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

[muscleman]

from Glen:

Judge Lamberth entered an order today denying FHFA, Fannie and Freddie’s request that he reconsider his not decision that preserved shareholders’ contractual claims.  Judge Lamberth declined FHFA and the GSEs’ invitation.  Accordingly, shareholders’ implied covenant breach claims will not be dismissed and will proceed to trial.  A copy of Judge Lamber’s decision is attached to this e-mail message.

 

Court doc attached...

Thank you, Luke. And Muscle. Don't you guys love this logic?

 

what logic? Lamberth’s reasoning in his order?

[muscleman]

Collin en banc "should" come out in late June (5 months from orals). Lamberth is a trial for next year. same with Sweeney.

 

my guess is that you will see the common trend up in anticipation of collins.  common should have a bigger % upside than prefs on collins.  of course collins is not assured, and the juniors are way "safer", but if you want to play collins itself that would probably be best done with commons

 

 

Thank you. I find it hard to believe that the Lamberth and Sweeney cases are moving so slowly. If trial is immediate, why can’t they just schedule it next week and get the decision the week after? Why another year?

[Midas79]

But my current base case is based on Moelis, so around $18 a share.

 

I would be very, very careful about basing a common share investment thesis on the Moelis plan, and especially careful about anchoring yourself on that $18 number.

 

1. There are two projections, and you're taking the higher one ($17.75) and rounding it up while ignoring the lower one ($14.19). Investing based on the best case is a recipe for trouble, especially if you fall victim to the anchoring effect. This zaps a lot of investors that hold on to a bad stock hoping to break even before they sell.

 

2. Those two prices ($14.19, $17.75) assume that the common stock price rises 10% each of the next two years following recap and release. While this is certainly plausible, optimism doesn't make for a good investment thesis. This is even more true if you plan to sell your position soon after recap and release is complete. The better numbers to anchor on are their IPO prices of $11.73 and $14.67.

 

3. Moelis assumes that retained earnings all the way through the end of 2021 (and all the way back to Q4 2018) will go towards the recap. This is almost certainly off the table, because it all needs to be done by late 2020 at the latest to assure the Trump administration that they can get it done (and more likely it gets done much sooner to avoid running into the campaign and election cycle). For a new president, keeping FnF in conservatorship is much, much easier than putting them back in. All this means that the capital raise will be even bigger, and the easiest way to do so is to sell more common shares.

 

4. The new Moelis plan assumes that the juniors will convert at par at the IPO price, for a ratio of either 1.7 to 1 or 2.1 to 1 (divide $25 by the IPO prices). Why would they agree to this when the market ratio is 4.4 to 1 right now? If I was a junior pref holder, and especially if I was a plaintiff, such an offer would insult me; I could have made 2-2.5 times as much if I had converted in the market right now.

 

5. This plan also has a (then) current price of $1.43, but an IPO price 8-10 times that (and 4-6 times current prices). In reality, offering prices are usually at a discount to that of the market, not at a huge premium. Doing the math on the optimistic scenario (page 29) shows that the final share count breakdown is 1.8B for existing commons, 1.13B for the half of converted juniors, 7.2B for Treasury, and the rest (4.9B) for the new investors. That gives those new investors only about 32.5% of the equity. Are they really going to provide almost all of the recap money for that little of a stake? I wouldn't if I were them, and they are much smarter and more ruthless than me. Treasury needs these new investors; they cannot afford for this to fail. They will need to offer much more than 32.5%. The scenario on page 28 works out to 37%, which is better but still not nearly enough in my opinion. Both of these large effects lead me to believe that the offering price will be much, much lower than Moelis projects, and Treasury will just have to accept the diminishment in warrant value. (as an aside, this is part of why I think Treasury might sell its warrants back to FnF rather than exercise them, but then the floor for the offering price drops out and the commons could lose a lot of money from here)

 

6. Comparing the projected returns on the prefs and commons is also not completely straight-forward. The naive way to do things is say "prefs go from 40% of par to 100% for a gain of 150%, while the commons go from $2.75 to $17.75 for a gain of 545%". However, taking the conversion into account, the prefs actually go to more than par (around 114%) because they participate in half of the two-year 10% annual gain, which narrows the gap on that end. My other points talk about why I think the $17.75 number is much too high.

