FNMA and FMCC preferreds. In search of the elusive 10 bagger.

[merkhet]

 

Great points. Could it be as simple as...with this proposal there is an automatic $52B already lined up ready to go, versus the govt somehow pitching to the private sector on its own why it should invest $52B on what would likely to be far worse terms than the current investor group would be getting by purchasing the prefs at a large discount to FV?

 

As BB says in his proposal, there must be a margin of safety in everything. Not that I would expect somebody like Nancy Pelosi to grasp such a concept, but the investor group has a large embedded MOS with the current set up in order to guard against the risk of taking a long-term stake (with a 5y lock-up) in an entirely new business venture.

 

Or perhaps you're right Merket, and the govt could simply raise the capital via a consortium of insurance companies??

 

 

I remember an old quote from somewhere that "[T]he infidels never think of themselves as infidels."

 

You're thinking about it from the point of view of the investors needing a margin of safety for a new venture. Why shell out $52 billion of private capital when you can shell out $6.9 billion (20% of private preferred par) + $17.4 billion and get $52 billion in return.

 

My guess is that the government (1) doesn't care about providing hedge funds and private equity firms with a margin of safety and/or good terms and (2) would view this as giving hedge funds and private equity firms a $27.7 billion windfall.

 

Also, if you're right (and I think you might be) and the new company is likely going to be worth $100 billion, I think they will not have a problem raising $52 billion for the NewCo.

 

 

I understood this proposal differently:

 

Essentially the Value of Fannie and Freddie is split between the runoff and the ongoing/future business.

The preferred holders contribute 17 bio USD cash and the preferred stock will be converted into

"restricted capital" - which could be allowed to be counted as capital. Then, over 5 years the business

originates profits, which cannot be dividended out, until the restricted capital is paid up.

 

Please share your thoughts.

 

 

dolce, I think we're all understanding this on the same lines.

 

Note that when you confer the preferred stock as "restricted capital," Fannie & Freddie still have to provide assets to the NewCo as paid-in capital of some sort...

[dolce2think]

Yes,

 

17 bio in "real" buffer capital seems too thin in light of what happened.

What was the combined value of the common and preferred pre-crisis for both entities?

Around 200 Bio ?

[morningstar]

Yes,

 

17 bio in "real" buffer capital seems too thin in light of what happened.

What was the combined value of the common and preferred pre-crisis for both entities?

Around 200 Bio ?

 

About 66 for Fannie and 51 for Freddie (market value); 42 and 27 book value ... Bloomberg #s for FY 2006.

[merkhet]

Hopefully someone can post the CNBC video clip on here later.

 

I watched the interview on TV, and it struck me that Bruce just kept saying "Let's just do this." over and over again -- but there was no real response to when Faber and Cramer asked them "Why would the government do this?"

[bmichaud]

So I guess it all goes back to the legal argument. If the govt never views the prefs as legitimate claims on the business, then it could go straight to the $52B rights offering and keep the money itself. Whereas if the prefs are viewed as legitimate claims, then the govt could so a $52B rights offering, pay off the prefs in full and keep the extra ~$17B for itself.

 

Under the proposed plan, and assuming the prefs are viewed as a legal claim on the business, then the govt extinguishes the $35B of prefs for a simple exchange of assets but without the profit a rights offering would bring. I guess one could argue that if it did a rights offering, it might be difficult to raise $52B due to the uncertainty surrounding a new business (I mean look at the discount the market applied to AIG for the govt overhang with an highly profitable existing business in place!!), and thus this plan would be superior due to significant capital already in place ready to go.

 

I still think there has got to be some margin I safety in all of this that we r not seeing (if it is not in fact this plan) because I just so not see how one exists outside of this plan. If the legal argument fails, there is no MOS. The prefs are zero. Yet BB says there is a MOS and has sized his position accordingly. Who knows....

[merkhet]

 

So I guess it all goes back to the legal argument. If the govt never views the prefs as legitimate claims on the business, then it could go straight to the $52B rights offering and keep the money itself. Whereas if the prefs are viewed as legitimate claims, then the govt could so a $52B rights offering, pay off the prefs in full and keep the extra ~$17B for itself.

 

Under the proposed plan, and assuming the prefs are viewed as a legal claim on the business, then the govt extinguishes the $35B of prefs for a simple exchange of assets but without the profit a rights offering would bring. I guess one could argue that if it did a rights offering, it might be difficult to raise $52B due to the uncertainty surrounding a new business (I mean look at the discount the market applied to AIG for the govt overhang with an highly profitable existing business in place!!), and thus this plan would be superior due to significant capital already in place ready to go.

