WSJ nice news(!): Hedge Funds Bet on Fannie(FNMA), Freddie Rise
Hedge Funds Bet on Freddie, Fannie Rise
By NICK TIMIRAOS
Some of the hedge funds that made fortunes in the housing-market crash are now betting on the recovery of Fannie Mae FNMA +26.32% and Freddie Mac, FMCC +26.37% the government-controlled mortgage giants.
Paulson & Co. and Perry Capital LLC are among a handful of hedge -fund firms that have bought so-called preferred shares in Fannie and Freddie, which collapsed in value in 2008 after the companies were taken over by the federal government.
These firms are hoping Fannie and Freddie's recent return to profitability on the back of a recovering housing market will lead the companies eventually to make payments to preferred shareholders .
Former Treasury official Jim Millstein, now Millstein & Co.'s chief executive, has invested in Fannie and Freddie.
Some investors already have benefited from a recent rally in the mortgage companies' shares . The most widely traded class of Fannie's preferred shares closed at $5.38 on Tuesday, the highest level since the companies were placed into a government-run conservatorship in September 2008. Two months ago, the shares traded for less than $2.
However, the hedge funds and other investors stand to make a lot more depending on how Fannie and Freddie are restructured. The best-case scenario for the investors would be that the government raises fresh capital for the companies and sells its stake on the market. That way, the investors hope, preferred shareholders might be paid out.
But that could be a long shot. Any recapitalization of Fannie and Freddie is viewed as a nonstarter by officials in the Obama administration, according to people familiar with the matter. The administration has repeatedly said the companies should be phased out instead of sold back to investors along the lines of how the U.S. unwound its stake in American International Group Inc. AIG +3.23% Once any overhaul of Fannie and Freddie begins, the administration could take additional steps to sell off the firms' assets in a way that would prevent any capital distributions to shareholders.
"To the degree these guys are placing a political bet, it is one that faces unimaginably long odds," said Jim Parrott, who served as a top housing-finance adviser in the White House until the end of last year.
Preferred shareholders may need to persuade Congress or the courts to revisit the current structure if they hope to recoup the full value of the shares. Paulson, Perry and others have been circulating plans before lawmakers that Fannie and Freddie should be restructured or privatized in some form, according to people familiar with the matter.
Hedge funds have stepped up their lobbying of Congress to encourage the sale of the government's stake in the firms, said Sen. David Vitter (R., La.) at a hearing on Capitol Hill last month. "And to some extent, investors are already speculating that the companies will be returned to the marketplace."
Representatives of Paulson and Perry, which shot to prominence with their winning wagers against the housing market before the financial crisis, declined to comment.
One of the proposals in Washington is being advanced by Jim Millstein, a former Treasury Department restructuring officer who oversaw the government's sale of AIG. He now runs his own restructuring firm, Millstein & Co., and has invested in the preferred shares. At some point over the next year, "the government is going to get all of its money back. So the questions for the government are what will, and what can, they do with the excess?" said Mr. Millstein.
Fannie and Freddie, which took around $188 billion from the U.S., will have paid the government about $132 billion in dividends by next month. Investors betting on the preferred shares are taking heart in those improved fortunes. They believe "there are going to be so many profits that the likelihood of the preferreds being worth zero in their mind is dropping," said Derek Pilecki, a former Goldman Sachs GS +3.27% portfolio manager who founded Gator Capital Management in Tampa, Fla., in 2008. He began investing the preferred shares that summer.
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Lately, more small investors also have begun to pile in, a trend that is "somewhat unsettling," said Isaac Boltansky, a policy analyst at Washington-based Compass Point Research & Trading, a dealer-broker for institutional clients. He pointed out that Freddie and Fannie remain political pariahs, with few signs pointing to any political will to resurrect the firms.
"This is one of those instances where we have a disconnect between securities valuation and D.C. policy," said Mr. Boltansky.
The episode is the latest reminder of the strange situation facing Fannie and Freddie, which are still nominally private entities. The U.S. Treasury agreed to rescue the companies in September 2008 to stave off a deep freeze in U.S. mortgage markets. In return for injecting vast sums of aid, the Treasury created a new class of stock—senior preferred shares—that paid an annual dividend of 10% to the U.S. government, along with warrants to acquire up to 79.9% of the firms' common stock.
Last summer, the Treasury revamped its bailout agreement to require nearly all of the firms' profits to be swept away as dividends. The problem facing investors is that those terms make it virtually impossible for the companies to ever recapitalize or pay back the government. Also, dividend payments aren't counted toward repayment of the Treasury's preferred shares.
The government didn't take full ownership of the companies in order to avoid consolidating some $5 trillion in assets and liabilities onto the federal ledger. The companies' shares, which were delisted in 2010 from the New York Stock Exchange , still trade over the counter. Before the crisis, the preferred shares, which would be worth $33 billion if paid in full, were widely held by community banks and mutual funds .
Sen. Bob Corker (R., Tenn.), who is working on a bill that would replace Fannie and Freddie with a new structure that would leave no room for private shareholders, said he sees the preferred shares as little more than a "lottery ticket." Messrs. Corker and Vitter joined two Democratic senators in introducing a bill earlier this year that would require congressional approval before the Treasury could sell its stake, a move designed to prevent private shareholders from cashing in.
—Gregory Zuckerman contributed to this article.
