Carl Icahn Buys $50M in Fannie, Freddie Stock - Analyst Blog

According to a court document released by The Wall Street Journal and CNBC on Tuesday, Carl Icahn jumped on the bandwagon of investors who hold stakes in government sponsored enterprises (GSEs) – Fannie Mae FNMA and Freddie Mac FMCC. After this disclosure, shares of mortgage financiers – Fannie and Freddie gained 4.73% and 3.38%, respectively.

According to the court filing, Carl Icahn is the latest billionaire to invest in Freddie and Fannie. He bought common stock worth about $50 million in these two companies on Mar 11, from Fairholme Capital Management LLC, the mutual-fund company run by Bruce Berkowitz. However, following the sale, Fairholme still holds common stock worth around $141 million of the two firms as of Mar 31 and more than $1.4 billion worth of preferred shares.

Notably, Icahn purchased 6.8 million shares of Fannie at $4.03 per share and 5.7 million shares of Freddie at $4.04 per share. These dealings would provide Icahn about 0.6% of Fannie shares outstanding and 0.9% of Freddie shares.

The terms of the agreement were disclosed in Fairholme's new lawsuit filing against the U.S. government. Last year, Fairholme along with other investors of Fannie and Freddie sued the federal government alleging it of illegally depriving the common and preferred stockholders from companies' profit.

Notably, in Sep 2008, the government had taken over Fannie and Freddie in the wake of the housing market collapse. The companies were infused with around $188 billion of tax-payers' money. Initially, Fannie and Freddie were supposed to distribute 80% of the profits to the Treasury. However, in 2012, such a ruling was amended, requiring 100% distribution of the earnings to the government. Consequently, many shareholders filed lawsuits against the government and the Treasury against such a ruling. Further, such a move restricted the capital generation ability of these firms.

Last month, the Senate Banking Committee approved the bill supporting elimination of these two GSEs. Though the bipartisan bill received support from 13 of the 22 members of the Senate Committee, several Democrats and Republicans voted against it. Hence, with the lack of full support from the Democrats, the chances of legislation passing the full Senate are slim.

The bill to wind down Fannie Mae and Freddie Mac was framed by Republican Senator Mike Crapo and his Democratic colleague Tim Johnson. The main aim of the bill is to ensure that the taxpayers' money will not be at risk in case Fannie Mae and Freddie Mac require a bailout again.

Despite turning profitable and aiding in lowering the federal deficit (through significant dividend payments), Fannie and Freddie are still considered a risk to the government. Hence, the bill aims to shift the mortgage financing risk to the private sector.

At present, Fannie Mae and Freddie Mac own or guarantee nearly 60% of all the U.S. residential loans. These loans are then packaged into securities and sold to investors. Therefore, any plan to close them could again lead to a housing crisis as the U.S. economy is still struggling to recover fully.

Gradually, with recovery of the economy and the housing market, the firms managed to book profits. Notably, for first-quarter 2014, Fannie recorded net income of $5.3 billion, while Freddie posted net income of $4 billion.

Ackman, founder and CEO of hedge fund firm Pershing Square Capital Management LP, which has a 10% stake in these GSEs, strongly advocated the reform of the firms rather than a complete closure. Moreover, big profile investors such as Richard Perry of Perry Capital and John Paulson are also in the favor of reform of the two firms.

In order to revive the housing market, several proposals have been put forward. Apart from winding down Fannie and Freddie, these proposed reforms include capital infusion from the private sector and government guarantee for the mortgage-backed securities. However, failure on such propositions in the absence of Fannie Mae and Freddie Mac that possess a strong standing in the industry will be a significant risk to the economy.

Currently, both Fannie and Freddie carry a Zacks Rank #3 (Hold). Some better-ranked finance stocks include Home Loan Servicing Solutions, Ltd. HLSS and Orchid Island Capital, Inc. ORC. Both of these have a Zacks Rank #1 (Strong Buy).