the target, this also buys us enough time to complete due diligence while collecting some theta payments. This strategy has yielded us strong annual results. We’ve had zero public exposure in real estate or it’s ancillary operations (MBS, Rents, Management, etc) since inception. After reviewing the performance of Fannie Mae, the calculated risk involved in an outright stock acquisition, was deemed a notable long-term play. This is one of the very few positions we’ve acquired on a majority anecdotal reference, though the numbers could certainly work in our favor, but more on that later.

Fannie Mae has been in conservatorship since 2008 and has no timeline as to when that may end. Part of it’s agreement with the Treasury department is that it sends back 90% of it’s net worth to Treasury until 2018, after which that will increase to 100%. This arrangement is steeped in strong political discourse from all directions, so we won’t get into how it all came about, or any rationale behind it. We weren’t there, and these are the operating conditions they abide by, creating a potential for opportunity down the road.

Getting into the numbers

FNMA showed strong performance in the previous year’s (2016) operations. Net income increased by 12% to just over $12B, though net revenues decreased by a marginal 2%. The credit quality of their single-family book of business has greatly improved since 2009, partly led by the age diversification of the portfolio (88% of the portfolio has been acquired post-2009.)

The dividend agreement between FNMA and Treasury is the most intriguing part of their operations, and to be quite frank, is the reason why we’ve made the acquisition that we have. Since entering conservatorship, FNMA has paid the treasury $154.4B in dividends, while drawing $116.1B in times of negative net worth realization. FNMA has not taken a draw since 2012 and does not appear to need anymore draws going forward. Operating for almost 10 years under such a structure has created a fiscally tight organization that could reap significant rewards if that sense of fiscal responsibility extends beyond the end of it’s conservatorship, though that is very uncertain.

The outlook

To be transparent, our acquisition of FNMA common stock is our smallest position to date, but we found it a calculated risk worth taking. Though, most calculated risks are moot when your time horizon is “forever” as we hope this to be. Due to a lack of liquidity and the nature of the beast, we forwent our traditional derivatives-based acquisition strategy and purchased the position over the past few weeks directly off the exchanges.

The longterm play is as follows… (again, we’re not getting into politics here, just analyzing an opportunity the current environment is providing.)

Steven Mnuchin has been a proponent of privatizing FNMA since before he entered public service. Though, yes, he is not the sole decider in this instance, he does have significant say in creating the policy framework that may lead to the end of it’s conservatorship. Administration officials aside, there has been a growing sentiment among Congress that FNMA should be removed from the government’s investment portfolio and placed back into the free market. The sentiment seems to continue towards this path of “normalcy” for the organization, and our position is indicative of our stance on the issue. Our thought being that once FNMA goes through the process of being released back into the marketplace with much more limited oversight, they would continue to operate under revised by-laws and operating procedures that create a positive net worth gain for itself and stakeholders. With a reduction in their dividend pay rate from 100% to 25-50%, that would create a net positive for all parties involved. Our strong belief is that FNMA will be taken out of conservatorship over the next 5-10 years (net positive to capital gains) and it will begin paying dividends to shareholders a maximum of 5 years after conservatorship ends (a net positive capital gain as well as a net increase to our total annual income.)

At the end of the day, we’re going long FNMA for the long-haul. Mixing politics and capitalism has always seemed to be a bit of a lightning rod, so our plan is to sit on our hands, and see how it all turns out!

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