We’ve been following the investment case for Fannie Mae and Freddie Mac for quite some time, and funds which have held the GSEs’ preferred shares continue to benefit. Gator Capital Management is among those which have held Fannie shares for an extended period, and its first-quarter returns demonstrate continued success.
According to its Q1 letter to investors, which was reviewed by ValueWalk, the fund gained 19.78% during the first quarter, outperforming its benchmark, the S&P 1500 Financials Index, which gained 8.66% during the quarter. The S&P 500 Total Return Index was up 13.65% for the first quarter.
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Fannie preferred shares remain profitable
Fannie Mae’s preferred shares continue to be one of Gator’s top performers, along with NMI Holdings, OneMain Financial and Syncora. The fund’s biggest detractors were Bimini Capital Management, Kingstone Companies, UBS Group and Community Bankers Trust.
Gator’s five largest long positions, excluding exchange-traded funds and fixed-income instruments like preferred stock (which includes Fannie Mae), are Zion’s Bancorporation, Syncora Holdings, Ambac Financial Group, SunTrust Bank, and KKR & Co. The fund’s five biggest shorts are Northwest Bancshares, Meridian Bancorp, UMB Financial, American Homes 4 Rent and Invitation Homes.
The Gator team said several of their non-bank financial holdings, including Sallie Mae, OneMain and NMI, recovered well from the selloff in December. Private equity managers also had a strong start to the year. They noted in their January letter that Fannie preferred shares started 2019 strong as investors speculated that the Trump administration could finally end Fannie’s and Freddie’s conservatorships this year.
The first step in the process was to confirm Trump nominee Mark Calabria as the new head of the Federal Housing Finance Authority, which oversees the GSEs. The Senate did confirm his appointment earlier this month. The Gator team believes the next step will be details from the Treasury Dept. about a plan to recapitalize Fannie and Freddie. They continue to hold preferred shares of Fannie.
Updates on other positions
Syncora remained a strong position for Gator during the first quarter, driven by the company’s announcement that it engaged an investment bank to run sales for the entire company or for just its insurance subsidiary. The fund’s management sees a number of ways Syncora stock could gain even more. The easiest answer would be for the entire company to be sold and shareholders to receive cash. Another possibility is for the insurance subsidiary to be sold and a large one-time cash distribution to be made to shareholders, along with a stub position in the remaining shell company.
Gator said UBS’ underperformance was driven by lower interest rates and “a difficult quarter from a capital markets perspective.” However, the fund continues to hold shares in UBS and also Barclays and Credit Suisse, both of which also declined during the first quarter, although not as much as UBS. Gator management continues to see all three as having “compelling” valuations, adding that they’re starting to return capital to shareholders via high-cost preferred securities, dividends and share repurchases.
The long case for SVB Financial
The fund’s management also outlined its long thesis for SVB Financial, which they bought during the first quarter. SVB is Silicon Valley Bank’s bank holding company, which is important because Silicon Valley Bank provides commercial banking to many venture capital firms and venture-backed investment
companies. Even though SVB has had a “strong franchise and a great long-term track record,” its stock has been underperforming since September.
Gator management also outlined five reasons for this outperformance, adding that they see an opportunity here because the concerns have pushed the stock “down to a level that is compelling.”
“While these concerns are valid, we believe each is temporary and will not diminish the long-term franchise value of SIVB,” they explained.
The first concern is related to interest rates as many investors note that SVB is the most asset-sensitive bank, which makes it the most exposed to lower rates. The second is related to the venture capital community, which has received so much interest over the last few years that valuations for late-stage venture companies are high, creating a more difficult environment for now.
The third concern is the expectation that the bank will have less warrant income in the first quarter because the government shutdown earlier this year pushed back the IPO calendar. Fourth, the bank’s management guided for a decline in deposit balances for Q4 “due to expected distributions by Venture Capital funds to their limited partners.” Finally, SVB has guided to higher-than-expected expense growth from time to time so that it can keep investing and expanding its franchise.
Here’s what they like about SVB Financial Group
Despite these concerns, Gator management sees several things to like about SVB. They feel the firm’s deposit base is “extremely attractive” and even “one of the best deposit franchises in the country,” based around the venture capital community. Second, they like the firm’s consistent double-digit loan and deposit growth, and third, they feel earnings estimates are too low.
Fourth, they like the firm’s position within the venture community, especially its relationships with venture capital and private-equity firms. They also like the high return on equity, which enable it to reinvest more of the capital it generates. Additionally, the Gator team expects SVB to benefit from the easing regulatory environment, and they predict the firm will regain its premium valuation of 15 to 22 times earnings per share estimates. It currently trades at a valuation of 11 times 2019 earnings per share estimates.
Finally, they like that the firm is generating extra capital and that its management has begun repurchasing shares.
This article first appeared on ValueWalk Premium