 

 

To summarize, there are many assumptions in the Moelis plan that lead to their valuations for the common shares, and in my opinion almost every single one of them is either at or above the high end of realistic.

[Guest cherzeca]

I think this is first time anyone in admin has admitted theyve been fully paid back on GSEs bailout (and more)... Phillips from yesterday.. Claims taxpayer IRR is up to 12%.. Easy to write off senior pfds when you share that view.

 

https://pbs.twimg.com/media/D6yMjFSW0AgFxoT.png:large

 

where is this quote from?  link to article/report?

[allnatural]

From the event he spoke at yesterday. He discusses it after the first question on the GSEs.

 

"@CraigPhillipsDC talking about GSE ($FNMA& $FMCC) reform from 29:30-33:23... vimeo.com/336717859"

 

 

 

I think this is first time anyone in admin has admitted theyve been fully paid back on GSEs bailout (and more)... Phillips from yesterday.. Claims taxpayer IRR is up to 12%.. Easy to write off senior pfds when you share that view.

 

https://pbs.twimg.com/media/D6yMjFSW0AgFxoT.png:large

 

where is this quote from?  link to article/report?

[Guest cherzeca]

From the event he spoke at yesterday. He discusses it after the first question on the GSEs.

 

"@CraigPhillipsDC talking about GSE ($FNMA& $FMCC) reform from 29:30-33:23... vimeo.com/336717859"

 

 

 

I think this is first time anyone in admin has admitted theyve been fully paid back on GSEs bailout (and more)... Phillips from yesterday.. Claims taxpayer IRR is up to 12%.. Easy to write off senior pfds when you share that view.

 

https://pbs.twimg.com/media/D6yMjFSW0AgFxoT.png:large

 

where is this quote from?  link to article/report?

 

@ allnatural great find!  I will watch later, but I see that he is being interviewed by vartanian.  that should be nice!

[DRValue]

But my current base case is based on Moelis, so around $18 a share.

 

I would be very, very careful about basing a common share investment thesis on the Moelis plan, and especially careful about anchoring yourself on that $18 number.

 

1. There are two projections, and you're taking the higher one ($17.75) and rounding it up while ignoring the lower one ($14.19). Investing based on the best case is a recipe for trouble, especially if you fall victim to the anchoring effect. This zaps a lot of investors that hold on to a bad stock hoping to break even before they sell.

 

2. Those two prices ($14.19, $17.75) assume that the common stock price rises 10% each of the next two years following recap and release. While this is certainly plausible, optimism doesn't make for a good investment thesis. This is even more true if you plan to sell your position soon after recap and release is complete. The better numbers to anchor on are their IPO prices of $11.73 and $14.67.

 

3. Moelis assumes that retained earnings all the way through the end of 2021 (and all the way back to Q4 2018) will go towards the recap. This is almost certainly off the table, because it all needs to be done by late 2020 at the latest to assure the Trump administration that they can get it done (and more likely it gets done much sooner to avoid running into the campaign and election cycle). For a new president, keeping FnF in conservatorship is much, much easier than putting them back in. All this means that the capital raise will be even bigger, and the easiest way to do so is to sell more common shares.

 

4. The new Moelis plan assumes that the juniors will convert at par at the IPO price, for a ratio of either 1.7 to 1 or 2.1 to 1 (divide $25 by the IPO prices). Why would they agree to this when the market ratio is 4.4 to 1 right now? If I was a junior pref holder, and especially if I was a plaintiff, such an offer would insult me; I could have made 2-2.5 times as much if I had converted in the market right now.

