Troubled lenders Freddie Mac and Fannie Mae might have suffered huge losses, but holders of the mortgage companies' preferred shares are seeing prices rise even as America's housing market slogs through another year in shambles. In a letter to investors in April, Tampa-based hedge fund Gator Capital Management reported strong returns from its holdings in Freddie and Fannie. Prices for the various classes of preferred stock tripled in value during the first five weeks of the year.
Gator Capital founder Derek Pilecki says that jump represented about half of the fund's 19.6% gain for the first quarter. About 10% of the fund's portfolio reflects Freddie and Fannie preferred stock.
Pilecki was somewhat of a contrarian when he told Fortune in February that prices of the troubled lenders would rise even after the U.S. Treasury announced plans to unwind Fannie and Freddie over the next several years. In 2008, as America's housing market crashed, the companies suffered staggering losses from bad loans and were rescued by the federal government. That's around the time Pilecki beefed up his fund's holdings of Freddie and Fannie shares, snapping up the securities for as low as 30 cents per share. It hasn't been an easy ride -- in 2010, both mortgage giants were among the top five worst-performing Fortune 500 stocks of the year.
Even while the companies suffered losses, their financial picture is improving, according to Gator Capital. Newer loans approved under tighter lending standards in 2009 and 2010 are relatively less risky and more profitable. The hedge fund predicts that Freddie Mac may turn profitable this year even after paying more than $6 billion in preferred stock. This would be a significant turn of events -- Fannie and Freddie lost more money than any other Fortune 500 company in 2009.
Is this wishful thinking? Though Freddie (FMCC) and Fannie's (FNMA) losses have narrowed since the height of the financial crisis, the companies together still owe the government about $153 billion in what has been called the costliest bailout ever. More importantly, depending on how the Treasury Department plans to shrink these companies, preferred shareholders could be wiped out entirely.
Indeed, any dramatic changes might come much later, as lawmakers might hold off on any decisions as the Presidential race in 2012 approaches. And it's certainly plausible that things could change, but scaling down Freddie and Fannie is very much the thumping tone on Capitol Hill today.
Pilecki's returns aside, investing in Fannie and Freddie is not for the risk averse or the faint of heart. Even if their shares have seen brighter days lately, it still has the sorry state of the U.S. housing market to answer to.
