Hey guys if you invest in preferred shares theres 50% annualized return on Fannie Mae and freddie Macs, so what do you think? green shoots everywhere! 
http://brontecapital.blogspot.com/2009/08/modelling-fannie-mae-and-freddie-mac_19.html
This is the money post. I put Parts I, II, III, IV and V together to come to the surprising conclusion that both Fannie and Freddie survive. This conclusion is highly-non-consensus and has substantial political and investment implications. Also I would like to thank FTAlphaville for linking to this series â most the rest of the blogosphere has been silent possibly because I disagree with their preconceptions/ideology. The comments on FTAlphaville reflect mainstream finance opinion â that Fannie and Freddie are irredeemably insolvent.
Putting the model together
We now have enough to do some basic modelling of Fannie Mae and Freddie Mac. I will do it for Freddie Mac only â and leave it to the more ambitious readers to do it for Fannie Mae.*
In the second post in this series I demonstrated how the losses that have been booked to date (rather than provisioned to date) have come primarily from outside the traditional guarantee book of business. Those losses are primarily mark-to-market losses on mortgage securities (especially subprime securities), mark to market losses on the hedge book and the write-off of tax assets.
None of those loss categories are going to expand â and indeed some will reverse.
In the fourth post I estimated the losses in the traditional guarantee book of business. I have asserted that the model is fairly robust (and will cover that in the next three posts) however I showed under quite reasonable assumption that there were $37.6 billion in losses to be realised at Freddie Mac at year end 2008. Since then $2.9 billion have been realised so there are $34.7 billion left to come.
Of these losses 25.2 billion have already been provided for. From now until when the problem-years of business loans run off Freddie will only need to take another 12.5 billion in provisions. They may elect to take more than $12.5 billion in provisions â but if they do and my models are reasonable â then in all likelihood the excess provisions will be reversed through the income statement.
Now if you go to the last Freddie Mac results you will see they have a positive net worth of $8.2 billion. However they owe the government $51.7 billion, as the government has injected $51.7 billion in senior preferred securities. They are thus $43.5 billion in the hole.
They will also â over time â take another $12.5 billion in provisions. So now, until all the problem years of business have run off, they will be $56 billion in capital short.
The Government can get its money back on their âinvestmentâ in Freddie Mac provided Freddie can earn more than $56 billion over a reasonable time period and meet the government interest charges.
This would be more certain if some of the losses described in Part II reversed. I am pretty sure that they will â but lets ignore them (until a later post). Pre-tax, pre-provision operating profits of Freddie Mac are running at over $15 billion. If the government were not demanding 10 percent on its preference shares the companies would be sufficiently well capitalised to repay their interest in 4 years. With the drag of having to pay the government $5 billion per annum it will take a bit over five years. Either way the operating profits of Freddie Mac are big enough to ensure the government gets its money back. If you do the same analysis for Fannie Mae its is even better. However Fannie has less aggressively marked private label securities to market so it has less chance of recoveries from their current marks. The consensus view that the GSEs are forever toast â and forever a drain on the US Government is very likely wrong.
http://brontecapital.blogspot.com/2009/08/modelling-fannie-mae-and-freddie-mac_19.html
This is the money post. I put Parts I, II, III, IV and V together to come to the surprising conclusion that both Fannie and Freddie survive. This conclusion is highly-non-consensus and has substantial political and investment implications. Also I would like to thank FTAlphaville for linking to this series â most the rest of the blogosphere has been silent possibly because I disagree with their preconceptions/ideology. The comments on FTAlphaville reflect mainstream finance opinion â that Fannie and Freddie are irredeemably insolvent.
Putting the model together
We now have enough to do some basic modelling of Fannie Mae and Freddie Mac. I will do it for Freddie Mac only â and leave it to the more ambitious readers to do it for Fannie Mae.*
In the second post in this series I demonstrated how the losses that have been booked to date (rather than provisioned to date) have come primarily from outside the traditional guarantee book of business. Those losses are primarily mark-to-market losses on mortgage securities (especially subprime securities), mark to market losses on the hedge book and the write-off of tax assets.
None of those loss categories are going to expand â and indeed some will reverse.
In the fourth post I estimated the losses in the traditional guarantee book of business. I have asserted that the model is fairly robust (and will cover that in the next three posts) however I showed under quite reasonable assumption that there were $37.6 billion in losses to be realised at Freddie Mac at year end 2008. Since then $2.9 billion have been realised so there are $34.7 billion left to come.
Of these losses 25.2 billion have already been provided for. From now until when the problem-years of business loans run off Freddie will only need to take another 12.5 billion in provisions. They may elect to take more than $12.5 billion in provisions â but if they do and my models are reasonable â then in all likelihood the excess provisions will be reversed through the income statement.
Now if you go to the last Freddie Mac results you will see they have a positive net worth of $8.2 billion. However they owe the government $51.7 billion, as the government has injected $51.7 billion in senior preferred securities. They are thus $43.5 billion in the hole.
They will also â over time â take another $12.5 billion in provisions. So now, until all the problem years of business have run off, they will be $56 billion in capital short.
The Government can get its money back on their âinvestmentâ in Freddie Mac provided Freddie can earn more than $56 billion over a reasonable time period and meet the government interest charges.
This would be more certain if some of the losses described in Part II reversed. I am pretty sure that they will â but lets ignore them (until a later post). Pre-tax, pre-provision operating profits of Freddie Mac are running at over $15 billion. If the government were not demanding 10 percent on its preference shares the companies would be sufficiently well capitalised to repay their interest in 4 years. With the drag of having to pay the government $5 billion per annum it will take a bit over five years. Either way the operating profits of Freddie Mac are big enough to ensure the government gets its money back. If you do the same analysis for Fannie Mae its is even better. However Fannie has less aggressively marked private label securities to market so it has less chance of recoveries from their current marks. The consensus view that the GSEs are forever toast â and forever a drain on the US Government is very likely wrong.