John Paulson’s recent take on GSE preferreds

Here is John Paulson’s recent take on GSE preferreds. I think he is right, there is still some upsides (3:1 return) in these preferreds.

GSE Preferred from Report of Schroder GAIA Paulson Merger Arbitrage (Paulson_fund_Dec_2017)

The preferred shares of Fannie Mae and Freddie Mac together represent a top holding and are currently trading at approximately 28% of par value. As discussed in the Q2 letter, if the GSEs were restructured, we believe the shares would be worth up to 70 to 100% or par, offering an option value of 3:1 return. The positions traded up in Q3, as we continue to see Washington moving towards a settlement that should resolve the situation and benefit current shareholders. While Congress is not currently active in legislating on the GSEs, various important and politically significant stakeholders have come out publicly in favour of the Trump Administration and Federal Housing Finance Agency (FHFA) ending the net worth sweep arrangement and raising capital at the enterprises. Most recently, six Democratic senators wrote a letter to the FHFA and Treasury Department calling on them to allow Fannie Mae and Freddie Mac to build capital by retaining profits. The Republican National Committee also passed a resolution stating that investors should be resolved “in a manner that honors and respects the rule of law governing the rights of corporate stockowners.”
We believe the GSE reform is likely to be addressed after tax reform, in the first half of 2018. Treasury Secretary Mnuchin, one of the key decision-makers over Fannie Mae and Freddie Mac, has reiterated that his priorities include taxpayer protection and mortgage market liquidity. Both of these goals can best be strengthened by allowing the GSEs to retain earnings, raise new capital, and build up their capital base. Importantly, the capital buffer goes to zero at year-end, so allowing the GSEs to retain capital is the first step to reform and could cause the securities to trade up in the near-term.

We see very large upside in the GSEs and believe a resolution could be reached following tax reform, likely in early 2018.