Fairholme Capital Management LLC, the mutual-fund firm run by Bruce Berkowitz, proposed buying two businesses that insure mortgage-backed securities from Fannie Mae and Freddie Mac to salvage a bet on the two government-backed companies.
The businesses would be acquired in exchange for about $34.6 billion in Fannie Mae and Freddie Mac preferred stock that Fairholme and investors including Paulson & Co. and Perry Capital LLC bought in a wager that the U.S. government would keep the mortgage companies alive. Fairholme’s proposal would raise at least $17.3 billion in additional funds from preferred holders and through a rights offering, Fairholme said yesterday in a statement.
The proposal by Berkowitz, who is locked in a legal battle with the government over his investment in the two agencies, would more than double the value of preferred shares in Fannie Mae and Freddie Mac that Fairholme, billionaire John Paulson and other investors own. The plan is a long-shot attempt to head off a bipartisan bill being prepared by U.S. senators that would transform the $9.4 trillion mortgage-finance system and probably wipe out the value of preferred shares, according to Isaac Boltansky, policy analyst at Compass Point Research & Trading LLC.
“This plan will not gain traction,” Boltansky said in a telephone interview. “It doesn’t in any way address the underlying political and practical issues” in the debate.
The government seized Fannie Mae and Freddie Mac after the mortgage-finance companies were pushed to the brink of bankruptcy by investments in bad loans. The two took $187.5 billion in taxpayer aid before reporting record profit this year as the housing market rebounded.
Any decisions about their ownership would have to be approved by the Obama administration, which has called for the two companies to be wound down and replaced. The Senate bill, introduced in June by Tennessee Republican Bob Corker and Virginia Democrat Mark Warner, would liquidate Fannie Mae and Freddie Mac within five years.
If the bill or a similar measure becomes law, preferred shares would “probably be wiped down to zero,” said Jaret Seiberg, an analyst in Washington for Guggenheim Securities LLC.
Denise Dunckel, a spokeswoman for the Federal Housing Finance Agency, declined to comment, as did Adam Hodge of the Treasury Department.
Fairholme is the single largest investor in the preferred shares, which are trading at less than 40 cents on the dollar, Paul Scarpetta, a spokesman for Fairholme at Sard Verbinnen & Co., said in a phone interview. The firm holds $3.5 billion to $4 billion of the preferred shares at par value, Berkowitz said.
Fannie Mae’s 8.25 percent preferred shares, which have a par value of $25, rose 6.3 percent to $9.84 at 2:25 p.m. today in New York. That’s the highest since 2008, when Fannie Mae and Freddie Mac were seized by the government.
Berkowitz’s plan would convert those shares into common equity in the target companies at 100 cents on the dollar. It would need the support of other investors in Fannie Mae and Freddie Mac.
“A significant number” of Fannie Mae and Freddie Mac preferred shareholders indicated an agreement in principle, Scarpetta said. The investor group would buy “the two entities but not the existing books of business.”
“Housing finance is most critical to the American dream and the government wants private capital to invest,” Berkowitz said today in an interview on CNBC. “We and other owners, we want to invest, so we’re ready.”
Spokesmen for Claren Road Asset Management LLC, Perry Capital LLC and Paulson, owners of the preferred shares, declined to comment or didn’t return telephone messages and e-mails seeking comment.
One of Berkowitz’s most successful investments since the financial crisis was in the bailed-out insurer American International Group Inc. (AIG:US) Fairholme owns more than 86 million shares in AIG, making it the largest shareholder in the New York-based firm.
“Berkowitz is an incredibly smart guy who worked closely with AIG,” said Boltansky at Compass Point. “These guys think they can do the same thing with Freddie and Fannie. But Freddie and Fannie are dirty words in Washington. They are difficult and complicated beasts.”
Fannie Mae and Freddie Mac package mortgages into securities for which they guarantee 100 percent payment of principal and interest. The Senate bill would replace them with a new government reinsurer. It would require private financiers to hold equity capital and take at least 10 percent of the first losses on mortgage securities. The government would step in with more aid during a financial catastrophe.
Seiberg said Berkowitz’s proposal would have to incorporate a key element of the pending Senate bill for it to have any chance of being approved.
“Neither Democrats nor Republicans are prepared to go back to a system that relies on an implicit government guarantee,” he said in a telephone interview.
Berkowitz and other preferred shareholders are already fighting the U.S. Treasury with a lawsuit over the distribution of dividends from Fannie Mae and Freddie Mac. The Treasury amended its agreement with the agencies in August 2012, depriving other shareholders of a potential share of profits, according to the lawsuit.
Fannie Mae and Freddie Mac will have returned a combined $185.2 billion to the U.S. Treasury by the end of the year, which counts as a dividend on the government’s stake in the companies and not as a repayment of the taxpayer aid. Under the current arrangement with the U.S. government, the companies must send all of their quarterly profits above a $3 billion net worth cap to the Treasury.
Preferred shareholders receive preferential treatment over common shareholders when a company distributes dividends or is liquidated. The shares carry a par value that is used to calculate dividend payments and indicates the amount of assets each preferred share is entitled to in the case of liquidation, according to fund research firm Morningstar Inc.
Fannie Mae and Freddie Mac common and preferred shares surged this year as profits spurred speculation the companies would repay the government and be released from conservatorship. Guggenheim’s Seiberg said investors were at odds with federal officials in seeing value in the shares.
Berkowitz, 55, was named Morningstar’s domestic stock manager of the decade in 2010. He has bet on insurers and financial-services companies with 78 percent (FAIRX:US) of his fund’s stock holdings in such shares as of Aug. 31, according to Morningstar.
After a 2011 slump that spurred investor redemptions, Berkowitz rebounded in 2012 and his $8.3 billion Fairholme Fund (FAIRX:US) has surged 31 percent this year to beat 97 percent of peers, according to data compiled by Bloomberg.
Fairholme, based in Miami, was founded by Berkowitz in 1997 and had $10.5 billion under management as of September.
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