Top Bond Investors Show Interest in GSE Capital Raising with Treasury Involvement

Includes: FMCC, FNMA
by: Ron Haruni

Bill Gross, chief investment officer at Pacific Investment Management Co. [PIMCO], who manages the world’s biggest bond fund, and Dan Fuss, vice chairman of Boston-based Loomis Sayles, who helps oversee more than $100 billion in fixed-income securities, according to Reuters - have expressed their interest in a capital raising by Fannie Mae (FNM) and Freddie Mac (FRE). There is one condition however. Both bond investors want the direct involvement and co-participation of the U.S. Treasury in the new deals.

While, Gross and Fuss agree on the importance of the U.S. Treasury’s involvement in the new deals — they seem to have opposing views in terms of what shape any deal with the Treasury should take.

Reuters points out Pimco’s preference, which is directed toward a straight preferred stock offering - where Gross “would buy preferred stock subject to significant Treasury participation and an attractive yield.” Fuss, on the other hand, objects Gross’ assertion by countering that the common stock approach is “a long-term call”. What Fuss, who in my view is fundamentally a ‘maestro’ in bond investing and anything about him is certainly worth reading, suggests instead, is an offering of convertible debentures.

Fuss owns Fannie and Freddie agency debt and preferred securities, and the theory behind his argument is that of raising capital for GSEs, about $15 billion each, in the form of new 30-year convertible preferreds, non-callable for life by Fannie and Freddie, with the option of holders converting the preferreds into common stock after holding them for a period of six years.

The Treasury’s investment, in new convertible preferreds “would add confidence that the securities would hold their value”, Fuss said. But Gross expressed no interest in a convertible preferred or convertible bond offering, stating that “the equity is virtually worthless and will continue to be”.

Since Nov. ‘07, Fannie Mae has raised more than $14 billion in capital to offset writedowns, while Freddie Mac has raised $6 billion.

Monday, Freddie Mac sold $2 billion of debt, a reassuring sign for investors that it and Fannie, who sold $2 billion of debt last week, can fund operations and continue functioning without a government takeover. Both GSEs are responsible for over half of the nation’s massive mortgage market.