 

5. This plan also has a (then) current price of $1.43, but an IPO price 8-10 times that (and 4-6 times current prices). In reality, offering prices are usually at a discount to that of the market, not at a huge premium. Doing the math on the optimistic scenario (page 29) shows that the final share count breakdown is 1.8B for existing commons, 1.13B for the half of converted juniors, 7.2B for Treasury, and the rest (4.9B) for the new investors. That gives those new investors only about 32.5% of the equity. Are they really going to provide almost all of the recap money for that little of a stake? I wouldn't if I were them, and they are much smarter and more ruthless than me. Treasury needs these new investors; they cannot afford for this to fail. They will need to offer much more than 32.5%. The scenario on page 28 works out to 37%, which is better but still not nearly enough in my opinion. Both of these large effects lead me to believe that the offering price will be much, much lower than Moelis projects, and Treasury will just have to accept the diminishment in warrant value. (as an aside, this is part of why I think Treasury might sell its warrants back to FnF rather than exercise them, but then the floor for the offering price drops out and the commons could lose a lot of money from here)

 

6. Comparing the projected returns on the prefs and commons is also not completely straight-forward. The naive way to do things is say "prefs go from 40% of par to 100% for a gain of 150%, while the commons go from $2.75 to $17.75 for a gain of 545%". However, taking the conversion into account, the prefs actually go to more than par (around 114%) because they participate in half of the two-year 10% annual gain, which narrows the gap on that end. My other points talk about why I think the $17.75 number is much too high.

 

 

To summarize, there are many assumptions in the Moelis plan that lead to their valuations for the common shares, and in my opinion almost every single one of them is either at or above the high end of realistic.

 

I'll respond to your numbered points. But first to clarify my valuation is based on a moelis share count and my conservative discounted earnings (less than moelis). It's not in front of me but its something like 19 a share. In any case there's plenty of dilution possible before we go to below 1.40. I just see more potential at this point than in prefs.

 

[*]Covered above.

[*]methodology above doesn't rely on 10pct projections

[*]calabria has said capital raise earliest h1 next year. And the process could take over 2 years. Then again he's said a lot of things.

[*]I'd argue the ratio right now won't be the ratio when reform is settled and recap officially commences. Won't the conversion be an offer by the company to pref holders? They can take it or leave it. Management should take common shareholders into account.

[*]partly addressed above but agree the number will be what it will be. Big difference between 1.40. What does buffet say about being roughly right rather than precisely wrong? I'm not sure the regulator would permit the companies to repurchase warrants while in conservatorship.

[*]in my pref hedge I only assume par. I'd be happy with a pref getting more in that respect.

 

So summarizing there's a big enough difference between my buy price and maximum valuation for me to be comfortable plus an 80pct shareholder that wants to maximise their return and a regulator who seems comfortable with the companies plotting their own path for capital.

 

I want to buy more but I don't want to pay over $2.50. Put me in the optimist camp.

[Ahab]

Here we go, after a long Trumpian speech he's got to talking about Fannie Mae....

[SnarkyPuppy]

Trump spoke maybe a minute on housing finance reform but didn't say anything new.  He did emphasize "working on congress to pass things" but next sentence said "do administratively what we need to do to modernize our housing program and get rid of ridiculous regulations".

 

And then talked about how reforms will include less paperwork so we can build our houses with better lumber.  So I guess that was new.

[allnatural]

He also mentioned working with wall street on this because they are very smart people.

 

Trump spoke maybe a minute on housing finance reform but didn't say anything new.  He did emphasize "working on congress to pass things" but next sentence said "do administratively what we need to do to modernize our housing program and get rid of ridiculous regulations".

 

And then talked about how reforms will include less paperwork so we can build our houses with better lumber.  So I guess that was new.

[DocSnowball]

from Glen:

Judge Lamberth entered an order today denying FHFA, Fannie and Freddie’s request that he reconsider his not decision that preserved shareholders’ contractual claims.  Judge Lamberth declined FHFA and the GSEs’ invitation.  Accordingly, shareholders’ implied covenant breach claims will not be dismissed and will proceed to trial.  A copy of Judge Lamber’s decision is attached to this e-mail message.

 

Court doc attached...

