I've thought about exile as well, but Fredo knows too much about the family business & would use that information to harm Michael as much as possible. Or he might even go to the senate and confess everything.
Again, if Michael had really considered Fredo's knowledge a threat, he would not have allowed him to live as long as Mama did, and certainly wouldn't give him free rein to the compound.
And Fredo would never have gone to the Senate, as that would have destroyed his ambitions of being a big shot in his own right.
