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A quick recap

The SPS is one of the most contentious and confusing aspects of the investment case for Fannie Mae and Freddie Mac.

In September 2008, Treasury put Fannie and Freddie into conservatorship and signed the Preferred Stock Purchase Agreements. In return for an unlimited backstop, it received non-voting senior preferred stock in each GSE plus warrants to buy 79.9% of the common at a nominal price, expiring September 7, 2028.

The GSEs drew a combined $193 billion between 2008 and 2012. That amount was added straight to the liquidation preference. Treasury was owed 10% annual dividends on the outstanding balance (12% if missed). The GSE’s were forced to mark losses to market via (unfair and unrealistic) loss provisions. Under that strain, they could not reliably pay dividends on the SPS amount. But the losses never materialized, and just as the companies were about to reverse the accounting provisions, and thereby repay Treasury in full (with interest), the government unilaterally amended the PSPA to sweep of every dollar of net worth above a tiny reserve. That’s the Net Worth Sweep.

Under this shameful agreement, Fannie and Freddie have sent Treasury roughly $301 billion. Yet the SPS liquidation preference never shrank. Instead if grew. As of Q1 2026, Fannie’s stands at $230.5 billion, Freddie’s at $143 billion. Combined: $373.5 billion. The CBO sees it climbing toward $400 billion by year-end as commitment fees keep accruing.

The paradox is obvious. They paid back more than they borrowed, with interest, but Treasury’s contractual claim is larger today than when the checks first went out.

**Note: I know this has glossed over many details on the Net Worth Sweep. But it will have to suffice for the purposes of this article.

The Money Arithmetic

Bill Ackman and Pershing Square laid this out in November 2025. The numbers hold up better than the critics admit.

Under the original PSPA, Treasury was entitled to 10% dividends on the outstanding liquidation preference. Run the actual $193 billion draws through a timing-adjusted 10% calculation and you get roughly $276 billion in total contractual dividends owed. The GSEs have paid $301 billion—about $25 billion more than the deal required. That works out to an internal rate of return for Treasury of roughly 11.6%.

Ackman’s core point: the economic substance of the investment has been satisfied. The government took real risk when it mattered most and collected more than the agreed return. The $373.5 billion liquidation preference is a legal artifact of how preferred equity works in that dividends don’t reduce principal, and the LP was designed to grow, not shrink. The Net Worth Sweep itself is Exhibit A: without the 2012 amendment, normal dividend mechanics might have allowed a repayment path; instead, the sweep extracted every available dollar.

By any normal investment metric, Treasury got its money back plus a solid return. But the instrument is preferred equity, not a loan. The contract doesn’t contain a repayment mechanism that reduces the LP when dividends are paid. Unfortunately for shareholders, both realities can coexist: taxpayers were made more than whole on an economic basis, and Treasury still holds a $373.5 billion contractual claim. This has been upheld by the courts despite considerable efforts to fight it. Resolving this claim is a political and administrative call. Neither Congress or the courts will help.

The Five Possible Paths to Resolution

There’s no single button. Here are the five plausible structures, each with different effects on the capital stack, the budget, investors, and the mortgage market.

1. Administrative PSPA amendment (Ackman-style “deemed repaid”): Treasury and FHFA amend the agreements to declare the SPS economically satisfied and zero out (or nominalize) the entire liquidation preference. No new legislation needed. Then exercise the warrants for 79.9% of the common on a fully diluted basis. Treasury ends up owning exactly 79.9% of the common equity; existing common holders retain 20.1%. Cleanest path for relisting.

2. Full LP-to-equity conversion: Amend the PSPA to convert the entire $373.5 billion LP directly into new common shares at a negotiated price per share. Combined with warrant exercise, this would push Treasury’s ownership well above 80%—likely 90–95%+ depending on the conversion ratio and enterprise value. Massive dilution for everyone else.

3. LP-to-debt conversion: Turn the SPS claim into long-dated GSE bonds. Moves it out of the equity stack and helps with ERCF capital treatment, but adds leverage and doesn’t fully clean the structure.

4. Guarantee fee / explicit backstop: Cancel the SPS in exchange for an ongoing annual guarantee fee on agency MBS. Mirrors the Ginnie Mae model—explicit, priced government backing.

5. Hybrid (partial forgiveness/restructuring + warrant exercise + residual SPS): Forgive or restructure a portion of the LP (say, the economic “excess” plus some negotiated amount), exercise the warrants for the 79.9% stake, and leave a reduced residual SPS on the books (perhaps $150–250 billion after partial write-down/conversion). Treasury secures dominant but not total ownership.

Paths 1-3 and 5 are feasible without Congress, though PAYGO budget scoring is a practical hurdle. The guarantee-fee route almost certainly needs legislation. The Hybrid path depends heavily on the terms “negotiated” (in quotation marks since the government will negotiate with itself on this one).

