Midas79

Yup, lots of time and patience. I'm lucky to have a work-from-home desk job that lets me both have the time to develop the model I made (been improving it for 4 years) and monitor prices. My success in this investment is no longer dependent on recap and release, though this wasn't true until recently. Ironically for a member of this board, I'm not really a value investor. I don't like stock-picking at all. I have owned stock in precisely 4 individual companies in my life, and Fannie and Freddie are two of them. If I make enough money from this stock to retire I will happily index from there and enjoy life. I also have the advantage (if you can call it one) of not believing in opportunity costs in the way that most people seem to, so I'm not bothered at all by other people making huge returns on things other than FnF. My method is working and I'm quite comfortable with it as opposed to either doing lots of research (classic value investing) or just jumping on the meme coin of the moment (FOMO-driven investing).

It's been a while since I posted here, but I am finally checking in. I run a pref-swapping model designed to take advantage of mispricings among the different series: results posted on the @midas79JPSmodel account on Twitter. Right now the liquid series (FNMAS, FMCKJ, FNMAT) are actually horrible buys relative to the others. When you can get a $50-par, albeit zero-dividend, series like FNMAP for only 10% more than the $25-par FNMAS (and they were almost at parity last week), buying FNMAS doesn't make sense at all. Par value is guaranteed to matter in the resolution of the conservatorships, while dividend rate is iffy at best. If you care about liquidity then FNMAS/FMCKJ/FNMAT are the only games in town. But if you're a small enough player or are willing to hold for a while, literally any other pref series is a better buy. Wiggins is correct above: the remedy in Lamberth's court would be based on par value and simple interest, not dividend rate.

I have all my FnF shares at IB now. I am able to trade every series I keep track of, which is 34 of them, including the variable-rates. I haven't tried to trade FNMFO or the privately-placed Freddie juniors (FREJO, FREJP, maybe there's one or two more?) though.

I still don't see this as an either/or. If the seniors are converted to common then the seniors are "toast" but the existing commons get crushed. And if the seniors are written off, they are actual toast and it's the capital raises and junior conversion that toasts the existing common.

Well put. I think this is both a legal special situation and a distressed company investment, they are not mutually exclusive. FnF are severely undercapitalized (which is the source of their distress, regardless of their profitability), even under a more reasonable capital rule, and a recapitalization is a form of restructuring. That's where placement in the capital stack comes in.

Released https://www.realvision.com/identifying-sound-anti-bubble-trades-fannie-mae-and-freddie-mac-live-with-michael-kao-and-tim-pagliara FYI Tim and Michael, and by extension the rest of us, have been asked not to share that link on Twitter. It was certainly an excellent interview and well worth listening to for any current or prospective FnF investor.

[*]All Scenario 2 does is show that the seniors don't count towards core capital. So I suppose I just disagree with your overall point that the earnings FnF retain from here are fictional capital. [*]The purpose of converting the seniors is as part of a settlement for all >$5B lawsuits; converting rather than cancelling the seniors allows UST to get something in return for them. In fact, I don't think UST is allowed to just give up the seniors voluntarily for no return consideration; when the September 2019 letter agreement had the 1:1 senior pref liquidation preference increase Calabria said that things had to be done that way. In that case this hypothetical $125B payment would never happen, meaning no later increase in value upon which to base the takings claim. [*]Tying the senior pref conversion with lawsuit settlement also prevents claims of higher values in the counterfactual universe because without lawsuit settlement the prices can easily be argued to have been around what they are now. [*]A final Collins APA win is years and years away anyway. If SCOTUS upholds the Fifth Circuit's ruling that Atlas erred in dismissing the case based on 4617(f) then the case goes back to Judge Atlas's court, where she would do discovery, depositions, conduct a trial, and render a verdict. Then that verdict would be appealed, en banc panel requested, petition for cert to SCOTUS, the whole works. I think that's around a 3-year process, and there is no guarantee at any point that UST would actually have to send back that money. Just getting the SCOTUS remand should motivate UST to settle anyway because they clearly want to settle/kill all cases with a contingent liability >$5B. [*]Any lawsuit over a senior pref conversion would be a Fifth Amendment takings case in the USCFC, and the citations Judge Wheeler gave specifically cover takings cases. Do you think these DE cases you refer to would have precedential power over the cases in those citations? Personally, I doubt it. [*]If your reasoning of "instant lawsuit" was correct then there would also be instant lawsuits when the warrants are exercised. Going from 100% to 20% is more than 4 times the amount of damages of going from 20% to 1% after all. But if UST feared any lawsuit over the warrants they certainly wouldn't have insisted on exercising the warrants in full before any outside capital can be raised. Yet another reason I think UST has nothing to fear from lawsuits over a senior pref conversion. [*]UST still (unfortunately) has veto power over just about everything regarding exit from cship, and they are the ones who care about protecting the taxpayer. Calabria just waving his hands and saying that the seniors now count towards core capital doesn't fulfill the 3% CET1 exit requirement that he himself agreed to and now can't undo without Yellen's help. Wachter can't change that unilaterally, and evidenced by her testimony she wouldn't do it anyway.

