Fannie Mae-No Politics (FNMA)

[obiterdictum]

Investor Fires Salvo Against Fannie, Freddie
Fairholme Funds' Bruce Berkowitz Scolds Mortgage-Finance Companies' Directors, Saying They Are Ignoring Shareholder Rights

By NICK TIMIRAOS CONNECT
Updated March 2, 2014 9:51 p.m. ET

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Bruce Berkowitz, a prominent mutual-fund investor, sent letters to the boards of Fannie Mae FNMA +2.78% and Freddie Mac FMCC +0.22% late Friday scolding directors for not protecting the rights of shareholders, upping the ante in his bid to let investors share in the spoils of the newly profitable mortgage-finance giants.

Letter from Berkowitz to the board of Freddie Mac

Letter from Berkowitz to the board of Fannie Mae

In an interview Sunday, Mr. Berkowitz said he hopes to "wake up the boards" so they realize "that they have a fiduciary responsibility" to shareholders such as his Fairholme Funds Inc., which last month disclosed that its position in the companies had grown to a combined amount of nearly $1.3 billion.

Fairholme and other shareholders are suing the U.S. government to challenge changes that the Treasury Department made to the 2008 bailout of Fannie and Freddie. The changes, effective last year, required the companies to send all profits to the government, replacing an earlier 10% dividend payment and preventing the firms from retaining any earnings. The shareholders say the terms amount to an unconstitutional expropriation of assets.

Some investors began buying up shares of the firms more than a year ago when they traded at a fraction of their value before the bailout, betting that the companies would rebound along with the housing market. In recent days, shares in various classes of the preferred stock, a form of senior equity, have traded near their highest levels since the bailout.

Over the past two years, Fannie and Freddie have seen a turnaround. The government will have collected nearly $203 billion in dividends from the companies by the end of the month after injecting nearly $188 billion between 2008 and 2011.

Mr. Berkowitz's letters serve as the latest reminder of how big profits at both firms could complicate the Obama administration's commitment to "wind down" the mortgage giants and leave nothing for shareholders. Fannie and Freddie owe much of their profitability to the government's backstop, which has allowed them to borrow cheaply, but Washington has been slow to advance any concrete overhaul.

The way Fannie and Freddie's bailout was structured left the door open for shareholders to argue they are entitled to more of their profits. The Bush administration didn't wipe out shareholders in 2008 when the companies were taken over through a process known as conservatorship for broader policy and accounting reasons. Henry Paulson, the Treasury secretary at the time, has said putting the firms into receivership—similar to a bankruptcy liquidation—would have destabilized markets.

The government took warrants to acquire up to 80% of the firms' common shares; taking full ownership would have required putting all of the firms' $5 trillion in assets and liabilities on the federal books, swelling the national debt in the middle of the 2008 financial panic.

Mr. Berkowitz in his letters encouraged Fannie and Freddie's boards to assert their independence from the federal government, including relisting the companies' shares on the New York Stock Exchange, and called on the firms to establish special committees to enter negotiations with the government about restructuring themselves as private companies. The letters also said the firms should consider ceasing the payment of dividends owed to the government in cash, instead making payments-in-kind that would boost the government's stake, using an alternative provided to the companies in their original 2008 bailout agreements.

Mr. Berkowitz also called for the companies to resume annual shareholders' meetings, which ended after the 2008 bailout. "Frankly, it has been a while," he wrote in the letter, which was also sent to the companies' regulator, the Federal Housing Finance Agency.

This latest move in Mr. Berkowitz's campaign to free the companies from government control highlights the uncertainties facing Fannie and Freddie's boards. The FHFA assumed all powers and rights—including those of the boards of directors—when the companies were seized in 2008 through conservatorship, Philip Laskawy, the chairman of Fannie's board, said in a statement. "I am confident the board is doing the job it has been given," he said.

While the FHFA has delegated back certain responsibilities to the board, it has exclusive control over certain decisions, said Mr. Laskawy, including making cash dividend payments. Representatives for Freddie and the FHFA declined to comment.

Freddie Mac last week said it had received three separate shareholder letters since last October demanding the companies join legal action against the government to challenge the bailout changes. The FHFA responded to the first of those letters in January—from a lawyer representing two individual shareholders—saying the FHFA "does not intend to authorize Freddie Mac or its directors or officers" to take such action, the company said in a filing.

Freddie has no plans to participate in such legal action, said William McDavid, Freddie's general counsel, in a call with reporters last week. "That is really in the hands of the FHFA," he said.

Fannie also hasn't engaged with shareholders. "Obviously, the issues related to their interest in the company are matters that I think are probably most appropriately dealt with by Treasury and other policy makers," said Timothy Mayopoulos, Fannie's CEO, in a call with reporters last month.

Investors in Fannie and Freddie, including hedge-fund firms Perry Capital LLC and Pershing Square Capital Management LP, have bet that the companies would not only return to profitability but that the courts or Congress would limit the Treasury's ability to prevent the companies from recapitalizing themselves.

Fairholme has filed two lawsuits challenging the bailout changes that sweep away the companies' profits as dividends. Last week, a federal judge said she would allow Fairholme to proceed with discovery before ruling on the government's motion to dismiss one of the cases, an early win for shareholders in what figures to be a long battle.

Fairholme also proposed to the FHFA last November that shareholders be allowed to recapitalize the firms as state-regulated bond guarantors. Fairholme said the FHFA never responded to his proposal, but the White House shot it down days after it was made.

Mr. Berkowitz said last week's letters followed a series of unsuccessful attempts to meet with the chief executives of both companies. "It's easy to see we're not welcome," he said, adding he was still waiting for a response. "If the directors have a pulse and five dollars in a bank account, I think they should be concerned because not responding to me would be bordering on gross negligence," he said.

The Treasury has said the bailout changes were needed to allay investors' concerns that Fannie might one day exhaust its government backstop by making large dividend payments. Mr. Berkowitz said Sunday that rationale was "total nonsense" because the companies were allowed to defer cash payment of dividends. "No one bothered to read the [original] agreement," he said.

Mr. Berkowitz said he believed the firms, whose shares currently trade over the counter, should be relisted on the NYSE because that would lower transaction costs for shareholders. "I think the directors would behave differently," he added, if they were listed on the Big Board.

Corrections & Amplifications
Timothy Mayopoulos is Fannie Mae's CEO. An earlier version of this article misspelled his last name as Mayopolous.