A quick note on how the Hybrid and Deemed Repaid Paths Compare

Importantly, the Trump administration’s “North Star” in this process are (1) reducing mortgage rates (or at least not making changes that increase them) and (2) achieving an IPO of Fannie and Freddie. As such, the “Pure Repaid” vs. “Hybrid” path decision matters greatly.

• Pure Deemed Repaid (Ackman proposal): The entire $373.5 billion LP is extinguished to zero or nominal. No residual senior claim remains. The Net Worth Sweep ends completely. Treasury exercises the warrants and owns exactly 79.9% of the common; existing common keeps 20.1%. The balance sheet is clean—no ongoing dividend priority ahead of private shareholders. This maximizes enterprise value (higher trading multiples because public investors see a true privatization story), supports faster capital deployment, and makes a successful NYSE relisting far easier. It also aligns cleanly with lower mortgage rates: no overhang means the GSEs can operate with stronger perceived stability, potentially allowing g-fee relief without spooking MBS markets. Key Downside: larger upfront budget scoring hit.

• Hybrid Path: A chunk of the LP (roughly $100–150 billion, starting with the IRR excess) gets forgiven or restructured. Another slice may convert to debt or equity. But a meaningful residual SPS stays on the books at a reduced level, still senior to both junior preferreds and common, with a modified dividend or accrual obligation (e.g., 10% or lower on the smaller balance). Treasury still exercises the warrants for its 79.9% common stake; existing common keeps the same 20.1% post-dilution. The companies must continue servicing that residual SPS first, which forces heavier earnings retention on top of ERCF requirements. Result: delayed or minimal dividends to junior preferred and common for years, a valuation drag (public investors discount the stock for the lingering senior claim), and slightly messier IPO optics. It does offer better political cover and a smaller budget score, but it complicates the IPO goal and could subtly weigh on MBS pricing if markets see incomplete resolution.

In short, the deemed-repaid path delivers the cleanest capital structure for a high-quality IPO and the strongest support for lower housing costs. The hybrid trades some of that cleanliness for easier politics and scoring. The major question would be how much does President Trump care about politics and budget scoring?

The Ackman Path: Administrative Amendment

In my opinion, this remains the cleanest, fastest option. Amend the PSPA (the sixth time) to acknowledge the SPS as satisfied, zero the LP, exercise the warrants, and relist. Treasury walks away with 79.9% of the common in two much stronger companies.

Why taxpayers should like “deemed repaid”: instead of clinging to an illiquid $373 billion LP claim of uncertain collectability, Treasury gets roughly 80% of a relisted, growing enterprise that analysts peg at $300–400 billion combined enterprise value (potentially higher once the overhang is gone and ERCF revisions take hold). That equity stake could easily be worth $240–320 billion in market value, with upside from future sales or dividends. Full conversion to 100% ownership would essentially nationalize the firms, crush private-market discipline, tank valuation multiples, invite more litigation, and look politically radioactive. Eighty percent is already ironclad control without those downsides. The warrant expires September 7, 2028. Technically Treasury could unilaterally change the deadline, but why should they when a clearer and simpler path is in front of them.

Other paths that require Congress to act are non-starters. Congress has not acted on this issue for going on 18 years and is unlikely to start now.

My thesis: the SPS gets resolved via the “deemed repaid” path because this is how Treasury can best satisfy their own stated priorities: lowering mortgage rates and housing finance costs while delivering a credible IPO and conservatorship exit.

The IRR math is real and publicly defensible. The Net Worth Sweep extracted more cash than the original terms contemplated. The warrant clock is ticking. The ERCF revision running in parallel removes the old capital-gap excuse. And this Trump administration is the most privatization-minded since the conservatorship began.

…But there are significant, and very real, challenges

There are legitimate challenges to the “deemed repaid” path that investors should be aware of.

First, the SPS was never structured as a loan. It’s preferred equity. Dividends don’t reduce principal by design. Legally, Treasury can’t just declare it “repaid” without an amendment that survives scrutiny [Note: they are negotiating with themselves, so they it has to survive their own scrutiny…if that makes any sense]

Second, budget scoring would sting. CBO/OMB might treat extinguishing $373 billion as a large one-time cost, triggering PAYGO issues. However, it is unclear how much the Trump administration would prioritize this consideration. [Note: the appointment of Marc Calabria to OMB, where he serves as Associate Director for Treasury, Housing and Commerce will almost certainly make this an issue]

Third, litigation risks from JPS holders. Cancelling the LP (SPS deemed repaid) moves them up the capital stack and materially improves their odds of par recovery as well as dividend reactivation. But they could still sue if Treasury’s PSPA amendment to deem SPS repaid funnels value straight to Treasury’s warrants/commons without explicit priority for JPS.

Fourth, optics about “bailing out hedge funds” is real. But I suspect the Trump administration does not have this very high on their priority list.