I stand by the <$5B of liability to Treasury on any lawsuit involving a senior pref conversion or warrant exercise. Judge Wheeler, when he awarded zero damages in the Starr/AIG case, extensively cited SCOTUS in saying that in a takings or illegal exaction case the only thing that matters when calculating damages is what the property owner lost, not what the government gained. So whatever market or economic value Treasury's common shares later have means nothing in this context. For citations see the first paragraph on page 35. http://online.wsj.com/public/resources/documents/StarrvUS06152015.pdf The only thing that common shareholders could prove that they lost is the drop in market price per share between when the conversion/warrant exercise happened and the date of the lawsuit. Unless the commons spike dramatically before one of those events, UST faces a maximum liability of 1.8B times the common share price of $2 or so, or less than $4B. And the whole reason to do a senior pref conversion is to attract private capital, with the intent of the capital raises happening well in advance of any final ruling in Collins, which is 1-3 years away because SCOTUS is only going to remand the case at best (from the plaintiffs' point of view). So the idea that the commons will rise to much higher levels before the senior pref conversion happens is, in my mind, just wishful thinking. If I had a nickel for every time someone incorrectly overestimated a short to medium term price target on the commons I could recap FnF myself. Even if such a price appreciation were plausible, UST would just convert the seniors to common sooner to prevent that extra liability. Changing capital definitions and requirements is in the purview of the FHFA director, not the UST Secretary. Also, there is no way the seniors can count towards core capital in their current form. HERA is explicit in saying that the only kind of preferred shares that count towards core capital are non-cumulative ones, which the seniors aren't. See (7) in https://www.law.cornell.edu/uscode/text/12/4502. Core capital is what determines FnF's capital classifications, so FnF won't be anything other than "critically undercapitalized" until and unless the seniors are written down or converted to commons. Making the seniors non-cumulative alleviates the core capital problem but leaves CET1 capital unchanged and doesn't allow for outside capital raises of new common shares when those new shares would be buried behind a mountain of seniors. The seniors being cancelled or converted to common allows outside common share investors to at least rank on par with UST. The whole point of private capital raises, and recap/release in general, is to place private capital in front of UST's backstop. Handwaving the seniors into compliance with capital definitions doesn't accomplish that goal at all. One problem Calabria had with Watt's rule is that it allowed too many prefs to count towards capital (which is why Calabria put in CET1 requirements), and Susan Wachter, a candidate to replace Calabria once Biden can fire him, said "While the GSEs are now less risky, the lack of equity capital to absorb losses leaves taxpayers still exposed to credit risk." in her June 2019 written testimony to the Senate Banking Committee. I can't see her doing this handwave, and if Zandi is the next FHFA director all GSE shareholders are basically screwed anyway. https://www.banking.senate.gov/imo/media/doc/Wachter%20Testimony%206-25-19.%20PDF.pdf I don't understand Scenario 2 here. How can Fannie sell more senior pref shares?

