o Trump was elected and his Treasury Secretary, Mnuchin, said GSE reform is a priority
and will be done super-duper, bigly fast with the help of congress
o The prefs went from ~15 cents on the dollar to ~40 cents on the dollar in late ’16, early
o Turns out tax reform, repeal of Obamacare, etc were more important than GSE reform
and Congress was not helpful
o Prefs drifted back down to ~25 cents on the dollar for most of ’17-‘18
Now, what has happened recently to change the calculus on the “always on the come” preferreds?
Simply, Trump appointed Mark Calabria as the head of FHFA, the GSE’s regulator, and he has been
explicit about ending the conservatorship and doing it quickly. Importantly, as head of FHFA, he has sole
authority to release the GSE’s and end the net worth sweep.
Trump issued a directive for Treasury and FHFA to provide plans for GSE reform. Calabria has been doing
a speaking circuit talking about a potential 2020 IPO. My guess is these claims get walked back to a more
reasonable timeline, but the cow is out of the barn and GSE reform is coming. The Prefs have rallied
back to roughly 50 cents on the dollar and are up roughly 100% year to date.
Why now? Isn’t the Calabria rhetoric priced in?
“Whether we can do some kind of conversion with preferreds, or whether they would get
par, it’s way too early to figure that out.” – Mark Calabria, CNBC, May 20, 2019.
We don’t think so. We think the next 3-6 months will cement the path forward and the market will begin
to discount some recovery some 2-3 years in the future. We believe active court cases and decisions
expected in the next year will hold the administration to the expressed timeline of “late 2019”.
Immediate par recovery is possible we suppose, but we think unlikely. A par recovery 3 years out, after
many machinations of capital raise and restructuring, discounted back at 15% per year would be about
65 cents on the dollar or another 30% from here. A 10% discount rate on a 2 year time horizon would be
~80 cents on the dollar or a 60% return from here. You can use whatever discount rate you prefer and
whatever time horizon, but we believe this trade is morphing from “hail mary” to regular way “merger
arb” and the required return for the market is dropping from multiples of capital to ~10% IRR. There is
still meat on the bone and it is likely to be realized in the next 6 months.
There are many different preferred issues that trade for both FNMA and FHLMC. I used FNMFO because it is the one trading at the largest discoutn to face value.
Happy to add more in the comments.