What to watch for in the coming months

• FHFA’s July 2026 report: concrete language on SPS treatment under capital reform is a strong signal

• Public comments from Secretary Bessent or Director Pulte on the IRR math, “taxpayers made whole,” or IPO timing

• Any OMB/Treasury signals on budget scoring for PSPA changes

• Warrant-exercise authorization

• Litigation settlements or congressional noise on explicit guarantees

I have long advocated for the SPS being deemed repaid…

To me, the “SPS deemed repaid” thesis is the most compelling and contested idea in the GSE trade. The economics are real, the administrative tools exist, the clock is ticking, and the administration’s own priorities of lower mortgage rates and a successful IPO/end to conservatorship now point strongly toward the cleanest resolution possible.

I expect a structured sixth PSPA amendment that extinguishes the vast majority (or all) of the LP, exercises the warrants for Treasury’s 79.9% common stake, and sets up a clean transition out of full conservatorship. Any hybrid elements would be engineered with a minimal or rapidly vanishing residual SPS to avoid undermining the IPO or rate goals. To the extent that the “explicit-guarantee” approach is tried, it will be handed to Congress to run in parallel. More likely, it gets quietly dropped.

By deeming SPS repaid and extinguishing the LP, Treasury gets a story it can defend, materially improves JPS recovery odds (cleaner waterfall, closed capital gap), dilutes common via the warrant (as always expected), leaves MBS and senior debt largely untouched, and hands taxpayers 80% of two growing companies rather than a stale LP claim.

…but the trade remains binary on the PSPA terms

Watch for language on an ERCF revision. This is likely to be the first major signal that Fannie and Freddie will exit conservatorship before the end of President Trump’s term.

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Over the last few quarterly updates, a curious re-framing of capital levels has not gone unnoticed. For instance, see the quote below from Freddie Mac CFO Jim Whitlinger’s prepared remarks

"Excluding buffers, our capital shortfall was $105 billion at the end of the first quarter, largely because the $73 billion of Senior Preferred Stock does not qualify as regulatory capital."

Read that again. He is saying that, as a technical matter, if its $73 billion of Senior Preferred Stock (SPS) qualified as regulatory capital their capital shortfall (excluding buffers) would collapse from $105 billion to roughly $32 billion. And that is against the current, unreformed ERCF. Pair that with a revised ERCF and the math shifts dramatically. [Note: Treasury’s SPS does not meet the ERCF’s Basel III-aligned capital definition, and we will return to this later]

In my previous article A golden window of opportunity for Fannie Mae and Freddie Mac I outlined why the Fed’s recent capital rule changes for MBS represented a big opportunity for FHFA to revise the ERCF. It makes no sense for the GSEs to have capital requirements more punitive than banks for the same underlying asset class. A simple harmonization of ERCF to make it consistent with the new regime is a clearly logical step.

Since this article, there have been some new developments. Largely, and surprisingly, unnoticed by most investors in Fannie Mae and Freddie Mac. Three things are now in motion simultaneously: Trump’s March 2026 executive order directed FHFA to revise capital requirements. The Fed/OCC/FDIC published 1,500 pages of proposed banking capital reforms on March 19. And the SPS acting as a giant pain in the capital stack. This last point is increasingly being framed by both the companies themselves as an obstacle to be dissolved, not managed around. These positions, taken by executives at both GSEs, would have been unthinkable under previous administrations (including Trump’s first term).

If all three resolve, both GSEs could technically exit conservatorship the day the ERCF final rule takes effect. No waiting. No IPO required to fill a capital hole. The timeline moves becomes very feasible within President Trump’s current term.

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The Regulatory Chain Reaction begins…

1. The Executive Order

On March 13, 2026, Trump signed ‘Promoting Access to Mortgage Credit,’ a housing affordability-focused EO that, for our purposes, does two specific things. It tells the Fed, FDIC, OCC, and NCUA to revise capital regulations for banks which includes risk weights on portfolio mortgages, mortgage servicing rights, and warehouse lines. And it tells FHFA to consider revising capital requirements and to submit a report within 120 days recommending changes.

The 120-day clock expires mid-July 2026. That report is the first hard milestone in the ERCF revision story, and the market will parse every word of it.

The underlying logic is straightforward: GSE guarantee fee pricing is a direct function of capital requirements. When the Biden administration implemented the ERCF in its g-fee pricing in 2022, average fees jumped 7–10 basis points overnight — from the 45-48 bps range to roughly 55 bps. The GSE share of new mortgage originations has declined every year since, hitting 37.6% in 2025, the lowest in nearly two decades. The administration’s position is that this outcome is incompatible with its stated goal of making mortgages affordable. The EO is the opening bid on reversing it.

2. The Banking Capital Overhaul

On March 19, only six days after the EO, the Fed, OCC, and FDIC jointly released the most significant recalibration of U.S. bank capital requirements since the post-crisis reforms. Three separate NPRMs, spanning 1,500 pages, with comments due June 18. The relevant provisions:

• — LTV-based tiering for residential mortgage risk weights, replacing the flat 50% standard weight. Lower-LTV loans get meaningfully lower charges.