I disagree that the NWS has been ended. I know, even Calabria has claimed that. But as long as the Sr Pfd balance increases right along with retained earnings, the GSEs are only building fictional capital. The NWS is not really ended as long as this continues. One thing that has been lost along the way is what exactly is meant by "capital". I'm seeing similar problems in my discussion with Tim Howard on his blog. I can see five different ways to define capital: [*]Total stockholder equity on the balance sheet [*]Amount of liquidation preference owed to shareholders upon liquidation [*]Core capital: stockholder equity minus cumulative prefs and AOCI [*]Tier 1 capital: core capital minus DTAs [*]CET1 capital: Tier 1 capital minus non-cumulative prefs When you say that only "fictional" capital is being built, that tells me you are using #2 as your definition, or perhaps something not on the list. All other entries on the list will go up with FnF's retained earnings because they are balance sheet calculations: the earnings go on there but the senior pref liquidation preference increases don't. The key is that core capital is defined under HERA, and FnF's post-release capital classifications are defined by HERA. Thus increasing core capital, which retained earnings now do, is important even if the senior pref liquidation preference increases along with it. This is real capital being built in the eyes of the law. The letter agreement might have been thin gruel, but it wasn't a complete nothingburger. The date at which the true NWS would have turned back on has been pushed from around now to 2044 or so. While not being nearly enough to accomplish recap and release, it's a significant step.

That's now how I understood it. [*]FnF never had (and currently does not have) the ability to pay down the seniors voluntarily because the funding commitment still exists: this is in Section 4(a) of the original contract that is not being contested. More technically, they can't pay down liquidation preference increases due to draws, which have been the source of all such increases. Thus the proposed remedy that pays down the seniors violates the original contract, while the other remedy (UST keeps the seniors but sends back $125B) respects it. Why would the Fifth Circuit choose the former over the latter in that light? [*]The funding commitment, whose removal could very well collapse the housing market, is tied to the existence of the seniors. Extinguishing the seniors entirely would alter large parts of the original contract, and I would imagine even the plaintiffs don't want this. Writing the liquidation preference down to its original value of $1B helps, but then the 1:1 increases in last week's letter agreement as FnF retain capital would stay in force. [*]My interpretation of the questions before SCOTUS is that they won't be determining the form of backward relief on the constitutional claim anyway, only if it should be available; the form would be remanded back down to the Fifth Circuit. Is this correct? [*]The same reasoning applies to the APA claims. On that front SCOTUS is only being asked if the APA claims should be dismissed due to either 4617(f) or the succession clause. A victory for the plaintiffs there merely means upholding the Fifth Circuit's ruling on that front, remanding the case back down the Judge Atlas, right?

I think you are misunderstanding how the SPS dividend works. The SPS don't get a dividend until FnF hit their full with-buffers capital level of 4% of adjusted total assets, even if a future FHFA director makes a new capital rule due to Section 5.15, unless Yellen and the new FHFA director amend that out. Once full capitalization is reached ("Capital Reserve End Date") the SPS get the lesser of any net worth increase from the previous quarter and 10% of the SPS liquidation preference. But dividends to other classes of shareholders subtract from net worth just as earnings add to it. So once dividends are paid out to other preferred and common shareholders, the SPS gets the rest of what FnF earned in that quarter. What that means, paradoxically, is that the SPS are at the back of the line in terms of dividends once full capitalization is achieved, and the SPS get no dividends at all before that. It remains to be seen how easy or possible it will be to sell new common shares who have zero liquidation preference ever but will get normal utility-like dividends. Without a settlement to the lawsuits and private capital raises the SPS will get no money from FnF for decades. Not even a commitment fee, unless a future FHFA director and UST Secretary reinstate it. Altogether this agreement actually gives Treasury an incentive to move quickly on raising private capital: slow accumulation of retained earnings provides less taxpayer protection (in terms of how much capital stands in front of UST's LOC) compared to fast and large capital raises, and those raises accelerate UST's timeline to getting payments on its SPS. The SPS dividend also answers a question I had, which was "what would FnF do with all their earnings once they hit full capitalization?" I couldn't imagine the government would be okay with private shareholders getting enormous dividends, and FnF would have no reason to save any money past full capitalization anyway. Now we know: UST gets all the extra money. Something else to consider is that 4% of adjusted total assets, the threshold at which the SPS divs turn on, was $265B as of last June and grows with FnF's asset base. I use 2.5% per year as a ballpark. FnF's combined core capital, though, was negative $167B at that time. That's a $432B gap! FnF make around $20B in earnings per year, but the 4% target grows at $6.6B per year right now and faster in the future as the 2.5% increases compound. Carrying out the math, that means not only will FnF not be fully capitalized through retained earnings by 2028, it will never happen at all! The smallest the gap between FnF's core capital and the requirement gets is $72B in 2065, then the compounding of the 2.5% becomes greater than $20B per year and the gap starts to widen again. Now, assuming flat earnings of $20B per year is probably unrealistic. If they also grow at 2.5% per year, which I think is reasonable because FnF's earnings are also roughly proportional to the size of their asset base, the $432B gap closes in a finite amount of time, but not until 2044. Note: only the SPS balance on the balance sheets count (negatively) towards core capital, a total of $193B for FnF combined. Increases to the liquidation preference due to the letter agreements, including the one from Thursday, are not reflected on the balance sheet and thus don't affect core capital at all.

