Top Hedge Fund Bets On Fannie Mae Preferred Stock Making Dough

Fannie Mae and Freddie Mac have been under U.S. government control for more than a decade now, but it’s finally sounding like that could end. One hedge fund which focuses on the financial services industry has been betting on a positive end to Fannie’s position as a government-sponsored enterprise (GSE), and the fund updated its thesis for Fannie Mae preferred stock in its fourth-quarter letter to investors.

Fannie Mae preferred stock is  "too cheap to sell"

At that point, the Gator team felt many of the stocks the fund owned were "too cheap to sell," so they held onto them so they wouldn't miss any potential rally. January did bring a strong rebound, and they said that as of Jan. 24, they had more than made back what was lost in December. They estimated that the fund was up 17% for 2019 through Jan. 24.

Updated thesis for Fannie Mae preferred stock

The Gator team also discussed at length their long position in Fannie Mae preferred stock. They last wrote in depth about it approximately four years ago, so much has happened on the GSE front since then. They believe the GSE story has finally reached an inflection point, and they now expect the Federal Housing Finance Agency to move Fannie and Freddie out of conservatorship this year. If or when that happens, Gator expects their preferred shares to either be converted to common shares or be refinanced. The firm went on to explain why think this will be the year Fannie and Freddie finally exit conservatorship.

Gator management also noted that the GSEs' former "political foes" in Congress have now retired. Rep. Jeb Hensarling and Sen. Bob Corker were both opponents of the GSEs for a long time, so Gator expects their replacements to bring "fresh perspectives on housing policy."

The fund's management also feels that most of the problems which had been identified over the last 10 years have now been dealt with. As a result, they don't believe legislation is required to reform Fannie and Freddie. They also feel the "narrative" behind putting Fannie and Freddie into conservatorship has now been "debunked." They believe the move was only the first of "several policy errors" which essentially "made it appear as though the GSEs were in a much weaker financial position than they were."

Finally, Gator feels removing Fannie and Freddie from conservatorship would be good for the housing market because the two companies will likely "make reasonable changes at the edges of their credit policy to help improve access to mortgage credit."

The fund's management expects the next step to be a plan for them to exit conservatorship, which they look for in the first quarter. They think the next step will be another amendment to the Treasury agreement to allow the GSEs to retain capital. Other steps they expect include a preferred-for-equity trade and an initial public offering.