• — The securitization risk weight floor drops from 20% to 15%, reducing capital charges on agency MBS holdings at banks.

• — Mortgage servicing asset capital deductions are replaced with a flat 250% risk weight — a net improvement for most community banks.

• — Overall bank capital requirements decrease modestly across the board, with larger cuts for smaller, more traditional lending-focused institutions.

The direction is unambiguous. The agencies are explicitly trying to ease credit conditions in the mortgage market. And here’s the problem that creates for the ERCF: the ERCF was designed to mirror the ‘advanced approaches’ framework used by the largest U.S. banks. If the banking framework those requirements were anchored to is now being revised downward, maintaining an ERCF calibrated to the old, more conservative version is analytically incoherent.The GSEs would be required to hold capital against the same credit risks at a higher rate than the banks who buy their paper. That cannot stand, and the EO signals that Washington knows it.

Independent analysis at the time the ERCF was adopted estimated that actual capital needed for safety and soundness, based on Fannie’s and Freddie’s own stress test results, was $120-135 billion combined. The ERCF demanded $312 billion, or a whopping 2.4x what the stress tests indicated. Since then, both companies’ stress test results have improved materially.

3. The Capital Math

Now, using yesterday’s actual Q1 2026 numbers, here’s what the capital picture looks like across four dimensions: current ERCF requirements, the SPS deduction, the effect of a revised ERCF, and where each enterprise lands if you combine both.

Lets walk through the figures in the above table. Fannie Mae’s adjusted total regulatory capital deficit was approximately -$18 billion at Q1 2026 (vs. total requirement, including buffers, of around $205 billion). That looks daunting. But that -$18B figure is almost entirely the result of one thing: the $120.8 billion of SPS on Fannie’s balance sheet is subtracted from regulatory capital because Treasury’s preferred doesn’t meet the ERCF’s qualifying capital definition.

Treasury deeming the SPS repaid changes picture dramatically. Fannie’s ERCF-qualifying capital jumps to approximately $103 billion. Against a revised ERCF requirement in the $88–112 billion range, Fannie is at or near compliance right now. Not in five years. Right now.

Freddie’s picture is almost identical in structure, if somewhat tighter in the numbers. As CFO Whitlinger stated on yesterday’s call, the $73 billion SPS is “largely” responsible for the $105 billion capital shortfall (excluding buffers). Remove that deduction, and Freddie’s qualifying capital becomes approximately $69 billion. Against a revised ERCF minimum (excluding buffers) in the $47–60 billion range, Freddie meets minimum requirements immediately. It would still need to build into full buffer compliance of roughly $6–26 billion depending on the revised calibration. At a current run-rate of $3.6 billion quarterly earnings, this puts Freddie Mac on pace to close the gap within 1–2 years.

The combined run rate is $7.3 billion per quarter — $29.2 billion annualized. Any remaining buffer gap after a revised ERCF + SPS resolution closes within a few quarters. Not years. Quarters.

A plausible timeline emerges…

Revising the ERCF requires a formal APA notice-and-comment rulemaking that includes a proposed rule, comment period and a final rule. The July 2026 report is not the rule; it’s the preview. The most realistic sequencing from there: proposed rule in Q3 2026, comment period through late 2026, final rule in H1 2027. That timeline lands the ERCF final rule in the same window where PSPA resolution discussions will be at their most advanced. The two processes are running in parallel, not sequentially.

A note of caution: Treasury’s SPS decision is a wildcard

I have long advocated that the simplest and most logical solution for Treasury to deal with their SPS is to simply recognize past dividend payments and deem it repaid. But investors need to be clear eyed that this is uncertain. There have been no indications from Treasury as to their preferred course of action, and this remains the single biggest risk to the timeline above and to shareholders in the companies.

I will do a follow-up article going into the details of what Treasury could do with their SPS in a subsequent article. Suffice to say, if you believe that the SPS being deemed repaid is a likely path, then the recent Executive Order and Fed Capital Rule changes mark a significant milestone. One way or another, investors won’t need to wait long - Q2 2026 could herald a major signal for whether Fannie Mae and Freddie Mac exit conservatorship during President Trump’s current term.

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On March 19, 2026, the Federal Reserve, FDIC, and OCC took a major step toward reshaping U.S. banking regulation. In a coordinated set of proposals, the agencies outlined revisions to the U.S. Standardized Approach and an expanded risk-based approach for larger banks. The changes are explicitly designed to be more risk-sensitive and less punitive than the 2023 Basel III endgame proposal, particularly for traditional lending activities like residential mortgages and mortgage servicing. Overall, large banks could see capital requirements fall by approximately 4.8 percent, with midsize institutions benefiting from a 5.2 percent reduction and smaller banks up to 7.8 percent.