What if Collins is settled? Does it depend on the settlement parameters? And if the Collins plaintiffs drop the case and ask SCOTUS not to rule, in order to preserve Calabria in office (until Biden files a copycat suit but that adds at least a year to the timeline), would SCOTUS comply?

To be honest I think that last part is true also. New money is always willing to step over the corpses of old money. That's why I believe the commons have so much more downside than the juniors: everyone is aligned against them; even Treasury because they have no reason to both maximize the warrants' value and write off the seniors.

UST writing off the seniors but trying to maximize the value of the warrants makes no sense whatsoever. If UST is in maximization mode they will convert the seniors (and it must be to commons due to CET1 capital requirements), not cancel them. The warrant shares were always going to be diluted by later capital raises anyway; there's a reason UST has never valued them at a full 80% of FnF's estimated market cap (Craig Phillips said UST's internal valuation was around $60B, or $8.33 per share). Also, Perry is the only case that affects the viability of capital raises because it holds the GSEs themselves liable. All other cases only involve UST eventually paying money to FnF if the plaintiffs win; with the seniors and NWS gone there is nothing else to fight over. Prospective investors would then price the capital raise shares conservatively relative to the assumed probability of success in the court cases. Any upside surprises in those cases would then mostly accrete to the new investors. In a SCOTUS loss scenario, there is no such thing as retained earnings, at least not for FnF or shareholders. UST would continue to sweep all profits because the NWS would be legal.

The PSPA would still have to be amended for this to work. Right now, any missed dividend payments add to the SPS liquidation preference, which prevents any later recap; by the time FnF have enough capital to think about exiting the SPS balance will be worth more than their market cap. At that point, even if new investors would be willing to invest enough money to pay off the SPS, they would demand 99.999% of the equity and wipe legacy common shareholders out. UST does have to give permission for release per the terms of the current PSPAs, so #5 will also require an amendment. What's the purpose of keeping the NWS on non-cumulative shares if FnF will never pay it anyway? An incentive to pay down the SPS as quickly as possible? That would increase taxpayer risk because FnF wouldn't be able to retain any capital beyond the thin cushion they have now.