 

Love it (as a non-legal layperson)...the ruling states on page 3 that implied covenant requires a party (FHFA here) "to refrain from arbitrary and unreasonable conduct which has the effect of preventing the other party (shareholders here) to the contract from receiving the fruits of the bargain".

 

I hope this ruling helps shareholders when FHFA and Treasury renegotiate terms later this fall re: the Fruits (dividend and liquidation value of preferred shares). This may be just as important as the restitution claims the trial will bring. For the lawsuits "to go away" as Calabria and Treasury desire (rather than continue and even increase), fair treatment is now a greater expectation based on this ruling. 

[Ahab]

"My administration is committed to reforming our housing finance system...so important."

"we have many geniuses looking at it...and we'll figure something out..."

"someone said: why are you using wall street?" "Cuz I want to get very smart people, people that do this."

 

Major points (nothing this board didn't already know):

No reform has happened yet 10 years after crisis, GSEs still dominate the market (more competition would be desirable), taxpayers still on the hook (urgent problem in a recession), Treasury and HUD should develop a framework for a modern housing financing system, work with congress and also pursue administrative solutions to help the US housing system.

[SnarkyPuppy]

He also mentioned working with wall street on this because they are very smart people.

 

Trump spoke maybe a minute on housing finance reform but didn't say anything new.  He did emphasize "working on congress to pass things" but next sentence said "do administratively what we need to do to modernize our housing program and get rid of ridiculous regulations".

 

And then talked about how reforms will include less paperwork so we can build our houses with better lumber.  So I guess that was new.

 

That's true - but I took that as in the context of they hired wall st people (phillips) to come up with a plan.  But could be taken the other way as well - but not new info as we know through other quotes treasury has been working w bankers on recap.

[Ahab]

My take on this speech is that it is moderately bullish for us shareholders. Trump is a volatile personality, so it is good that his mind (and not just that of his appointees) is set on recap and release. Mechanics remain TBD, but it was encouraging to hear the sentiments this board expresses daily said by the man himself..

[Jcmeg35]

Some good sharp questions from Katy O'Donnell in this interview, IMO.  Calabria doesn't provide any new info on some of the good ones. To @chereza's past comments, probably for the best that he gives non-answers on these tougher ones right now. Again, comforting to see that competition has to come as a result of legislation.

 

https://www.politico.com/story/2019/05/17/fhfa-director-mark-calabria-1453740

[Midas79]

I'll respond to your numbered points. But first to clarify my valuation is based on a moelis share count and my conservative discounted earnings (less than moelis). It's not in front of me but its something like 19 a share. In any case there's plenty of dilution possible before we go to below 1.40. I just see more potential at this point than in prefs.

 

You use lesser earnings and the same share count, but come up with a higher price? That can only mean that your projected multiple is higher.

 

Also, seeing more potential in the commons is a valid reason to own them, but your price point of $1.40 is meaningless. The only thing that matters is where you think they will go from here. My model tops out at around $7 for the commons, but has a worst-case scenario of $0.75 that involves Treasury selling the warrants and the capital raise issuing an enormous number of shares. Therefore I only own prefs because by my projections (which include the new investors insisting on at least a 2/3 stake for their capital) don't include any scenarios in which the commons outperform. This is on top of the embedded call option on the commons that I believe the prefs have.

 

I'd argue the ratio right now won't be the ratio when reform is settled and recap officially commences. Won't the conversion be an offer by the company to pref holders? They can take it or leave it. Management should take common shareholders into account.

 

If the new investors do "leave it" then the whole thing gets torpedoed. Having the recap happen with more dilution is more favorable to existing common shareholders than having it all go down in flames, so management might not push for the highest price possible. The best way I have seen this put: every dollar that existing common shareholders end up with is one fewer dollar for the new investors. These new investors didn't get the billions they have to invest by being stupid, or by leaving money on the table.

 

I agree about the ratio, but it was even higher than today's 4.4 to 1 when Moelis released its updated plan. When the first plan came out it was at least in line with the market at the time. I don't know why Moelis thinks the juniors will take such a bad deal now.