The driving rationale, as articulated by Fed officials and echoed in coverage including The Wall Street Journal, is to reverse the migration of mortgage origination, holding, and servicing out of the regulated banking system into nonbanks and GSEs. By making on-balance-sheet mortgage activity more capital-efficient, regulators hope to broaden participation, improve liquidity, and support housing access without compromising safety.

This article takes a deep dive into these proposals, with a sharp focus on the mortgage-specific provisions. It then compares them to the far more conservative Enterprise Regulatory Capital Framework that governs Fannie Mae and Freddie Mac. Finally, it explores the central hypothetical:

• What if FHFA rewrote the ERCF to mirror the new bank rules exactly?

• How much capital would each GSE actually need?

• How does that compare to their current GAAP net worth?

• And, assuming the senior preferred stock held by Treasury is deemed repaid through administrative or legislative action, how quickly could the Enterprises exit the seventeen-year-old conservatorship?

All figures are drawn from the GSEs’ official disclosures, the agencies’ March 19 proposals, and contemporaneous analyses. While no such alignment has been proposed or announced, the potential for it is a golden opportunity for FHFA (Fannie and Freddie’s regulator) to finally get the ball moving on returning these two financial giants to public markets.

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This was the second major announcement about Fannie Mae and Freddie Mac in the last two weeks, and investors should take note of the change in tone. In the first announcement, President Trump said “I am giving very serious consideration to brining Fannie Mae and Freddie Mac public…and will be making a decision in the near future”. Now note the above post: “I am working on taking these amazing companies public”. In other words - President Trump’s decision has been made and the conservatorships will end on his watch (i.e. by the end of 2028). I didn’t expect my previous analysis to get validated so quickly, but I’ll take it.

Now the major questions become (1) What needs to happen to achieve President Trump’s objectives? and (2) How much are Fannie Mae and Freddie Mac worth?

I’ll address these questions in reverse order, with this article focusing on updating my price targets. I build on my prior content and cover valuation methodology (including a review of Pershing Square’s methodology), shareholder dilution and my price targets for Fannie Mae and Freddie Mac. The details are behind a paywall (paid subscribers can continue reading). Suffice to say, the shares are up ~600% in the last 12 months and I think they still have massive upside potential. Free subscribers should consider upgrading to paid for this one - the potential upside on these stocks is huge. It might be the single best investing decision you’ll make.

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Yet these companies have been in under government conservatorship for 17 years (a consequence of the Great Financial Crisis in 2007-2009). As a result, they trade Over-The-Counter, lost among the wilderness of penny stocks. President Trump came to office in 2016 with the aim of ending their government conservatorship and restoring them to private market glory. But he ran short of time as the companies had virtually no capital on their books, and needed years to build this up. Their penny stock status remained. In 2020, the Biden administration had no interest in dealing with the future of these firms. The upshot: Fannie Mae and Freddie Mac continued to build capital…lots of it…and almost nobody was paying attention. I wrote my first buy-side research article on these firms back in January. These were deep dive reports covering the detailed histories, financials and valuations of the companies. I asserted that as they continued to build capital, the probability of exiting conservatorship increased and so to did the anticipated share values.

Trump returned to office with these companies in a much stronger position than in his first term. Then, last week, President Trump posted that he was seriously thinking of ending the conservatorships. This single message sent the shares up >50% in one day !

With this single post, President Trump has massively increased the odds that the conservatorships will end before he leaves office in 2028.

So I think this is a great time to revisit my previous deep dive on Fannie Mae ($FNMA) and Freddie Mac ($FMCC), including my valuation models and price targets. I will do this in two parts. The first part (this post) will cover why I think both companies can accumulate enough capital via retained earnings alone to exit conservatorship. This is a critical achievement, as it means additional shareholder dilution (in excess of the outstanding government warrants) is less likely. In Part 2, I will review my valuation model and price targets and comment on the price target from Pershing Square (Bill Ackman’s hedge fund). The details are behind a paywall (paid subscribers can continue reading). Suffice to say, the shares are up ~600% in the last 12 months and I think they still have massive upside potential. Free subscribers should consider upgrading to paid for this one - the potential upside on these stocks is huge. It might be the single best investing decision you’ll make.

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One month ago I released a presentation / podcast on Applied Materials (trading symbol $AMAT). They are one of the largest suppliers of tools and equipment needed to manufacture semiconductors. Its a cyclical business and I had argued that we were nearing (but not at) the bottom of a cycle and that long-term investors could benefit tremendously during the next bull run.

In fact, I had a pretty optimistic price target of $292-$330 per share (90% to 110% upside) to be hit in the next 36 months [see slide below]

Although I did mention emerging risks from tariffs and geopolitics, I largely ignored these in my valuation as I thought most of the risks were manageable. Export controls had already been put in place and had worked their …

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In other words, investors with a long-term horizon can find very high quality businesses in a secular growth industry trading at reasonable or attractive prices. My previous presentation covered Applied Materials $AMAT. KLA Corp ($KLAC) is a similar company, but one that specializes in a niche of “inspection and metrology” equipment. These are the tools that inspect and detect defects during the production process and are mission-critical for ensuring semiconductor production efficiency. By some estimates, KLA has ~50% market share in this specialized space and enjoys entrenched customer relationships and very high…

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What does KLA Corp do?