@WB_fan I do agree that the central question is about the timing and amount of FnF's third-party capital raise(s). Following is the reasoning I posted on another board. Right now I'll use the assumptions that FnF need to hit $235B in core capital at the end of 2025, that the seniors are cancelled/converted, and that they earn $20B per year. Without the seniors their core capital right now is around $35B. That leaves $100B of common shares to be sold some time between now and the end of 2025. Note: with the current capital rule FnF's 4% with-buffers core capital standard, which is a percentage of total assets, would be around $300B at an annual asset growth rate of 2.5%. Thus my assumptions include a 22% reduction in the capital requirements. Consider the following three scenarios: 1) FnF raise $100B immediately. Their core capital levels are $135/155/175/195/215/235B at the end of 2020-2025. 2) FnF raise $20B per year. Capital levels of $35/75/115/155/195/235B. 3) FnF raise $100B five years from now. $35/55/75/95/115/235B. It is clear that #1 dominates #2, which in turn dominates #3. At every moment in time, more capital is better than less capital. Period. This remains true even if you tweak the assumptions above. I have heard the argument made before that FnF have operated with little to no capital for 12 years so what's the rush? My response is summed up well by this tweet: https://twitter.com/the_CMLA/status/1339600322046513160 In conservatorship and with the NWS in place, the government both has control over FnF and rights to all its profits, while taking all the risk. But FnF are meant to be private, shareholder-owned companies, and there is no point to having shareholders if they gain no economic benefits from their shares. A permanent nationalization truly would consolidate FnF onto the government's balance sheet, an outcome everybody involved wants to avoid. If Treasury wants to remove that risk to the taxpayer, they must get private capital involved, and the sooner the better. Calabria has also said that FnF will go under in a severe economic downturn. In the end, I see no reason not to raise capital ASAP and in as large amounts as the market will support. The only ones who benefit from a slow, earnings-only capital raise are existing commons, who have nobody on their side except maybe Treasury due to the warrants, and Treasury has enough ways to make money here that they aren't going to try to maximize the value of just the warrants, especially if they give up the seniors. To the rest of your points: [*]COBFInfinity summed up my feelings on dividends nicely. FnF need a ton of outside capital, and restricting the investor pool by not offering dividends is unwise, if it's even possible. Not to mention the facts that the offering price of the commons will be lower than it otherwise would be if there were dividends. The same is true for an early junior conversion: if one doesn't happen immediately, there will have to be $33B more of commons raised later than if the conversion does happen first. That future dilution risk will be factored into the offering price. [*]In a low-interest rate environment, I fully expect any FnF junior pref share with a div rate of at least 5% or so to trade at >=120% of par once dividends are turned on. Even discounted back 3 years that's at least 80% of par. The choice on whether to own the commons or juniors now is based on the prices of each at the time of the first share offering, and is answered simply by whether you think the pref:common ratio will be greater then than it is now. If yes, own prefs, it no, own commons. If you think it will be close own both, though I'd still weight towards prefs due to my opinion that they have less downside. It doesn't matter what the commons do later because the juniors could just convert in the open market at the time of the first capital raise. For the commons to be a better buy (and hold) right now they will have to hit at least $6 or so (and that's with no immediate divs or conversion) when everything is announced and stay there (because short-term irrational exuberance could push it above there temporarily but we're talking long-term value). I don't think there's enough future upside to the commons at $6 for them to stay there for long. [*]The retained earnings from the last year do count as capital because of the way capital is calculated. Core capital is balance sheet equity minus the seniors and minus AOCI (a rounding error). The concomitant increases in senior liquidation preference don't change that because they don't show up on the balance sheet. And weren't you the one saying liquidation preference doesn't matter outside actual liquidation? If so, why do last year's earnings not count for raising the common share price but future ones will? [*]Your argument that Calabria won't allow dividends, even though he specifically included the possibility of exceptions to the dividend restrictions in his capital rule for the purposes of raising capital (thus showing that he thinks immediate or near-immediate dividends will be necessary to raise capital), conflicts with your argument that he won't push for a third-party capital raise ASAP. If the purpose of keeping divs off is to build capital faster, why unnecessarily delay third-party capital raises? [*]The seniors are already repayable upon the issuance of capital stock. In fact the paydown would be mandatory. The problem is that in your scenario of the seniors staying in place (though becoming non-cumulative), the first $193B FnF raise would have to go towards paying off the seniors and thus wouldn't build capital at all. Raising that much equity, which would have to be all common shares, would cause a crazy amount of dilution in and of itself. $193B is already 80% or so of the future market cap, so the investors will want even more. Add in Treasury exercising the warrants first and you're looking at the existing commons having low single-digit % of the overall equity in the end. This scenario likely leads to the commons being worth less per share than they are now. [*]Your idea that some FnF debt could be exchanged for equity is something I hadn't considered. It certainly would raise capital, though again it would have to be for common shares only because the juniors take up all the available room for non-cumulative prefs in Calabria's capital rule. It's hard to say how this would affect the price, but corporate debt investors, especially in companies as safe as FnF, are unlikely imo to take the risk of owning common shares unless they are richly compensated, resulting in more dilution to the existing commons than just doing a public offering. [*]If Treasury does what I expect and takes actions that will allow third-party capital to be raised, they will be out of the loop in terms of capital raise timing. That's the whole point of getting this done before Yellen takes over: neither Calabria nor Mnuchin want her to be able to stop the recap and release process. Then it becomes only Calabria's call as to how soon to raise capital, and he has said in interviews he wants it done sooner rather than later. [*]This shows the difference between Calabria and Mnuchin in terms of capital raise urgency. Mnuchin has an incentive for third-party capital to be raised sooner due to taxpayer protection, but the housing market has been robust enough during Calabria's term that he hasn't had to worry about FnF going under, especially with the increased capital levels due to the letter agreements. He has also had a ton else on his plate. Calabria, on the other hand, has been very outspoken about FnF's lack of adequate capital and the need to build it. The only reason he hasn't had FnF do capital raises already is that the conditions that would allow that have not been in place (NWS, seniors). He even said that he would have wanted FnF to do huge capital raises earlier this year but it just wasn't possible at that time. Once Calabria is free to determine how fast FnF raise third-party capital, I believe he will push for (and get because he's the FHFA director) the largest possible raises ASAP. No self-proclaimed safety and soundness regulator would do otherwise.

