There were two notable additions to Fairholme's (FAIRX) portfolio as of Nov. 30, 2013. One could have easily missed the fund's new positions in common shares in both Fannie Mae (FNMA) and Federal Home Loan Mortgage Corp. (FMCC), also known as "Freddie Mac." The two new positions in common shares in the agencies were just 1.1% of the November portfolio, but they signal manager Bruce Berkowitz's increasing confidence in his claim against the U.S. government and his belief that the shares won't be rendered worthless. Recall that Berkowitz is suing the government to restore the rights of preferred and common shareholders following the Treasury department's 2012 decision to send all profits to the government. Berkowitz's endeavor seemed quixotic at first, but last week, the judge on the case allowed Fairholme to continue with discovery.
This all began when Berkowitz built positions in Fannie and Freddie preferred shares last summer. (That combined position grew to 10.7% of the portfolio in November.) The preferreds offered a slightly less risky bet on the companies than the common shares because they're higher in the capital structure. But the bet still looked extremely speculative given the government's stated intention to wind down the companies in the housing crisis aftermath.
Both Fannie and Freddie have recovered along with the housing market and will soon have more than repaid the $188 billion they received in a government bailout. Meanwhile, Berkowitz sent letters to the boards of the two companies last Friday exhorting them to honor their fiduciary duty to shareholders. The ultimate outcome of all this remains highly uncertain, but Berkowitz's argument seems to be gaining some traction.
Kevin McDevitt, CFA does not own shares in any of the securities mentioned above.