In brief, KLA Corp occupies a highly specialized niche in the semiconductor manufacturing equipment space. Their products are mission-critical for inspection and metrology (i.e. the tools required to check and measure things at key stages of manufacturing).

They are divided into 3 business segments:

1. Semiconductor Process Control (~80-85% of revenue): consi…

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Applied Materials is a global leader in semiconductor equipment. In other words, they make the tools that make semiconductors. When you hear about companies like NVIDIA in the news, they contract out the manufacturing of their semiconductors to “contract manufacturers”. These companies use the tools supplied by Applied Materials to make the chips. This is a highly technical and complex engineering process, requiring AMAT to be embedded with chip manufacturers at each phase of the manufacturing process.

In other words, AMAT is very hard to replace and they are very good at what they do. By some estimates, they have ~40% of the total global installed base for semiconductor production equipment (that comes with a very lucrative services business as well). Some quick figures:

• Q1 2025 revenue: $7.2 billion

• Gross Margins: 49%

• Operating Margins: 30.6%

Let that sink in for a moment. Here we have a US based B2B manufacturer of industrial tools – and they have operating margins over 30%. Clearly, they have pricing power and a technological edge that acts as a serious barrier to entry in their markets. Over the past decade, its stock has compounded at 21% annually, despite the recent pullback. Those are some serious returns.

And the company has never been as financially strong as today.

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Measuring Texas Pacific Land Corp’s Operating and Financial Health

Texas Pacific Land Corp. (TPL) has built its financial strength on a highly efficient business model, deriving income from royalties on its land without directly engaging in oil and gas production. This asset-light approach, with minimal capital expenditures, allows TPL to capture revenue at multiple stages of an oil and gas well's lifecycle. To evaluate TPL’s financial performance, we focus on key metrics tailored to its distinctive operations, such as royalty revenue growth, yield per acre, royalty coverage ratio, and free cash flow per share. These indicators illustrate not only the company’s historical success but also its ability to deliver long-term shareholder value.

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Recent reporting from Nikkei Asia has put Hong Kong Dollar peg squarely in the headlines – and potentially in question. While the peg's defenders cite substantial reserves and institutional resilience, the concerns raised about its long-term viability are getting much harder to ignore.

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A Shield or a Shackle?

The Hong Kong Monetary Authority (HKMA) asserts that the peg remains essential for stability, and with $420 billion in foreign reserves, it seems well-equipped to defend it. Although reserves have declined from their peak in 2021, they claim there is no immediate cause for panic.

Yet, as the Nikkei Asia reports, this drop has raised questions about how much longer Hong Kong can rely on these buffers to sustain its currency linkage. This has become especially true as Hong Kong authorities have begun publicly discussing the sensibility of linking to the USD versus the Chinese RMB. Their premise: Hong Kong’s economy is more closely tied to China and the recent divergence in USD and RMB currencies has hurt Hong Kong’s economic prospects. For example, they cite higher borrowing costs in Hong Kong versus mainland China and dampening retail activity in Hong Kong as residents travel across the border to shop in China instead.

The pressure is building

Two scenarios are quietly adding pressure (1) potential US sanctions on China could upend the Hong Kong monetary system; (2) a gradual integration and usage of the Chinese RMB in Hong Kong could erode the HKD.

Sanctions are a possibility, but the issue triggering those sanctions would have to be quite severe for the US to go after a major conduit for USD funding in China.

The second scenario is likely to happen eventually in preparation for discontinuing the HKD [See my previous article on the HKD peg]. But it is unlikely to happen “naturally”. Right now, Hong Kong residents have no incentive to use the Chinese RMB. In fact, its the opposite – they get more for their money when they shop in China. Improved transit links mean residents can be in Shenzhen in under 30 minutes where their HKD goes much further than the local currency. For those that can get paid in HKD, but incur living expenses in RMB, they are feeling a “wealth effect” of their relatively strong currency. I suspect this wealth effect is quite popular. The Chinese RMB will eventually become more prominent in Hong Kong – but by government mandate, not market sentiment.

But do residents even have to know which scenario they face or when it could come? The incentive to convert to USD and transfer it out of Hong Kong is increasing rapidly. In fact, Nikkei Asia interviewed a Hong Kong based portfolio manager doing precisely that.

A Hong Kong-based portfolio manager at a China state-owned bank said he has been converting local currency into U.S. dollars, and putting those in several banks including a U.S. one. The manager, who declined to be named, cited concerns over accessing dollars saved in a local bank if it is cut off from SWIFT, the dominant global payments system that is partly overseen by the Fed.