Then Tsy owns more than 80% of common and GSE liabilities get added to U.S. Gov't debt. Is that a plausible scenario? Treasury can convert some of the seniors to get them to 79.9% ownership (the warrants become superfluous here) and the rest to non-cumulative zero-div prefs with a mandatory conversion to common upon sale to an outside party. The zero-div part is so Treasury doesn't just sit on them, and the mandatory conversion is for compliance with CET1 capital standards. Those would essentially be valued as commons (because they would become commons when sold) without actually being commons. Also, if they can find immediate buyers for 7.2B shares (that would be 80% of the total) they can do a partial conversion for 7.2B shares, sell them, convert more seniors to get 28.8B more shares (80% of the new total), giving them de facto 96% of the pre-raise ownership while never having more than 80% at any one time. Naturally the buyers of the 7.2B shares would know about the later second conversion and price the shares accordingly. A third round of this could get them to 99.2%. I could probably come up with more possibilities if I put my mind to it. Suffice to say, the 80% threshold is no bar. I think Treasury only picked that number for the warrants because that's the most they could do in a single transaction. Senior pref conversion is what opens the door to more, and is part of why I think the commons have much more downside potential than the juniors. When Treasury's incentives become opposed to those of the existing commons, it's no secret who will win. I consider it somewhat ironic that the one of the worst-case scenarios for the commons (huge senior pref cramdown) comes alongside recap and release.

@WB_fan One more thing. I do appreciate your continued posts, even though I disagree with much of the content. At the very least this allows me to crystallize my thinking by putting it in writing (as well as exposing it to outside criticism); I don't consider trying to change your mind to be a goal of mine. In the end, the disagreement is motivated by differing opinions of whether the commons or juniors are a better investment from this point forward. You see similar downsides for both and more upside for the commons, while I see similar upsides for both and more downside for the commons. This is primarily fueled by disagreements over when capital will be raised and when dividends will resume (you say later, I say sooner). This summary is for those who don't feel like reading through my longer posts because I have always erred on the side of post length.

The $50-par fixed-div prefs trade at around $15.00, which represents a 6.25:1 ratio to the commons (give or take). That means if they are eventually converted at par and at the market price of the common, the commons will have to be at $8 ($50 / 6.25) at that time in order for owning commons now to be better. That would be a 233% gain from here, greater than the median of your range. So owning commons now requires an assumption that the top end of your range will be hit. It also assumes both that the prefs won't get dividends between now and then (increasing the overall return of the prefs and their market price; 6% FnF prefs should trade above par) and that earlier capital raise participants won't insist on the juniors being converted first, which they have every reason to do because otherwise $33B more of commons would have to be raised later due to the CET1 capital standard. In the end, nobody involved, not even the boards or UST, is going to take steps specifically to lower the amount of dilution. There's just no benefit to that other than to existing common shareholders, who truly have no voice or no say in this process.

