Bill Ackman’s hedge fund-firm took stakes in Fannie Mae (FNMA:US) and Freddie Mac, the government-owned mortgage insurers that investor Bruce Berkowitz is seeking to restructure, and said it may seek talks with management, shareholders and the government.
Pershing Square Capital Management LP bought a 9.98 percent stake in the common shares of Fannie Mae that aren’t owned by the U.S. government, and a 9.77 percent stake in the Freddie Mac shares available to the public, according to a regulatory filing today (FNMA:US). The government owns almost 80 percent of both companies since bailing them out in 2008.
Ackman and Berkowitz are seeking to influence the future of the two government-sponsored enterprises at a time when the consensus in Washington among Democrats and Republicans is that Fannie Mae and Freddie Mac should be dismantled and shareholders wiped out. Any effort to recapitalize Fannie Mae and Freddie Mac would require government approval and the White House and Congress have shown no interest so far in plans proposed by private investors.
“I don’t think our deliberative reform efforts should be pre-empted by an unsolicited proposal that’s based more on shareholder profits than achieving any public policy goals,” Senator Mark Warner, a Virginia Democrat and co-author of a bipartisan bill that would overhaul the housing finance system, said in an e-mailed statement.
Fairholme Capital Management LLC (FAIRX:US), the mutual-fund firm run by Berkowitz, this week proposed that it and other junior preferred shareholders buy two businesses out of Fannie Mae and Freddie Mac that insure mortgage-backed securities to salvage a bet on the two companies. The government holds the companies’ senior preferred shares.
The Obama administration believes Fannie Mae and Freddie Mac should be wound down, the Treasury Department said in a statement.
Charles Zehren, a spokesman for Pershing Square at Rubenstein Associates, declined to comment on today’s filing.
Berkowitz is the single largest investor in the junior preferred shares, with a stake of $3.5 billion to $4 billion at par value. The shares currently trade at about 40 percent of par value.
Ackman has been buying more recently, starting Oct. 7 and accelerating purchases after Oct. 21, according to the filing. Ackman paid a total of $401 million for his combined holdings, which were worth $577 million on Friday, representing a 44 return. Unlike Berkowitz, Ackman acquired common stock (FMCC:US) in the two companies.
Under Fairholme’s proposal, the preferred shares would be exchanged at their full par value of $34.6 billion for shares in a new mortgage insurer that would separate new underwriting from the legacy investments held by Fannie Mae and Freddie Mac. Ackman’s common shares would give him ownership of the pair’s legacy book of business, including mortgages that soured during the housing crisis.
While that legacy business would shrink over time, Ackman, in an interview with CNBC last year, said Fannie Mae should stop selling foreclosed assets and become a residential real estate investment trust.
“They should just keep the foreclosed assets, fix them up and rent them, and become a big residential REIT that owns homes,” Ackman said in the interview. “That would immediately stabilize the housing market.”
Ackman’s Pershing Square said today it disclosed the stakes and decided to seek talks “in light of the proposed Fairholme transaction.”
“The issuer’s common stock is undervalued and is an attractive investment,” Pershing Square said, adding that it may seek “discussions with management, the board, other stockholders of the issuer, representatives of the federal government, and other relevant parties.”
Fannie Mae’s 8.25 percent junior preferred shares, which have a par value of $25, rose 1.3 percent to $9.93 today. That’s the highest since 2008, when Fannie Mae and Freddie Mac were seized by the government.
Berkowitz and investors including hedge fund-firms Paulson & Co. and Perry Capital LLC bought the shares 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 in a Nov. 13 statement.
While the plan wouldn’t require common shareholders to contribute capital or grant them shares in the new companies, it may give common shareholders an opportunity to purchase common stock of the new entities, Paul Scarpetta, a spokesman for Fairholme at Sard Verbinnen & Co., said in an e-mail.
Scarpetta said common shareholders under Berkowitz’s plan would gain a more senior claim on the value of Fannie and Freddie, as preferred holders would be removed.
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. (MORN:US)
Excluding the government’s stake, Fannie and Freddie common shares hold a combined value (FMCC:US) of about $6 billion. Fannie Mae shares gained 7.8 percent to $3.30 and Freddie Mac gained 6.2 percent to $3.08.
Fannie Mae was established near the end of the Great Depression in 1938 to help boost homeownership by making mortgages more available. Along with its smaller rival Freddie Mac, created in 1970, the agency bundles loans into mortgage-backed securities that are sold to investors with the support of the federal government.
As private lending to homebuyers declined during the financial crisis that began in 2008, the companies expanded their influence in the mortgage market. They own or guarantee more than half of all U.S. mortgages and have grown crucial to keeping capital flowing to lenders and borrowers.
Both returned to profit in 2012, when Fannie had its best year ever and reported net income of $17.2 billion for the whole year. Freddie earned $11 billion last year. The pair said on Nov. 8 they will return $39 billion to the Treasury out of third-quarter profits, bringing their total payments to within about $2 billion of the cash aid they got after the credit crisis.
Under terms of the government’s ownership, technically referred to as conservatorship, the government since last year has been taking all of the companies’ quarterly profits beyond a $3 billion net-worth cap. The money counts as a return on the U.S. investment and not as a repayment of the aid, leaving Fannie Mae and Freddie Mac without an avenue for exiting conservatorship and fueling controversy among holders of their junior-preferred and common stock.
Berkowitz and other preferred shareholders sued the Treasury, arguing that the government had expropriated the value of their holdings.
Jaret Seiberg, an analyst in Washington for Guggenheim Securities LLC, said government officials and lawmakers are unlikely to even discuss a deal with private investors until a court rules on that suit.
“Either the government is still owed $187 billion or the government has been repaid,” he said. “I don’t see how you cut a deal until that question is solved.”
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.
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