[Guest cherzeca]

MAGA

[DRValue]

@Midas79

 

Moelis use a price / earnings multiple where I discount the earnings so slightly different. My earnings are the average of moelis projections and actuals combined growing at roe rate * by retained earnings (70pct) at 80pct confidence.

 

That does produce a higher p/e technically if you want to divide the market cap by the share count, yes.

 

But valuations vary. Ackman had them up to 40 doesn't he? My valuation would say he's wildly over pricing them.

 

Thinking about the investors demanding 2/3 stake. If Fannie retains 33b over 3 years,  gets 20b from treasury and capital required is 87b why should they get 2/3s of earnings if they provide 40pct of the capital (34b)?

 

I see the pref conversion differently. I don't see how pref conversion failing impacts a common raise

 

Can we agree the common value will be somewhere between 0.75 and 19 a share? :)

 

 

[rros]

From the event he spoke at yesterday. He discusses it after the first question on the GSEs.

 

"@CraigPhillipsDC talking about GSE ($FNMA& $FMCC) reform from 29:30-33:23... vimeo.com/336717859"

 

 

 

I think this is first time anyone in admin has admitted theyve been fully paid back on GSEs bailout (and more)... Phillips from yesterday.. Claims taxpayer IRR is up to 12%.. Easy to write off senior pfds when you share that view.

 

https://pbs.twimg.com/media/D6yMjFSW0AgFxoT.png:large

 

where is this quote from?  link to article/report?

Thanks. What's funny about the 10% moment remark is that it had nothing to do with the question raised by the Alex Pollock. Philips brought it up all by himself to highlight how smart Pollock was (is). Alex Pollock actually responded he re-calculated yesterday the IRR from the sweep to be at 11.5%.

 

Muscle, how Lamberth dissected and differentiated the notions of breach-of-contract and implied covenant duties. I thought his reasoning was very powerful.

[james22]

>50% of my portfolio... All pfds...

 

About 60% of my portfolio.

 

All my common exposure is hedged with prefs...

 

Thanks.

 

I made the commons a 3% position today and I'll make the preferreds 5% Monday.

[allnatural]

Ackmans original $40pt assumed that the government would simply do the right thing and forfeit their 80% warrants. No chance.

[DRValue]

Ackmans original $40pt assumed that the government would simply do the right thing and forfeit their 80% warrants. No chance.

 

I don't think so as he projected the warrant valuation as an incentive for treasury to allow his recap. Would need to see his share counts too as a bit fuzzy on that.

 

 

[Midas79]

But valuations vary. Ackman had them up to 40 doesn't he? My valuation would say he's wildly over pricing them.

 

Ackman had $23-47 including the warrants being exercised, but he valued the warrants at or above $300B. I think $50-60B is a more reasonable number (Moelis says $100-125B, but I think they're being too optimistic), so scaling down appropriately gives $4-9 which is right around my target range, though that's mostly coincidence.

 

Thinking about the investors demanding 2/3 stake. If Fannie retains 33b over 3 years,  gets 20b from treasury and capital required is 87b why should they get 2/3s of earnings if they provide 40pct of the capital (34b)?

 

I don't think Fannie will get anywhere close to 3 years to retain capital. Four quarters max, and most likely less. Also, the extra money from Treasury won't be returned to Fannie if the Collins plaintiffs get what they want, but instead Fannie gets a tax credit (the $20B is also FnF combined, so Fannie itself would get less). I don't know if the tax credit count towards core capital, so I am not including it for now.

 

The reason that the new investors will insist on more equity than their capital contribution is the certainty equivalent. $60B in cash, for example, is worth much more than 50% of the equity in a company that is worth roughly $120B. 40% of the capital could easily demand 2/3 of the equity if not more. Also, these new investors will want the lowest share price possible to maximize their ROI, and they cannot afford to be pushed away lest the entire recap fail. Again, every dollar the existing common shareholders get is one fewer dollar for these new investors. They will fight tooth and nail.

