https://www.greenstreet.com/news/hedge-fund-alert?breakdownId=50
Hope Not Lost for Mortgage-Agency Play
01/20/2021
Hedge fund operators haven’t given up all hope of profiting from the removal of Fannie Mae and Freddie Mac from government conservatorship.
As the Trump Administration fast-tracked efforts to recapitalize the mortgage agencies last year, several managers built equity positions that they saw as likely to benefit from that process. But the outlook for those plays dimmed as it became clear that the privatization push would not gain traction before today’s inauguration of President Joe Biden.
The odds of a near-term exit also shrank when the U.S. Treasury Department said on Jan. 14 that it was looking at a timeline under which it would take years for Fannie and Freddie to build up the capital needed to exit government control.
But fund operators still think the U.S. Supreme Court could offer a lifeline via the case of Collins v. Mnuchin. That case, initiated by Fannie and Freddie shareholders, challenges the constitutionality of the Federal Housing Finance Agency on the basis that the regulator is controlled by a single director who can be removed by the president only under a narrow set of conditions. It also challenges the legality of some $300 billion of dividends that the Treasury collected from Fannie and Freddie following their credit-crisis bailouts.
The court heard initial oral arguments on Dec. 9. One possible outcome: It could decide that the government already has been repaid, restoring the seniority of shareholders while allowing retained earnings to accrue to their benefit and allowing them to participate in a recapitalization that might take place in 2022. “Now the whole story turns to the ruling of the Supreme Court, which should be in May or June of this year,” one source said.
“If the Scotus ruling goes in our favor, it will require the conservator to be a conservator. That is, no more raiding on the GSE,” another source said, referring to government-sponsored enterprises. But, he added, a decision in the government’s favor could result in a messy situation in which nobody would take any money out of Fannie or Freddie for 10 years but related warrants would expire in 2027. The agencies’ preferred-stock agreements also would require restructuring.
While Treasury Secretary Steven Mnuchin and FHFA head Mark Calabria had vowed to move Fannie and Freddie into private hands, Biden has long been viewed as supporting continued government control.
In over-the-counter trading, the common shares of Fannie and Freddie have fully given back gains that followed the November election, when it seemed the Trump Administration plan might have more momentum toward its goal. Meanwhile, hedge funds including Mountaineer Partners’ Mountaineer Partners GSE Opportunity Fund and Muirfield Capital’s Muirfield GSE Fund have been betting on the agencies’ junior preferred shares.
In marketing its fund early last year, Mountaineer was projecting a return of 50% to 100% over a year to a year-and-a-half. Acknowledging the potentially volatile nature of the play, the New York operation presented investors at the time with a “bear case” return of minus-50% and a best-case return of 200%.
It was hoping to raise $100 million, up from $25 million last April.
The Muirfield fund launched in December 2017. After a flat first month, it lost 17% in 2018 and gained 67.3% in 2019. In marketing the vehicle last year, Muirfield pegged the junior preferred shares of Fannie and Freddie as trading at 30% of their par values while predicting that they would gain value rapidly once the agencies exit conservatorship.
Marketing firm Protocol Capital still was shopping the vehicle to potential limited partners as of Dec. 8. Marketing materials at the time expressed confidence in the privatization process, referring to “a good prospect that Calabria will end the conservatorships before Biden takes office on Jan. 20th.”
The fund had $160 million under management at the beginning of this year.