 

I still think there has got to be some margin I safety in all of this that we r not seeing (if it is not in fact this plan) because I just so not see how one exists outside of this plan. If the legal argument fails, there is no MOS. The prefs are zero. Yet BB says there is a MOS and has sized his position accordingly. Who knows....

 

 

I don't understand why the AIG example would matter. There wouldn't be an overhang with a $52 billion rights offering for a NewCo mortgage insurer. The government wouldn't own any piece of it.

 

Also, if there was not a perceived margin of safety, Bruce wouldn't own it in the first place. It does not follow that because of the ownership, there is an actual margin of safety. As I've stated before, I think we're on the wrong side of the Chevron doctrine. (link: http://en.wikipedia.org/wiki/Chevron_U.S.A.,_Inc._v._Natural_Resources_Defense_Council,_Inc.)

 

This will be interesting to watch develop. Right now it's a bit too risky for me to sell parts of SHLD and GM to buy private preferreds in Fannie & Freddie -- especially since, in light of what seems to me to be no new and/or negative news, the bet is now only paying 3 to 1. Like wellmont, I think I'd be interested if and when there is a restructuring on the table to see whether there are inefficiencies (banks that have their preferreds changed to equity and must dump, etc.)

[bmichaud]

I don't understand why the AIG example would matter. There wouldn't be an overhang with a $52 billion rights offering for a NewCo mortgage insurer. The government wouldn't own any piece of it.

 

I'm just using AIG as an example. The huge discount to BV for AIG was created by the govt overhang. In the case of the F&F NewCo, the overhang would likely be created by the mere fact you'd be buying into a brand new entity.

 

But main point was that the AIG overhang was assigned by the market DESPITE a highly profitable business already in place. With the F&F NewCo, not only are you investing in a brand new entity, but there is not really a business already in place (essentially the plan would give birth to a new industry over night), thus I would guess the overhang created by the market would be that much more punitive.

 

But yes I would agree taking a stake now would likely be premature. Given rampant insider information finding its way into stocks, I imagine the recent run-up in the prefs was due in part to this plan. As with most event-driven situations, there is a lot of volatility, and any hint of a delay or dismissal of the plan would send the prefs back down.

[bmichaud]

Hopefully someone can post the CNBC video clip on here later.

 

I watched the interview on TV, and it struck me that Bruce just kept saying "Let's just do this." over and over again -- but there was no real response to when Faber and Cramer asked them "Why would the government do this?"

 

 

I can't find a good clip to attach, but was able to see a quick 3 minute clip. Berkowitz sounds like a f$cking moron talking to Faber - wouldn't answer a single question, doing nothing to make his case. I've never been able to stand listening to him anyway, particularly in that ridiculous interview with Moynihan in 2011, and now this....doesn't instill much confidence in what he's doing....

[Guest wellmont]

this presentation isn't for the government. it's for guys like you and me. :) Bruce's "second level thinking".

[jay21]

Can someone please send me a link to the plan/letter that Buffett sent around during the financial crisis?  I can't remember if that was for F&F or more of a TARP type plan.

 

Found it:  http://www.valuewalk.com/2012/01/warren-buffetts-letter-to-hank-paulson/

 

While not pertinent to the discussion, I find it amazing that he was trying to basically structure an ABS CDO.  Profits would have been pretty fat on this.

[constructive]

Berkowitz trying to take credit for "helping" AIG by buying their stock on the secondary market is self-righteous nonsense.

[fareastwarriors]

From Fairholme's report.

http://www.fairholmefunds.com/show_pdf.php?file=http://www.fairholmefunds.com/sites/default/files/FAIRX%20July%202013.pdf

 

The Fund’s latest investments in the recovery of homeownership are in the preferred stocks of Fannie Mae and Freddie Mac. Your current mortgage may be backed by Fannie or Freddie – about 60% of new mortgages are. Millions of families depend on them to lower the costs and

increase the availability of homeownership. In times of stress, Fannie and Freddie stand to ensure the continued functioning of our housing market. Their twelve thousand employees do yeoman’s work helping to preserve a cornerstone of the American dream.

 

The Fund was able to purchase the preferred stocks of Fannie and Freddie near one-fifth of liquidation values – a significant bargain thanks to market predictions of U.S. Government agencies expropriating their assets. We see them differently. Fannie and Freddie are successful, publicly

traded, shareholder-owned companies just like AIG and Bank of America. Shifting political winds can change their futures, but not alter their pasts.