@WB_fan [*]I don't buy the TMUS comparison. They aren't a utility the way FnF will be, and neither are VZ or T. Each of those has the potential for rapid growth with the right innovation and/or major mistake by competitors. Those can't happen with FnF, especially with the CSP in place. FnF are a duopoly with no realistic way to be threatened by a competitor, especially with Calabria's high capital standards. The specter of 2008 will also prevent them from getting to innovative because FHFA will be quick to step in. Calabria has already said he wants approval power over new products. These factors limit growth to roughly that of the housing market, which increases investor demand for income. And what exactly are the "certain utilities" you refer to? In my opinion, to be comparable to FnF these utilities need to be monopolies/duopolies and have relatively limited prospects for future growth. [*]Even if dividends aren't offered immediately, the offering price will be lower without dividends than with. That means more dilution, so in the quest to deny value to the juniors, the existing commons would be cutting off their noses to spite their faces. Earlier capital raises also provide more stability to the housing market and taxpayer protection than later ones, so the idea that FnF could just build earnings and not raise capital until 2023 or later is, to me, just a fantasy. It works against the incentives of both FHFA and Treasury, even when they are led by Biden's picks. [*]Of the economic value shares have, only liquidation preference and dividend preference vary with the health of the company as measured by the balance sheet. Take a company with essentially no going-concern problems like Apple. If they were to receive a $5B check then the stock price would go up, but the only real change would be an increase of liquidation preference attributable to common shareholders. A similar but opposite effect would happen if $5B suddenly disappeared. Liquidation preference absolutely matters outside of liquidation when it comes to stock value. You even agree with this: you argue that FnF's stock price should rise as they retain earnings. All the retention of retained earnings does is increase the liquidation preference of the commons. [*]A much more relevant time when liquidation preference matters is in a restructuring of the capital structure. That is exactly what it going to happen with FnF. [*]The idea of special dividends to common while trying to shaft the juniors (by not paying their dividends before or after the special dividend) is pure wishful thinking. It's possible in the sense that winning the Powerball is possible, and it doesn't prove any point at all. FnF could just as easily turn on junior dividends and keep common dividends off instead. [*]Yes, there absolutely has been retention over the last year. Just look at the balance sheets. FnF haven't paid Treasury a dividend since September 2019. The liquidation preference increase to the seniors will be unwound when the seniors themselves are resolved (either by writing them off, converting to common, or some combination of both). That won't remove the retained equity from the balance sheet. What you appear to have missed is that the liquidation preference increases due to the retention of earnings don't show up on the balance sheet. Go look at the balance sheet from Q3 2019. The senior pref amount is the same as it is now. FnF's capital has been rising as they have retained earnings. And the stock price hasn't moved much. [*]The increase in senior liquidation preference has nothing to do with their cumulative nature. It has to do with the wording of the PSPA and senior pref stock certificate contracts. [*]The reason the senior pref balance on the balance sheet hasn't risen due to the letter agreements is because when it ballooned in 2008-2012, FnF was receiving cash from Treasury. That had to be accounted for somehow, and it was done by increasing the senior pref line on the balance sheet. This also undercuts your argument that liquidation preference only matters in a liquidation. If that were true, why would Treasury consider the liquidation preference increase to have any value at all? That's the consideration they received in return for allowing FnF to retain more earnings. [*]As such, I think the current P/E reflects just how much uncertainty there is over the final share count, not the amount of capital FnF have (which really has been steadily rising for the last year, again, check the balance sheets). There are 1.8B shares out there for FnF combined, but I can easily see it expanding to 30B or more depending on warrants, junior conversion terms, and capital raise size/timing. [*]If the seniors are converted to other shares it will have to be commons, not non-cumulative prefs. With that level of non-cumulative prefs on the balance sheet ($193B worth), capital raises will be impossible. That not only closes off common dividends in the immediate term, it does so until the seniors are gone, otherwise the senior dividends would eat up all of FnF's income. It's one thing to say that new common investors won't want immediate dividends. It's quite another to say that they will be okay not receiving one for a decade. [*]The other reason the seniors would have to be converted to commons is the presence of a CET1 capital standard, and the fact that both buffers must be comprised entirely of CET1 capital. No prefs, not even non-cumulative ones, count towards that. [*]The commitment fee might be absurdly high while FnF have low capital amounts. I also expect something reasonable (FDIC-like) once FnF are fully capitalized, but not necessarily before then. Also, once the seniors are gone FnF's credit lines will revert back to $200B per company, unless FHFA and Treasury negotiate a different amount (which might be even higher, and could be sized differently for each GSE). 1% of that per year is $2B per company, which represents a roughly 17% drop in earnings for Fannie and 25% for Freddie. [*]As I explained above, I don't think converting the seniors to non-cumulative allows third-party capital to be raised. Mnuchin specifically mentioned third-party capital, so I can't see him taking some steps that would allow that to happen but not all of them. [*]Why does the re-IPO price have to depend on the then-current market price of the commons at all? The new investors will have a good idea of FnF's earnings power (in fact they already should), and thus they will know how much of the equity they will demand in return for their money. For example, if they are asked for $100B and estimate the market cap to be $250B (both numbers FnF combined), they will demand 40% of the equity at a bare minimum, and in my opinion they will want a good bit more. None of that depends on the market price of the commons.