Hong Kong authorities should dread this. I suspect finance professionals and portfolio managers are already “hedging their bets” and that the race for the exits has slowly begun. Whether the trigger is concern over potential sanctions, HKMA policy shift or the eventual end of “one country, two systems” is irrelevant for those holding their wealth in HKD. I return to the question of my first article: Is a HKD currency crisis inevitable? The HKD may seem stable for now, but it seems confidence is eroding.

Texas Pacific Land Corp. ($TPL) stands as one of the most intriguing and unconventional success stories in American business. Tracing its origins back to the 19th century, TPL emerged from the ashes of the Texas and Pacific Railway’s bankruptcy, inheriting vast swathes of undeveloped land and mineral rights that nobody foresaw would become extraordinarily valuable. Over the decades, what began as an effort to liquidate land assets transformed into a thriving enterprise, capitalizing on the rich natural resources beneath its holdings.

The numbers alone highlight TPL’s remarkable ascent. In 2024, the company’s value skyrocketed by an astounding 185%. Over the past five years, it delivered a return of 435%, while its ten-year performance stands at an eye-popping 3,750%. These are growth figures more commonly associated with disruptive tech startups, not a century-old entity originally tasked with selling land to pay off creditors. Yet, TPL has defied expectations at every turn, proving itself a paragon of resilience and adaptability.

This report delves into the historical evolution of TPL, examining its journey from a relic of railroad history to a major player in land and mineral rights management. It provides an in-depth exploration of the company’s unique business model, financial performance, and long-term growth prospects. Whether you’re an investor or simply curious about one of America’s most fascinating corporate transformations, this analysis offers a comprehensive overview of TPL’s legacy and future potential.

The story begins with a bankrupt railroad…

The Texas and Pacific Railroad Company was chartered by federal act in 1871, with the Texas legislature granting permissions to consolidate several railroad companies and expand the rail network. Rail was the primary mode of transportation during a construction boom, facilitating commerce and population growth across the vast American West. The model of granting land to railroad companies for building infrastructure was a bold strategy aimed at accelerating development while offsetting costs. By the late 19th century, these grants were among the largest land giveaways in U.S. history, and the railroads became both transportation enterprises and some of the largest landholders in the nation.

However, the optimism was short-lived. In 1888, a series of natural disasters—including a devastating flood in Louisiana and crop failures from a Texas drought—pushed the Texas and Pacific Railroad into bankruptcy. During bankruptcy proceedings, the courts converted more than 3.5 million acres of the company’s land holdings into a new entity, the Texas Pacific Land Trust. Bondholders received shares in this trust, and its trustees were tasked with selling the land to repay debts. And so began one of the longest bankruptcy liquidations in American history. Interestingly, the trust persisted for decades, as demand for this remote and undeveloped land was very slow to materialize.

The slow pace of land sales, and general lack of interest in the land portfolio, frustrated the Texas Pacific Railway bondholders, now shareholders in the land trust. Their shares in the trust proved illiquid and hard to sell. But beneath the surface lay some value. At the time the trust was established in the late 19th century, mineral rights were not widely understood – and they came attached to the land rights [in contrast to today, where surface rights and mineral rights are commonly separated]. It seemed the shareholders, long waiting for an opportunity to cash-out, had finally caught a break. The Texas Oil Boom of the 1920’s (also known as “The Gusher Years”) converged with the stock market boom of the “roaring twenties”. There was significant public enthusiasm for new company listings, valuations were rich – and the mineral rights were considered a potential “hidden treasure” after oil was discovered on the land holdings. In 1927, nearly four decades after its creation and with much of the trust’s land still unsold, the shares began trading on the New York Stock Exchange. The land portfolio remained mostly barren and undeveloped, but the stock market mania allowed some long-term shareholders to find an attractive exit. [Note: the stock market crashed in 1929 – so investors that sold at, or just after, the IPO may have had very good timing]

The Texas Oil Boom ended with the Great Depression. But oil exploration and development took on new significance during and after World War II. In the 1950’s, the hunt for oil on TPL’s land was back in earnest. In 1954, TPL established the TXL Oil Corporation to capitalize on its mineral assets, formalizing its role in the oil industry. The trust slowly began to shift focus towards the value of its mineral assets. As before, this evolution moved very slowly. In the 1970s, the Arab Oil Embargo accelerated domestic production and significantly boosted TPL’s royalty income. In the 1980s (now almost a century after the original bankruptcy), TPL made a big strategic pivot: they would emphasize shareholder value, leveraging oil revenues to repurchase shares and reduce outstanding stock. The focus on land-sales, despite it still being the “official purpose” of the Trust, was being deprioritized (though they were still selling down land on a regular basis).

TPL remained a relatively boring, but stable, business until the 2000’s. A new technology: horizontal drilling promised to unlock vast oil resources in the Permian and Delaware Basins of the United States. TPL found itself sitting on the land and mineral rights for a big part of one of the world’s richest oil fields. The boom was on – and this one made the 1920’s “Gusher Years” look miniscule by comparison.

