The 2 Hour Analysis with Fannie Mae

Did it take 2 hours for investors to assimilate the potential upside in Fannie Mae thus creating a $.05 bid and $.10 ask in the January 2.50 Fannie Mae calls in early hour trading? Better yet, what potential upside am I even talking about? Some analysts believe the Fannie Mae equity is literally worth zero. So what drove the asking price (a 100% increase to the previous asking price of $.05) when the underlying Fannie Mae common shares were unchanged, as matter of fact down in early trading on November 2nd? As a holder of Fannie Mae calls, here is what I have to say.

Even though Fannie Mae is one of the most speculative plays out there considering its volatility and unusual volume trends, some very interesting news came out just last night and I believe the markets just picked up on that news, 2 hours after the opening bell, or when the asking price for those options doubled…

Recently, Fannie Mae got hammered down when an analyst downgraded the shares contending that it must be recapitalized to survive and even if it was rejuvenated, the amount FNM would owe would still be so great that still Fannie would not endure. However, just last night, there were some sparks. The Wall Street Journal stated how Goldman Sachs was attempting to buy near $1 billion of tax credits from Fannie Mae and that GS could gather other investors for the deal as well. I interpret that as ‘a lot more than $1 billion of tax credits’ could be picked up by GS and other investors. If such a deal was to happen, it would give a lot of needed relief to Fannie’s balance sheet. The only problem is that the government, being the controller of Fannie Mae, will not approve such a deal because it might not be in taxpayers’ interest and that it is enabling GS to cut its tax bill. My first thought is if the government owns Fannie Mae, doesn’t the ‘taxpayer’ theoretically own Fannie Mae therefore making it ridiculous for the government to block such a deal if it is good for Fannie Mae? Maybe it is too good for Goldman Sachs and therefore should not be approved because Wall Street is recovering better than Main Street? If that somewhat is the case, consider it absurd!

Anyways, back to these tax credits. Why would it be very good for Fannie if Goldman was to buy these besides the obvious point being that it would relieve Fannie of some financial distress? Well these ‘tax credits,’ or “low income housing tax credits” have been traded in a market where “observable transactions” have been curtailed. “There is decreased market demand for tax credit investments because there are fewer tax benefits derived from these investments by traditional investors, as these investors are currently projecting much lower levels of future profits than in previous years. This decreased demand has reduced the value of these investments.” – Page 23, Fannie Mae Form 10-Q for the quarterly period ended June 30, 2009

I think the 100% increase in the asking price for the January 2.50 calls is factoring in the probability that the government would approve such a deal and this decreased demand in ‘tax credits’ can very possibly be stabilized or increase if investors do want these tax credits. Goldman Sachs is expecting to win approval sometime this week, and if that is the case, Fannie could see significant upside. Keep in mind that FNM is again extremely volatile and is also reporting its 2009 3rd quarter results on November 4th – any surprises could send the stock flying. Also, I believe Goldman Sachs can convince the Obama Administration that this deal will benefit the ‘taxpayers’ as well.

Furthermore, Fannie Mae stated the following during their 2009 2nd quarter report: “Taking into account unrealized gains on available-for-sale securities during the second quarter and an adjustment to our deferred tax assets due to the new accounting guidance, the loss resulted in a net worth deficit of $10.6 billion as of June 30, 2009. As a result, on August 6, 2009, the Director of the Federal Housing Finance Agency (FHFA), which has been acting as our conservator since September 6, 2008, submitted a request for $10.7 billion from the U.S. Department of the Treasury on our behalf under the terms of the senior preferred stock purchase agreement between Fannie Mae and the Treasury in order to eliminate our net worth deficit. FHFA has requested that Treasury provide the funds on or prior to September 30, 2009.” This intertwines with the reason as to why Fannie Mae needs to be recapitalized.

But perhaps with Goldman (and other investors) seeking these tax credits and hopefully reaching a deal, it could offset the burden Fannie faces with its quest for $10.6 billion from the UST. And let us keep in mind that although many do argue government intervention has fueled this recent run-up in equities, we shall not forget the prosperity that comes with private capital.

I understand that Fannie Mae is a very non-ending, delicate, and tedious situation, that is why I encourage as much criticism and additional thought to this analysis as possible.