The no-div, no-earnings companies are completely inapposite comparisons to FnF because the former are high-growth companies, while FnF are closer to utilities. Utility investors primarily care about income. So in the end I just plain disagree on this point. I still think new investors will want immediate dividends. Liquidation preference determines how much earnings power flows to the commons. If, hypothetically, there was $1T of liquidation preference ahead of the commons, they would trade at pennies. The retained earnings rate really isn't that fast. By the end of the five-year period that Fannie and Freddie want for full compliance with the capital standards, the with-buffer minimum capital standard will be $300B ($265B in 2020 grossed up at 2.5% per year). In five years they will still be around $150B short of that with retained earnings. New investors putting in $150B of commons will want at the very least a controlling stake, and I think they will want more like 3/4 of the equity. That doesn't leave much for the existing commons, especially with Treasury's warrants taking up 4/5 of what new investors don't get. I maintain that third-party capital must be raised, it will be raised in the next 12-18 months, and that the juniors will either have their divs turned back on or be offered a generous conversion to common at that time because it aligns with incentives for FHFA/UST/new investors and only harms existing commons (which nobody cares about). You evidently disagree with that, but at this point we seem to just be talking past each other regarding that. And you're just making an assumption that the commons will explode later, which drives your "virtuous cycle". If the coming PSPA amendment says that FnF have to pay a commitment fee based on their capital levels, with the fee being large while capital levels are low (as they are now), then not only would retained earnings alone take multiple decades, it also incents FnF to perform larger capital raises rather than smaller, and sooner rather than later. That leads to a much lower offering price, and if the fee is high enough the commons could actually drop on the announcement. If I had a dollar for every future high common price prediction that didn't come true I could recap FnF myself. I do think the commons will take off faster than the prefs once the PSPA amendment is finally announced, but how the terms affect the commons will quickly sink in. A good trading opportunity, perhaps, but we're talking long-term value here. The P/E of the commons right now means nothing because the final share count is hard to estimate and will certainly be far higher than it is now. If one year of retained earnings should double the stock price, why hasn't it doubled in the last year when FnF have been retaining their earnings the whole time? It doesn't work that way.

Do you think new commons can be issued while the juniors still exist but without turning dividends on? Another argument: boiled down, the economic value of common shares comes from its liquidation and dividend preference. New commons would rather have less of each in front of them, so they should actually insist on the juniors being converted first, especially because it costs the companies no money. Otherwise they will pay less for their shares than without the conversion. And another: the capital rule leaves no room for new pref issuance. That means if the juniors stay in place, all capital raises must be all common shares. If new investors buy commons while the juniors exist, they will know that if FnF want to raise capital later, it will either be more common shares (dilution) or via converting the juniors and issuing new prefs (dilution). That specter of future dilution will also serve to lower the offering price. Note that Citi offered its pref stock exchange both for the express purpose of increasing tangible common equity (equivalent to CET1) and while it supposedly owed a fiduciary duty to the common shareholders. There is absolutely precedent for FnF doing something similar. There are three things that can be done with the juniors: leave them as-is, redeem them for full par in cash, or convert them to commons. Redemption makes by far the least sense because it accomplishes the same capital stack-clearing goal as conversion but costs $33B more in cash at a time FnF need to be building capital. Redemption is completely off the table. Refinancing the juniors adds zero capital. Converting the juniors and then selling $33B of new ones adds $33B of capital. CET1 capital requirements, along with the zero room for new prefs while the juniors exist, means that a debt-for-equity swap with the purpose of recapping FnF just results in as much dilution as a huge re-IPO would.

@cherzeca (and anyone else who might know) A legal question. 12 USC 4617(a)(7) says: while Section 5.3 of the PSPA says: Is there a conflict here? Is FHFA allowed to voluntarily tie its hands and allow another US agency, namely Treasury, to exercise a right that FHFA has, namely the ability to end the conservatorships without declaring receivership? More accurately, Treasury would be preventing FHFA from exercising that right.

As for the WSJ article, it seems to me that the entire conclusion that Mnuchin won't act before inauguration is based on the quote "In a Wall Street Journal interview, Mnuchin said he’s not going to pursue any actions that put taxpayers at risk or limit consumers’ access to home loans." That conclusion cannot be logically drawn from the quoted premise. Amending the PSPAs to eliminate the NWS and seniors neither puts taxpayers at risk nor limits access to home loans. Taxpayers would actually be more protected because those two things are necessary to raise third-party capital, and as long as the backstop remains in place access to home loans shouldn't be any different than it is now.

See Bloomberg Intelligence's take attached... Actual intelligence from Bloomberg! (tongue in cheek there, Ben Elliott has been excellent)