 

The Fund has filed complaints in the Court of Federal Claims and the U.S. District Court in Washington. In our suits, we seek nothing more than the enforcement of existing contractual rights, which require the payment of dividends to Fannie and Freddie preferred shareholders. Our

arguments are based on fundamental principles. In America, property ownership is a sacrosanct freedom, guaranteed by our Constitution. In America, we follow the rule of law, not the rule of the crowd. In America, profitable companies honor contracts.

[LC]

Sounds like a way to shift old assets into the gov'ts hands while privatizing the ability to write new mortgage insurance...probably to AIG as has been mentioned as they're one of the few companies with the scale to do so.

 

IMHO not a serious proposal: if the gov't takes them up on this I will be pretty upset as a taxpayer over such a fleecing.

[fareastwarriors]

http://online.wsj.com/news/articles/SB10001424052702303559504579198312328068096?mod=WSJ_business_MoreArticles

 

Fairholme Seeks to Profit From Growing Interest in Fannie, Freddie

[vinod1]

To me it looks like the deal is really all about getting full 100 cents on the dollar for the preferreds for Fairholme. If this deal passes they would have made 5x on the preferreds. Even if it means locking that capital for 5 years, it represents a pretty good return.

 

Vinod

[txlaw]

Bill Ackman getting in the mix:

http://www.businessinsider.com/bill-ackmans-pershing-square-reports-98-stake-in-freddie-mac-2013-11

[tng]

Bill Ackman getting in the mix:

http://www.businessinsider.com/bill-ackmans-pershing-square-reports-98-stake-in-freddie-mac-2013-11

 

Seems like Ackman is getting in as a common shareholder instead of a preferred. Very interesting.

[Grenville]

Bill Ackman getting in the mix:

http://www.businessinsider.com/bill-ackmans-pershing-square-reports-98-stake-in-freddie-mac-2013-11

 

Interesting to see Ackman build 10% positions in both Freddie and Fannie common stock. He was buying heavy at $3 at least in Fannie.

 

http://www.sec.gov/Archives/edgar/data/310522/000119312513443212/d630953dex992.htm

http://www.sec.gov/Archives/edgar/data/310522/000119312513443212/0001193125-13-443212-index.htm

[constructive]

Remember this from a few years ago? Ackman seemed to think these securities had a high risk of permanent loss of capital when they were priced much lower.

 

http://video.cnbc.com/gallery/?video=1786618239&play=1

 

Bill Ackman (Pershing Square): Who are you a fiduciary for? The shareholders?

Clayton Rose (Freddie Mac boardmember): Our fiduciary duties run strictly to the conservator.

Ackman: So you can make decisions that are adverse to shareholders?

Rose: Correct.

Ackman: Yet there is no liability to you?

Rose: Correct.

[Mephistopheles]

Bill Ackman getting in the mix:

http://www.businessinsider.com/bill-ackmans-pershing-square-reports-98-stake-in-freddie-mac-2013-11

 

Interesting to see Ackman build 10% positions in both Freddie and Fannie common stock. He was buying heavy at $3 at least in Fannie.

 

http://www.sec.gov/Archives/edgar/data/310522/000119312513443212/d630953dex992.htm

http://www.sec.gov/Archives/edgar/data/310522/000119312513443212/0001193125-13-443212-index.htm

 

The article says 10% stake, not 10% position. :)

 

I'm confused though because a 10% stake in FNMA would be nearly $2 billion, and in FMCC would be $1 billion.

 

According to Fannie's 10-Q, there are 5.8 billion shares outstanding. http://www.sec.gov/Archives/edgar/data/310522/000031052213000205/fanniemaeq30930201310q.htm#sBE5B9CCD847B2587CC9B7E4F6CD88837

 

But according to Pershing's 13D, there are 1.2 billion shares outstanding, which if so would make the 115 million share stake a 10% position.

http://www.sec.gov/Archives/edgar/data/310522/000119312513443212/d630953dsc13d.htm

 

Am I missing something here?

[txlaw]

Bill Ackman getting in the mix:

http://www.businessinsider.com/bill-ackmans-pershing-square-reports-98-stake-in-freddie-mac-2013-11

 

Interesting to see Ackman build 10% positions in both Freddie and Fannie common stock. He was buying heavy at $3 at least in Fannie.

 

http://www.sec.gov/Archives/edgar/data/310522/000119312513443212/d630953dex992.htm

http://www.sec.gov/Archives/edgar/data/310522/000119312513443212/0001193125-13-443212-index.htm

 

To me, it seems pretty risky to be going into the common.  The preferred clearly has risks as well, but the common . . .

 

I mean, do people really expect that there will be full payoff on the preferred?  I can see a preferred asset swap occurring, but I don't see why the government would actually capitalize the new companies with cash.  Maybe it's just a starting point bid, where the hedgies don't really expect cash to be contributed?

