President-elect Donald Trump has made many investors bullish on the market, which has been on an incredible two-year run. Many believe that deregulation and corporate tax cuts could create powerful winds, unlocking positive investor sentiment that could. propel stocks higher.
Not surprisingly, billionaire investor Bill Ackman, a vocal Trump supporter, is all aboard this train. Ackman and his fund Pershing Square Holdings they have brought extraordinary gains over the past five years. Ackman now thinks two of Pershing’s long-standing businesses are poised to perform at about 900% thanks to the incoming Trump administration. Let’s take a look.
In 2013, Ackman and Pershing acquired an approximately 10% stake in the common stock of the government-sponsored entity (GSE). Federal National Mortgage Association(OTC: FNMA) and Federal Home Loan Mortgage (OTC: FMCC)known as Fannie Mae and Freddie Mac. Recently in X, Ackman presented his thesis on how the two mortgage giants could get out of government conservatorship and be recapitalized, leading to significant shareholder gains.
To provide some background, the US Treasury Department took Fannie and Freddie into receivership in 2008 after both agencies were caught holding too many subprime mortgage loans. Fannie and Freddie serve as a vital source of liquidity for the mortgage market, buying mortgage loans from financial institutions and lenders and packaging them into securities that are then sold to investors. Fannie packages mortgage loans from larger banks, while Freddie packages them from smaller banks.
While conservative, Fannie and Freddie passed all their profits to the Treasury under what is known as the net sweep agreement. The Treasury also holds more than $193 billion of senior notes preferred stock in Fannie and Freddie, as well as warrants that equal close to 80% of the common shares of Fannie and Freddie and expire in September 2028. The Treasury injected $187 billion of capital into Fannie and Freddie when they took them under conservatorship and has seen since about $300 billion. reimbursed by the net sweep agreement.
Shareholders, who were crushed after Fannie and Freddie went into receivership, have argued that it is time for the Treasury to release the two GSEs from receivership, while other hedge fund managers such as Ackman have I bet this will happen eventually. Things started to move in that direction under the first Trump administration. Treasury Secretary Steven Mnuchin ended the net sweep agreement and allowed Fannie and Freddie to keep profits to build capital. Meanwhile, the Federal Housing Finance Administration (FHFA) has set new capital requirements that Fannie and Freddie must meet to exit conservatorship.
A major problem is how Fannie and Freddie can realistically raise tens of billions in capital when the Treasury holds hundreds of billions in senior preferred stock and cash mandates because there is likely to be significant dilution.
Ackman believes the second Trump administration is ready to finish the job. He envisions a path where the GSEs are credited for their previous distributions to the Department of the Treasury under the net sweep agreement, which then withdraws the senior preferred shares. The GSE’s total capital requirement would be set at 2.5% of mortgage securities outstanding, a level Ackman believes would create a balance sheet that could cover about seven times the losses that Fannie and Freddie incurred during the Great Recession. The Treasury could then cash in its warrants and sell the common stock within five years, making a profit of $300 billion.
Ackman assumes Fannie and Freddie will raise capital in the fourth quarter of 2026, giving another two years to build capital. GSEs have strong earning power, so they can accumulate capital quickly. At that point, they will need another $30 billion to reach their 2.5% capital requirements.
Ackman estimates the value for Fannie and Freddie at about $34 per share. That’s 888% upside for Fannie and 909% upside for Freddie from their current levels (as of January 2).
While stocks are rising after Ackman’s post, investors should understand the significant risk in this investment and the many variables at play. Ackman assumes that the Treasury will credit past distributions towards senior preferred shares and that the capital requirement will be at 2.5%. However, the Congressional Budget Office (CBO) ran some scenarios about the GSEs exiting conservatorship in 2020, and the lowest capital requirement used was 3%. It is also not clear that the Treasury will apply old distributions to senior preferred shares.
That said, if the administration really wants to get the GSEs out of conservatorship, they’ll probably need to make concessions on senior preferred stock or warrants, and it’s definitely possible that they’ll use a lower capital requirement of 2.5%.
I agree with Ackman that the likelihood of the GSE exiting conservatorship has increased significantly. However, many unknown variables could arise, so investors should be careful.
Another idea is to buy junior preferred shares, which are also trading at a significant discount. There is less upside than common stock, but junior preferred stock has a higher priority than common stock in the capital stack. It depends on where you want to be on the risk spectrum. A smaller speculative position is probably better here.
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Bram Berkowitz has positions in the Federal National Mortgage Association. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