 

I see the pref conversion differently. I don't see how pref conversion failing impacts a common raise

 

The capital structure can't tilt too heavily towards prefs because it chews up income attributable to the commons (leading to a lower offering price too). There's also a 2016 line by Calabria saying that he thinks FnF's capital should mostly be common equity. Converting existing prefs allows new ones to be issued in whatever amount FnF deem appropriate, and more importantly this doesn't cost FnF a dime. I think a conversion is highly likely and will be part of settling the court cases. Since the plaintiffs are mostly pref holders I expect the ratio to be generous, and certainly better than what Moelis projects.

 

Can we agree the common value will be somewhere between 0.75 and 19 a share? :)

 

Of course! Please don't take my posts personally, I am just stating my case. It is quite possible that I am too ossified in my thinking. If anyone wants to chime in they are more than welcome.

[orthopa]

@Midas79

 

Moelis use a price / earnings multiple where I discount the earnings so slightly different. My earnings are the average of moelis projections and actuals combined growing at roe rate * by retained earnings (70pct) at 80pct confidence.

 

That does produce a higher p/e technically if you want to divide the market cap by the share count, yes.

 

But valuations vary. Ackman had them up to 40 doesn't he? My valuation would say he's wildly over pricing them.

 

Thinking about the investors demanding 2/3 stake. If Fannie retains 33b over 3 years,  gets 20b from treasury and capital required is 87b why should they get 2/3s of earnings if they provide 40pct of the capital (34b)?

 

I see the pref conversion differently. I don't see how pref conversion failing impacts a common raise

 

Can we agree the common value will be somewhere between 0.75 and 19 a share? :)

 

Just to throw my $.02 in so we can all hash this out....

 

I think what gives a prfd investor a little solace is a bunch of things.

 

1. The par value is a bench mark and a contract. Once the conservatorship is over /NWS done those contracts should be valid again. 

 

2. If/When Sr. Prfd are considered paid Jr prfd go to top of the food chain and into top bargaining position. Everyone knows a bunch of money needs to be raised and someone is going to lose more then the other.  Why would prfd holders agree to a deal that includes returns that supersede their own? They have a negotiable bench mark and all common holders should know that bench mark.

 

3. To piggy back on 2 if prfd is converted they will convert in a ratio favorable to them. Otherwise why convert? If you getting the better deal in 2. why convert back and lose? They will only convert on favorable terms thus midas's call option. Again your second fiddle.

 

4. 2. and 3. above show that common is not only at the mercy of treasury's stake but the prfd holders projected return.

 

5. If your able to mentally get around the above you have an unknown dilution % coming that is >80%, is associated with likely billions of shares of similar class stock forming a supply overhang and at this point unable to really provide any predictive valuation metrics. What the in the hell multiple do you choose?

 

6. Even in the aftermath of FnF getting back to business as usual earnings have been a little erratic. How will the market reward/punish that?

 

7. Common doesn't have a seat at the table. Jr Prfd, Treasury and new money do. People would argue they should and at second glance they do, the 80% owner that would sell their soul to the devil to get out as quick as possible and for the most profit for them and "tax payer"

 

8. Many have argued why would new $$ come in if they were going to be diluted? They wont, they will come in after the initial dilution as subsequent dilution. Because again. Why would they come in if they knew they were going to be diluted?

 

9. The only thing I have'nt completely rationalized is the exact mechanism treasury goes about this without dragging out their profit for years. Again looking at the previous TARP deals they swapped classes of stock, sold warrants, etc. They could create a new class of stock in exchange for the warrants senior to the legacy common that converts to dilute the common on a ratio basis that they could sell to new money that dilutes old shareholders but not new. These wall street guys are smart fuckers. And what can the common do? Your money is paid in already. They dont need your money. They need the NEW money.

 

My diatribe is not meant to dissuade your position but to rationalize out loud why I only hold prfd for the sake of arguement.

[allnatural]

That's amazing i always assumed Ackman had $40pt bc of zero warrant excercise. $300b in value for government, he really is in lala land!  Even at $150b warrant value which is what he claims today thats $20/shr per his valuation.