Fanatical Infidel
3 months ago
Fannie Mae Preferreds Offer Election Opportunity
https://seekingalpha.com/article/4723054-fannie-mae-preferreds-offer-election-opportunity
Summary
Preferred stock of Fannie Mae and Freddie Mac should rise sharply if Donald Trump wins.
Recent prices are out of line with the election odds.
I estimate the potential gains and losses for investors in the immediate aftermath of the election based on the 2016 and 2020 patterns.
In July, I wrote about why junior preferred stock issued by Federal National Mortgage Association (OTCQB:FNMA) and Federal Home Loan Mortgage Corporation (OTCQB:FMCC) were a good bet in the event of a Donald Trump victory in November and possible recapitalization.
The article received more than 100 comments, with some disagreeing with my thesis that a second Trump administration would release the two mortgage guarantee firms from government control, since it failed to do so the first time around.
One difference is the Trump team would no longer have to surmount obstacles such as the objections of Mel Watt, the anti-release head of the Federal Housing Finance Agency, for much of the term. Legacy agency directors are no longer an issue due to a Supreme Court decision that allows presidents to replace such officials before their terms end. Trump blamed Watt in a 2021 letter to Senator Rand Paul urging "full privatization."
The Wall Street Journal recently reported that Trump allies including economist Larry Kudlow are working on a privatization plan.
In this article, I want to go beyond the July one by quantifying the expected gains and losses in the immediate aftermath of the election.
While the politics were complex in the immediate aftermath of the 2008 conservatorships, the Democrats' wish to keep them in government hands has been clear since the Obama administration imposed a net worth sweep on the companies' profits in 2012, requiring them to return virtually all profits to the Treasury.
After a period in which some Congressional Republicans seemed to favor abolishing the two mortgage giants entirely, the Trump administration made its position clear by ending the net worth sweep in 2019, allowing the companies to rebuild capital.
There have been two elections since the sweep was imposed, with one win for each party, and the stock prices have reflected this.
The following chart shows the closing prices of some highest-volume preferred issues the Friday before the 2016 and 2020 elections, and again at the close of the inauguration week the following January. The effect on the share prices was almost symmetrical.
Issue Coupon Liq. Pref. Recent price % of Pre-2016 2017 Inaug. % gain Pre-2020 2021 Inaug. % gain
full value election price price election price price
FNMAS Floating 25 4.31 17% 4.09 8.85 116% 9 4.44 -51%
FNMAT 8.25% 25 3.92 16% 4.05 8.58 112% 8.2 5.02 -39%
FMCKJ Floating 25 4.189 17% 4.05 8.28 104% 8.8 5.52 -37%
FNMFN Floating 50 6.48 13% 6.8 14.75 117% 14.31 9.06 -37%
Sources: Yahoo Finance, author's spreadsheet
Let's use FNMAT as an example. Note that the recent price of $3.92 is similar to what it was when Barack Obama was president, just before Trump scored his upset victory.
In the next three months, the price more than doubled, to $8.28 on the Friday following Inauguration Day. This is the same party-in-power swap that would occur this year if Trump triumphs.
But when Democrat Joe Biden won in 2020, the price declined 39% to $5.02 by Inauguration Week. The path was bumpy, as investors were unsure of the outcome until Congress confirmed the result in the early hours of January 7, 2021.
With the current odds of the race around 50-50, this looks like a straight-up bet. If Trump wins, a doubling is likely before the inauguration.
Risk Factors
Since the result wouldn't be as much of an upset as 2016, the move could be somewhat less.
If Kamala Harris wins, expect prices to fall nearly in half as investors will likely have to wait at least four more years for a recapitalization.
A double from 4 to 8 is worth twice as much as a halving to 2 costs, so the odds seem favorable as long as Trump has better than a 33% chance of victory. (If there were three elections and Harris won twice, the $4 total loss would equal the gain from the one Trump victory.)
In theory, one could hedge against a Harris victory by buying a stock or ETF that would likely benefit from continued Democratic control of the regulatory agencies, such as in renewable energy.
Note that this analysis only covers the period until the inauguration. Once the new president takes office, price changes will depend on the progress (or lack of same) toward recapitalization, which likely would see them converted to shares of a new common issue at liquidation preference value.
FNMAT is only selling at 16% of liquidation preference, so this would mean a gain of sixfold. Former Federal Housing Finance Agency director Mark Calabria has estimated it will take two to three years for the recap to take place.
In some ways, my analysis is similar to that of SA's main expert on the GSEs, Glen Bradford. However, I view the underpricing as being natural because of the risk-aversion of the market as a whole, and thus believe the stocks are unlikely to rise significantly until after the election unless Trump's odds improve to near-certainty.
Conclusion
Investing in Fannie and Freddy preferreds is risky, but if you think Trump has at least a 50/50 chance of winning, it could make sense to buy them as a short-term play, regardless of whether his administration ultimately succeeds in returning the mortgage insurers to private hands. If you also think Trump would complete the recapitalization, the trade would become a long-term investment.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
This article was written by
Vlae Kershner
trunkmonk
5 months ago
No punches pulled straight forward assessment. Buuut I believe Ps, as in every other company that has Cs and Ps, has value according to the health of the commons, which is supposed to reflect the value of the company. If commons were around Par value, Ps would be worth Par territory also. thats how the world of stocks works, no matter what the KTCarneyCircus thinks says or does.