As talks about Fannie Mae and Freddie Mac exiting conservatorship continue to swirl, investors and analysts are paying especially close attention to the government-sponsored entities’ stocks, especially their preferred shares. Several big hedge funds are banking on a big-time payday from Fannie’s and Freddie’s preferred shares when the GSEs finally do leave conservatorship, where they’ve been languishing for the last decade.Now well-known bank analyst Dick Bove of Odeon Capital says he does see further upside ahead for Fannie’s preferred shares – specifically, the 8.25 Junior Preferred shares.
Why Fannie is sure to exit conservatorship
In a note this week, Bove explained why he sees “a high probability” that both Fannie and Freddie will exit conservatorship at some point this year. He cited economic reasons related to housing, legal pressures, and ongoing activities within the Trump administration. If the GSEs do finally leave the government’s oversight as he expects, then he thinks there could be “substantial capital gains” for investors who hold preferred shares.
One reason Bove expects the GSEs to exit conservatory ship is due to economic necessity. He pointed out that the economy does seem to be slowing, and he cited housing as “a critical factor in changing this trajectory.” Of course, housing depends on mortgage financing, and Fannie and Freddie play important roles in the market. Bove describes the current mortgage industry as “a mess at both the primary and secondary levels,” so he feels change is absolutely necessary.
Legal and political reasons
He also noted three legal cases involving the GSEs which are pending in our nation’s courts. The cases are finally nearing decisions following “years of wrangling.” In all three cases, Bove feels the judges’ language suggests they will favor the plaintiffs over the government. This is pressuring the government to “reach some accommodation prior to potentially hostile decisions.”
Finally, he noted that Congress is starting to lose its ability to have any impact on what happens to Fannie and Freddie. Trump’s pick to head the federal agency which oversees the GSEs appears highly motivated to move, and multiple reports have suggested the president may even sidestep Congress on Fannie and Freddie and make decisions without lawmakers’ involvement.
Bove said that even though the Trump administration doesn’t appear to have any real plan for the GSEs yet, the fact that they’re “intimating they have one” suggests they will in the very near future. Trump‘s team is working to get Mike Calabria in as the new head of the Federal Housing Finance Agency, and Bove believes his plan is to have “the GSEs recapitalized and restructured as banks.”
Upside for Fannie Mae 8.25 Junior Preferred
The analyst noted that Fannie’s 8.25 Junior Preferred shares have been highly volatile since 2014. They hit $10 in September of that year but then plunged to $2.80 in January 2016. A year after that, the stock soared to $10.88 before sliding back to $5.45 in May 2018. On Wednesday, the stock reached $10.17 per share a new 52-week high, he added.
He now predicts that the stock’s next “major move” will be higher rather than another plunge based on his reasoning that Fannie will exit conservatorship this year.
“One never knows if the pressure to free the GSEs from their conservatorship will end but it would appear that there are [sic] a very strong set of forces moving to make that happen at present,” Bove wrote. “Further capital gains for investors seem likely.”
Hedge funds are betting on Fannie preferred shares
Several big hedge funds have been betting on Fannie’s preferred shares for years. One fund we’ve been following is Gator Capital, which has enjoyed significant gains from the stock over the last few months. Fannie’s preferred shares were one of the fund’s best-performing stocks in the fourth quarter. The Gator team also believes this will be the year the GSEs finally exit conservatorship, which is the key part of their thesis for Fannie’s preferred shares.
Gator’s January returns sheet showed that it was up 17.76% for January. Although the fund didn’t include any commentary, there’s little doubt that the GSE played a role in that gain. GSE preferred shares were Gator’s third-largest position in January, after only Zions Bancorporation and Syncora Holdings.
Other hedge funds which have reported positions in GSE preferred shares include Bill Ackman‘s Pershing Square and John Paulson’s fund.
This article first appeared on ValueWalk Premium