Bill Ackman and his fund Pershing Square Capital Management have built up quite a reputation over the past decades. So much so that Ackman is now considered one of the greatest investors ever. Between 2003 and 2021, Ackman generated an annualized return of 17.1%, easily beating the broader benchmark S&P500.
These types of returns have investors following Pershing’s every move. Interestingly, Ackman’s fund Pershing Square Holdings owns a 10% stake in two over-the-counter stocks. Although this move was made more than a decade ago, Pershing has maintained its position in these two stocks. Let’s see.
The case for Fannie Mae and Freddie Mac
In November 2013, Securities and Exchange Commission filings show that Pershing Square purchased a nearly 10% stake in the stock market. Federal National Mortgage Association (OTC: FNMA)known as Fannie Mae, and the Federal Home Loan Mortgage Company (OTC: FMCC)known as Freddie Mac.
Both Fannie and Freddie buy mortgages from banks and then hold them on their respective balance sheets or package them into mortgage-backed securities, which they typically sell to investors. You’ll find many banks purchasing mortgage-backed securities as an alternative to using cash to make loans. Fannie buys mortgages from larger banks and Freddie does the same for smaller banks. The two entities are an important part of the U.S. housing market because they allow banks to take mortgages off their balance sheets, thereby serving as a critical source of liquidity for lenders so they can make new loans.
Fannie and Freddie got into trouble during the Great Recession because they made too many subprime mortgages before the housing market crash, which eventually led to so much financial stress that the government had to bail out both companies and put them into receivership. The Treasury Department injected $187 billion of taxpayer money into the two companies in 2008 in exchange for senior preferred stock.
In the sixteen years since this happened, there has been enormous controversy over the fact that the two government-sponsored entities (GSEs) are still in receivership. In 2012, certain changes were made to the agreement between the GSEs and the Treasury Department, which essentially required all their profits to go to the Treasury after reaching a certain stock value. That ultimately led to Fannie and Freddie passing on more than $300 billion in profits to the Treasury at the end of 2019.
Shareholders, who have seen Fannie and Freddie’s stock prices plummet and not recover, are not happy. They would like the government to release the GSEs from receivership and recapitalize them. In 2019, under the Trump administration, the agreement between the GSEs and the Treasury Department was changed, and the two GSEs were allowed to retain profits instead of giving them to the Treasury. The purpose of the amendment was to allow the GSEs to build capital and ultimately exit conservatorship. The Federal Finance Housing Agency, the regulator of the GSE, ultimately set capital requirements for the GSEs, which together range somewhere between $250 billion and $300 billion.
The GSEs have started building capital quickly because they are large companies that can collectively generate between $15 billion and $20 billion in annual revenues. Fannie Mae’s total equity has increased from about $6.2 billion at the end of 2018 to nearly $86.5 billion in the second quarter of 2024. Freddie Mac recently surpassed $53 billion.
The problem is that Fannie and Freddie are still saddled with Treasury senior preferred stock worth a combined $193 billion, in addition to tens of billions in preferred stock and common stock. The Treasury Department also holds warrants that expire in 2028 and give the agency the right (but not the obligation) to purchase 79.9% of the outstanding common stock in both GSEs. In a 2020 report from the Congressional Budget Office (CBO), the agency said that if Fannie and Freddie are to be capitalized, the two GSEs would likely have to buy back the senior preferred stock and address the claims of existing shareholders.
A journey full of variables
Fannie and Freddie had a combined $140 billion in equity at the end of the second quarter of 2024, meaning they are in theory already halfway to the capital needed to exit conservatorship. However, they must figure out what to do with the senior preferred shares, the Treasury Department’s warrants and possible claims from other shareholders. It appears that a recapitalization would be quite difficult if the GSEs bought back the senior preferred stock and the Treasury Department also cashed in its warrants, so something may have to change in these agreements if a recap is made a priority by the government. Be that as it may, to recap, it would probably take a massive IPO – perhaps the largest ever – to bring the GSEs out of conservatorship without waiting at least another decade or two.
This process is also highly political. Former President Donald Trump was a strong supporter of the GSEs’ exit from conservatorship and began the process during his time in office, so if he wins the election, his administration could accelerate the process. But it is also entirely possible that the Kamala Harris administration or another administration will not make GSEs’ exit from conservatorship a priority in the future, and the process will drag on for many years.
Ackman hasn’t sold his position in more than a decade. In Pershing Square Holdings’ annual presentation in February, the company said it sees the reprivatization of the GSEs as an “opportunity” that could take some time. In a 2023 report, the company said it believes there are “political and economic reasons” to take the GSEs out of conservatorship, and cited a Trump re-election as a potential catalyst.
Ultimately, preferred and common stock will remain highly risky, given the level of uncertainty and the amount of capital required. So if you are a risk-averse investor, I would not make this investment. But if you’re interested, I think the junior preferred stock could be worth a small investment for investors with time on their side. I own some of the preferred shares in my retirement portfolio, which currently trade at about 18% of par value ($25). The common stocks have the most upside, but their path is the most uncertain and therefore carries the most risk.
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Bram Berkowitz holds a position in the Federal National Mortgage Association 8.25% Pref Shs Series S. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
Billionaire Investor Bill Ackman Holds a 10% Stake in 2 Over-the-Counter Stocks was originally published by The Motley Fool