[Mephistopheles]

Also a couple of beginner questions:

 

1. I asked this before but didn't get replies so I'll just ask again. How can we check Congressional stock holdings? I am wondering if members of Congress own either the common or the preferred.

 

2. The risk for both the common and the preferred is that the government will take all the money and they will go to $0, correct? But if shareholders win the lawsuits, then the money will flow through. So in that case wouldn't the common offer a much higher return at nearly the same risk?

 

EDIT: Just saw your reply txlaw.

 

This seems like a binary sort of event in which if the judge rules in the shareholders favor, there would be plenty of money for all shareholders, and in which case the common would offer far greater returns than the preferred. On the other hand, they can all go to zero.

[JRH]

2. The risk for both the common and the preferred is that the government will take all the money and they will go to $0, correct? But if shareholders win the lawsuits, then the money will flow through. So in that case wouldn't the common offer a much higher return at nearly the same risk?

 

I would agree with this line of thinking. The preferreds have preference in any sort of liquidation/transformation event, but given that the company is probably worth either zero or bucketfuls to the stockholders (depending on the legal outcome), the fact that the preferreds have a bounded upper payout and the common does not may make the bet better, probabilistically.

 

It sounds like this isn't a big holding for Ackman, and is probably best compared to his purchase of GGP in bankruptcy that had a chance for a very high potential payout (that just happened to occur, in that case), and probably a very real risk of being worthless.

[txlaw]

2. The risk for both the common and the preferred is that the government will take all the money and they will go to $0, correct? But if shareholders win the lawsuits, then the money will flow through. So in that case wouldn't the common offer a much higher return at nearly the same risk?

 

I would agree with this line of thinking. The preferreds have preference in any sort of liquidation/transformation event, but given that the company is probably worth either zero or bucketfuls to the stockholders (depending on the legal outcome), the fact that the preferreds have a bounded upper payout and the common does not may make the bet better, probabilistically.

 

It sounds like this isn't a big holding for Ackman, and is probably best compared to his purchase of GGP in bankruptcy that had a chance for a very high potential payout (that just happened to occur, in that case), and probably a very real risk of being worthless.

 

Well, one thing to consider is that when there are legal battles like this, with sophisticated parties on each side, there tends to be an outcome that is not binary in nature (i.e., win or loss).  Instead, there usually are ongoing negotiations where some deal is reached.  Take the MBI/BAC ordeal, for example.

 

So, to the extent you believe the government has some reason to negotiate rather than see this out, then it's a question of how much the private owners will benefit from the deal.  Has anyone run the numbers on how the common would benefit from the run-off ops profit sharing option?

[Vish_ram]

I think there are several possible outcomes , each offering a different upside to common.

 

Option1: Privatize F&F after paying off UST;

  pros: pref goes to par, may also get accrued dividends, common gets all the upside

  cons: the new entity will be without implicit guarantee, will be a monopoly controlling >60% market.   

          New competitors may emerge, but will be slow to catch up. A potential anti-trust action can 

          ensue

 

Option 2: berkowitz plan

          run off (govt + common benefit) + newco (mostly pref and some common)

          pros: pref gets more upside (no wonder berkowitz is proposing it)

                  common: limited upside compared to Option 1

 

Option 3: Govt does nothing in near term (1-3 yrs)

          pros: pressure grows to reinstate div on pref, pref goes up

                  common languishes in uncertainty

 

Option 4: Govt puts f&f in run off, gets paid with principal & interest, pays off pref with div (buys back all pref) and rest accrues to common.

 

              Govt lets private companies underwrite guarantee. Companies like brk, aig, ..etc start setting up shop and competes for biz.

        pros: pref gets paid fully

        cons: limited upside to common, milks the run off. How do we deal with existing f&f employees, patents, infrastructure once runoff is complete? there could be lots of opposition from this stakeholder.

 

I think 3 & 4 are likely options.

 

disclaimer: long pref.

 

2. The risk for both the common and the preferred is that the government will take all the money and they will go to $0, correct? But if shareholders win the lawsuits, then the money will flow through. So in that case wouldn't the common offer a much higher return at nearly the same risk?

 

I would agree with this line of thinking. The preferreds have preference in any sort of liquidation/transformation event, but given that the company is probably worth either zero or bucketfuls to the stockholders (depending on the legal outcome), the fact that the preferreds have a bounded upper payout and the common does not may make the bet better, probabilistically.

 

It sounds like this isn't a big holding for Ackman, and is probably best compared to his purchase of GGP in bankruptcy that had a chance for a very high potential payout (that just happened to occur, in that case), and probably a very real risk of being worthless.