Write to Nick Timiraos at nick.timiraos@wsj.com
Hedge Funds Bet on Freddie, Fannie Rise
By NICK TIMIRAOS
Some of the hedge funds that made fortunes in the housing-market crash are now betting on the recovery of Fannie Mae FNMA +26.32% and Freddie Mac, FMCC +26.37% the government-controlled mortgage giants.
Paulson & Co. and Perry Capital LLC are among a handful of hedge -fund firms that have bought so-called preferred shares in Fannie and Freddie, which collapsed in value in 2008 after the companies were taken over by the federal government.
These firms are hoping Fannie and Freddie's recent return to profitability on the back of a recovering housing market will lead the companies eventually to make payments to preferred shareholders .
Former Treasury official Jim Millstein, now Millstein & Co.'s chief executive, has invested in Fannie and Freddie.
Some investors already have benefited from a recent rally in the mortgage companies' shares . The most widely traded class of Fannie's preferred shares closed at $5.38 on Tuesday, the highest level since the companies were placed into a government-run conservatorship in September 2008. Two months ago, the shares traded for less than $2.
However, the hedge funds and other investors stand to make a lot more depending on how Fannie and Freddie are restructured. The best-case scenario for the investors would be that the government raises fresh capital for the companies and sells its stake on the market. That way, the investors hope, preferred shareholders might be paid out.
But that could be a long shot. Any recapitalization of Fannie and Freddie is viewed as a nonstarter by officials in the Obama administration, according to people familiar with the matter. The administration has repeatedly said the companies should be phased out instead of sold back to investors along the lines of how the U.S. unwound its stake in American International Group Inc. AIG +3.23% Once any overhaul of Fannie and Freddie begins, the administration could take additional steps to sell off the firms' assets in a way that would prevent any capital distributions to shareholders.
"To the degree these guys are placing a political bet, it is one that faces unimaginably long odds," said Jim Parrott, who served as a top housing-finance adviser in the White House until the end of last year.
Preferred shareholders may need to persuade Congress or the courts to revisit the current structure if they hope to recoup the full value of the shares. Paulson, Perry and others have been circulating plans before lawmakers that Fannie and Freddie should be restructured or privatized in some form, according to people familiar with the matter.
Hedge funds have stepped up their lobbying of Congress to encourage the sale of the government's stake in the firms, said Sen. David Vitter (R., La.) at a hearing on Capitol Hill last month. "And to some extent, investors are already speculating that the companies will be returned to the marketplace."
Representatives of Paulson and Perry, which shot to prominence with their winning wagers against the housing market before the financial crisis, declined to comment.
One of the proposals in Washington is being advanced by Jim Millstein, a former Treasury Department restructuring officer who oversaw the government's sale of AIG. He now runs his own restructuring firm, Millstein & Co., and has invested in the preferred shares. At some point over the next year, "the government is going to get all of its money back. So the questions for the government are what will, and what can, they do with the excess?" said Mr. Millstein.
Fannie and Freddie, which took around $188 billion from the U.S., will have paid the government about $132 billion in dividends by next month. Investors betting on the preferred shares are taking heart in those improved fortunes. They believe "there are going to be so many profits that the likelihood of the preferreds being worth zero in their mind is dropping," said Derek Pilecki, a former Goldman Sachs GS +3.27% portfolio manager who founded Gator Capital Management in Tampa, Fla., in 2008. He began investing the preferred shares that summer.
[image]
Lately, more small investors also have begun to pile in, a trend that is "somewhat unsettling," said Isaac Boltansky, a policy analyst at Washington-based Compass Point Research & Trading, a dealer-broker for institutional clients. He pointed out that Freddie and Fannie remain political pariahs, with few signs pointing to any political will to resurrect the firms.
"This is one of those instances where we have a disconnect between securities valuation and D.C. policy," said Mr. Boltansky.
The episode is the latest reminder of the strange situation facing Fannie and Freddie, which are still nominally private entities. The U.S. Treasury agreed to rescue the companies in September 2008 to stave off a deep freeze in U.S. mortgage markets. In return for injecting vast sums of aid, the Treasury created a new class of stock—senior preferred shares—that paid an annual dividend of 10% to the U.S. government, along with warrants to acquire up to 79.9% of the firms' common stock.
Last summer, the Treasury revamped its bailout agreement to require nearly all of the firms' profits to be swept away as dividends. The problem facing investors is that those terms make it virtually impossible for the companies to ever recapitalize or pay back the government. Also, dividend payments aren't counted toward repayment of the Treasury's preferred shares.
The government didn't take full ownership of the companies in order to avoid consolidating some $5 trillion in assets and liabilities onto the federal ledger. The companies' shares, which were delisted in 2010 from the New York Stock Exchange , still trade over the counter. Before the crisis, the preferred shares, which would be worth $33 billion if paid in full, were widely held by community banks and mutual funds .
Sen. Bob Corker (R., Tenn.), who is working on a bill that would replace Fannie and Freddie with a new structure that would leave no room for private shareholders, said he sees the preferred shares as little more than a "lottery ticket." Messrs. Corker and Vitter joined two Democratic senators in introducing a bill earlier this year that would require congressional approval before the Treasury could sell its stake, a move designed to prevent private shareholders from cashing in.
—Gregory Zuckerman contributed to this article.
Write to Nick Timiraos at nick.timiraos@wsj.com
