Sunday, February 12, 2017

Fannie Mae valuation

Future common share price = future earnings available to common shareholders multiplied by P/E multiple divided by number of shares outstanding 

Tim Howard's FNMA estimate = $9.3B x 10 / 1.158 = $80 per share (undiluted)
Ackman's FNMA estimate = $10B x 14 / 5.79 = $24 per share (warrants exercised)
(Ackman's FMCC estimate = $5B  x 14 / 3.21 = $22 per share)

Ackman's plan is for FNMA to build up $79B (2.5% capital ratio) through retained earnings only.  Tim Howard's plan is for FNMA to build up $70B (2% single family; 3% multi-family; 2% for interest rate risk).  I do not believe that it will be politically viable to wait 8 years to build capital to these levels.  I believe that there will be an equity issuance to raise capital and that equity cannot be raised without cancelling all of the warrants.  It is hard to estimate the amount of share dilution that an equity issuance will cause, but I estimate that Tim Howard's estimate would be knocked down to $16 to $40 per share.

"There’s one final wrinkle I’ll just touch on here. As of September 30, 2016, Fannie had $22.5 billion in its loan loss allowance. That’s capital. But $21.3 billion of that is tied up in “life on loan” reserves on loans that were modified pursuant to Treasury’s mandatory Home Affordable Mortgage Program (HAMP). The vast majority of these HAMP reserves are against loans that are now performing, but the accounting rules require that the loss reserves be maintained until the loans either amortize or are paid off. If I were at Fannie—and searching for a way to reach full capitalization as quickly as we could—I would look very hard at ways to free up as much of that “regulatorily immobilized” capital as I could. Any amounts of loss reserves moved from the “individually impaired” to the “collectively reserved” category would reduce the amount of the equity capital the company would need to raise." - Tim Howard

Note: Proposed reductions in corporate tax rates would increase earnings, but DTA's would also have to be written down and capital would have to be raised (new corporate tax rate of 20% would cause a $15B write down of DTA's for FNMA & $8B for FMCC).

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