In 2021, TPL transformed from a Trust to a Corporation formally eliminating its mandate to liquidate its land holdings. Today, TPL’s market cap exceeds $32 billion. A hypothetical $1,000 invested in TPL in 1995 would be worth over $1 million today [January 2025]. What had started as a bankruptcy induced entity to dispose of distressed land transformed into a highly profitable corporation, owning 868,000 acres in one of the world’s richest oil fields.

A lucrative business

Texas Pacific Land Corp. (TPL) operates a unique business model that capitalizes on its vast land holdings in the Permian Basin without directly engaging in oil and gas production. This asset-light, high-margin model allows TPL to benefit from every phase of development on its land, from infrastructure construction to oil extraction and beyond. Its operations are organized into two primary business segments: Land and Resource Management and Water Services and Operations, each contributing to its strong financial performance and growth trajectory.

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A Simple, Lucrative Business Model

The business models of Fannie Mae and Freddie Mac are simple. They each operate two business categories: (1) Securitization and Guarantee Business and (2) Retained Portfolio business. The Securitization and Guarantee Business is by far the most important, as the Retained Portfolios have been effectively wound down and will be a negligible part of their earnings going forward.

Securitization and Guarantee Business

The companies acquire “qualified” mortgages from lenders, bundle them into pools of Mortgage-Backed Securities (MBS), and sell these securities to investors. They guarantee the timely payment of principal and interest on these securities by charging a “guarantee fee” (g-fee) to lenders for this service. Lenders pass on the fee to the homeowner. This fee has ranged from 50 to 60 basis points in recent years. It is embedded in the mortgage rate itself – making it largely unnoticed by homeowners.

The companies take on two main risks associate with this business line: Credit Risk and Pre-Payment Risk. Credit risk is the risk of a borrower defaulting on their mortgage. Pre-Payment Risk is the risk that borrowers refinance their mortgage (or otherwise pay off) their mortgage earlier than expected, thereby affecting the g-fee income stream.

To mitigate against Credit Risk, there are strict underwriting standards for mortgage eligibility. The g-fees are priced based on risk (i.e. they charge more for riskier mortgages, or to borrowers with lower credit scores). They also use g-fee income to build capital reserves to cover potential losses. In recent years, they have introduced a Credit Risk Transfer system by selling portions of risk to investors. To mitigate against Pre-Payment Risk, the companies structure MBS pools with callable or non-callable options that can manage pre-payment speeds. There are also complex hedging strategies to offset the financial impacts of pre-payments.

The g-fees charged are meant to provide capital to cover any potential losses arising from Credit or Pre-Payment Risk. Importantly, housing is one of the areas where extensive long-term data sets are available. Forecasting risk becomes relatively straightforward. Capital reserves are built to withstand shocks to the housing finance system that occur very infrequently [Note: Dodd-Frank Stress Tests are conducted annually to mimic another Financial Crisis and determine capital sufficiency. In recent years, both companies have passed easily]. The g-fee business has proved extremely resilient over time.

Retained Portfolio Business (“pre-2008”)

Both companies also maintain a “retained portfolio” where they acquire mortgages from lenders, but retain them instead of selling MBS to investors. Naturally, this comes with Interest Rate Risk as well as Credit Risk and Liquidity Risk. However, this business consists of mortgage pools on their books from before the 2008 Great Financial Crisis. Regulations introduced after 2008 prevent the companies from re-entering this space. The legacy pools of mortgages have largely run off their books by the time of this publication. Going forward, their contribution to either Fannie Mae or Freddie Mac’s income streams will be effectively negligible.

The business model has scaled with the size of the US housing and MBS markets, and has proven to be highly lucrative over time. The Retained Portfolio was the source of trouble for both companies during the Great Financial Crisis, not the Securitization and Guarantee Business. Going forward, they will only be in the Securitization and Guarantee Business.

Net income has averaged $17.4 billion and $9.3 billion for the last 5-years for Fannie Mae and Freddie Mac respectively. These enormous returns are very stable and could command a high valuation if/when their conservatorships end.

An investment thesis emerges

At time of writing, a new Trump administration is preparing to take office. There is considerable speculation about this new administration moving to end the conservatorships. There is also considerable uncertainty that needs to be recognized. The biggest question is what Treasury will do with their existing SPS obligation.

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Yet despite their staggering scale and influence, these publicly traded giants have languished in obscurity since the Great Financial Crisis in 2008. For over 15 years, they have been relegated to the “pink sheets”, trading over-the-counter (OTC) often for under $1/share. They still filed quarterly and annual reports with the SEC. But their earnings calls were almost perfunctory, often lasting roughly 20 minutes with no analyst participation allowed (no Q&A with the management team). For all but some avid investing nerds, these companies were forgotten – out of sight, out of mind.

The re-election of Don…

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