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Fairholme Capital Management LLC, a Miami-based equity fund manager, has recently declared its intention to acquire the insurance businesses of Freddie Mac (FNMA) and Fannie Mae (FMCC). The move forms part of the company’s plan to expand its business in the insurance sector. The deal will come in exchange of equities worth $52 billion to be issued by the fund manager.

Underlying the proposed plan, Fairholme Capital Management will exchange Fannie Mae and Freddie Mac preferred stock worth $34.6 billion. Additionally, the company will raise a sum of $17.3 billion from preferred stockholders and rights offerings.

We believe that apart from generating inorganic growth, the acquisition will have other benefits for Fairholme Capital Management as well. It is worth noting that Freddie Mac and Fannie Mae were troubled mortgage lenders that were bailed out by the government during the financial crisis and preferred stock worth $34.6 billion was floated in the market for the recovery.

Fairholme Capital Management is the largest holder of these preferred shares. However, the future of these shares seems uncertain as the government plans to liquidate Freddie Mac and Fannie Mae in the near future. Both Freddie Mac and Fannie Mae’s performances have improved after the financial crisis and therefore the preferred stock buybacks would actually result in lower profits for Fairholme Capital Management.

Hence, to prevent this, Fairholme Capital Management has proposed the aforementioned recapitalization program of converting the preferred stock into equities. This will be similar to the government’s planned liquidation program for Freddie Mac and Fannie Mae in the near future. Moreover, it will relieve the government from regular supervision of these firms.

The deal is subject to approval from the Federal Housing Finance Agency, U.S. Treasury Department and other investors in Fannie and Freddie.

At present, both Freddie Mac and Fannie Mae have a Zacks Rank #2 (Buy). Other financial services stocks with the same Zacks Rank include BankUnited, Inc. (BKU - Analyst Report) and Comerica, Inc. (CMA - Analyst Report).

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