Investors including hedge funds are buying the preferred stock of government-controlled mortgage firms Fannie Mae and Freddie Mac in a long-shot bet they will have a future as private companies.
Fannie Mae’s 8.25 percent of preferred shares have more than doubled this year after the company reported record earnings. Some investors see the odds rising the two loan guarantors may somehow return to private ownership without cutting out existing investors, according to Bose George, an analyst at Keefe Bruyette & Woods in New York. The securities have a par value of $25, meaning investors could recoup more than five times the current price of $4.26.
“The idea is eventually, as these companies have paid back their debt to the government, they could potentially be turned back on,” George said. “From our perspective, you can only make an argument for this if you think the government’s going to change the rules somehow to benefit the preferred shareholders.”
The gains come after the U.S. Treasury Department changed the terms of the enterprises’ bailout last year to force them to turn over profits to the government. The agreement provides no mechanism for them to repay the $187.5 billion they owe the government from their 2008 bailout, a prerequisite to a change in their status.
Jim Millstein, the U.S. Treasury Department’s former chief restructuring officer, who’s been putting forward a plan to privatize Fannie Mae and Freddie Mac, said his firm Millstein & Co. has been receiving more calls about the overhaul from investment managers and policy groups in the past month after the mortgage companies reported improved earnings and a Senate proposal limiting outside use of their increased income.
“It’s premised on a turnaround in Fannie and Freddie’s results and a financial restructuring that enables” them to fully pay back the government, Millstein said. “That now looks like less of a long shot after record earnings at Fannie Mae,” said Millstein, who owns preferred shares in the firms.
“The real question is whether policy makers will use the opportunity of these improved results to restructure Fannie and Freddie, reform the government’s role as a guarantor of housing finance and end the conservatorships,” he said. “Our plan is at least one way to get that done without wrecking the recovery underway in the housing market.”
The recent jump in the preferred shares is a long overdue boost for some investors who first started dabbling in the investment several years ago. Kyle Bass, whose Dallas-based hedge fund Hayman Advisors LP made $500 million in 2007 betting against U.S. subprime mortgages, said at a conference in Las Vegas in May 2011 that buying the preferred shares “could be an eight to 10-bagger from here.” At the time, the securities were trading at $2.40. A little more than a year later he told website TheStreet.com that he’d exited the trade because Republicans and Democrats wanted to kill Fannie Mae and Freddie Mac. Bass didn’t return calls for comment.