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

[SnarkyPuppy]

So it's too speculative but you can't clearly articulate a downside scenario for the preferreds?  Not sure about your fancy formula but I see a low downside and some uncertain upside scenario becoming more and more certain as each day passes. 

 

Some are calling it speculation but the name ain't important if the process is sound. 

 

Goal:  Raise private capital

Constraint:  Existing shareholders

Constraint:  Low risk solution required

Constraint:  There is no alternative

 

I think people are overcomplicating this and conflating risk w/ uncertainty.  The plan is obviously finished and is being teased to gauge reaction prior to formal release.  The plan involves recapitalization using new common equity.  If you want to recapitalize using new common equity, it seems pretty basic to me that the old preferreds should be worth some amount > 50% of par (not necessarily par to account for time value until dividends turn on and ipo execution risk).  Thought of another way, I see no process that has a basis in reality that recapitalizes these things in a re-ipo with junior prefs getting < 50% on the dollar. 

[james22]

So it's too speculative but you can't clearly articulate a downside scenario for the preferreds?

 

Let me articulate: Trump comes to believe privatization will hurt his election chances and so puts off the process, advocates of the big banks vs those of the hedge funds can never agree as to the How, court rulings delay the process, the (overvalued) market crashes and puts off the IPO, etc., etc. 

 

I see no process that has a basis in reality that recapitalizes these things in a re-ipo with junior prefs getting < 50% on the dollar.

 

I can see a process that doesn't get to recapitalization.

 

If you assign the conditional probabilities of FNMA/FMCC exiting conservatorship at 70% AND the preferreds paid out at par at 90%, you've only a 63% chance of getting your double today.

 

Look, the market may not be perfectly efficient, but it isn't dumb either. There are enough bright people with enough money to buy the shares up if they knew it was undervalued.

 

I agree with you that things are looking up (and why I asked if anyone was adding to their position), but I believe it is still a speculative bet.

[investorG]

So it's too speculative but you can't clearly articulate a downside scenario for the preferreds?

 

Let me articulate: Trump comes to believe privatization will hurt his election chances and so puts off the process, advocates of the big banks vs those of the hedge funds can never agree as to the How, court rulings delay the process, the (overvalued) market crashes and puts off the IPO, etc., etc. 

 

I see no process that has a basis in reality that recapitalizes these things in a re-ipo with junior prefs getting < 50% on the dollar.

 

I can see a process that doesn't get to recapitalization.

 

If you assign the conditional probabilities of FNMA/FMCC exiting conservatorship at 70% AND the preferreds paid out at par at 90%, you've only a 63% chance of getting your double today.

 

Look, the market may not be perfectly efficient, but it isn't dumb either. There are enough bright people with enough money to buy the shares up if they knew it was undervalued.

 

I agree with you that things are looking up (and why I asked if anyone was adding to their position), but I believe it is still a speculative bet.

 

True. There are black belts involved in this trade, it's not fully inefficient to provide anything easy at this point.

[investorG]

I will, but at lower prices.

 

I'm pretty insensitive to price, given the range of outcomes.

 

I'll have to pay a higher price as uncertainty is resolved, but the risk/reward should only improve.

 

That's funny, as I'm sensitive to price given the range of outcomes!  :)

 

Really? If FNMA is $9-18 next year, I'll wish I'd have added today whether the shares were $2 or $4.

 

while possible, it's unlikely those price targets you mentioned are achieved.  Entry points should matter. 

[investorG]

POtus just told chuck and Nancy he wouldn’t work with them until investigations stop.  This after Nancy said potus is engaged in a coverup. So a bipartisan legislative solution doesn’t look good for now.

 

I’m torn by all this jabbering by Calabria. On one hand it shows some momentum and it also shows MBA/tbtf has no response. But all his talk about competition just unsettled the market. Mnuchin should tell him to stop the amateur hour

 

imo Calabria leading the charge is optimal from an optics standpoint.  He speaks clearly, is smart, and doesn't have some relationship baggage that others carry.

[investorG]

@orthopa

 

I doubt moelis can present plans to and work with treasury and then change the terms at the last minute.

 

They had to sell it to govt to make treasury the maximum return. Presenting something too beneficial to juniors would dilute treasury too much and risk not being taken up.

 

Then again, who says it's moelis

 

Your right who says its moelis? You reference it in a previous reply to Midas.  ;)But every common shareholder is wringing that report in their hands and the vast majority of the reason why many have invested. 2nd most argued reason is treasury maximizing their return. I can tell you right now treasury without a doubt will maximize their return and I bet it will fundamentally come separate from the legacy common holder. As a result its not treasury vs prfd but prfd vs common in a conversion scenario and at the bargaining table.

 

A nice sweetener for a prfd conversion would be a favorable conversion ratio and warrant with a lower strike price of common.

 

I'm guessing at this point that Tsy values getting their plan completed > maximizing their return. 

 

while Tsy might attempt to do both, one way to increase odds of a potential deal getting done is to give new shareholders a larger portion of the pro forma market cap, perhaps at the expense of Tsy's share (warrants).  after already making > $100bn, is it absolutely crucial to the decision makers whether the Tsy makes another $70 vs $40bn in a potential deal?

[orthopa]

@orthopa

 

I doubt moelis can present plans to and work with treasury and then change the terms at the last minute.

 

They had to sell it to govt to make treasury the maximum return. Presenting something too beneficial to juniors would dilute treasury too much and risk not being taken up.

 

Then again, who says it's moelis

 

Your right who says its moelis? You reference it in a previous reply to Midas.  ;)But every common shareholder is wringing that report in their hands and the vast majority of the reason why many have invested. 2nd most argued reason is treasury maximizing their return. I can tell you right now treasury without a doubt will maximize their return and I bet it will fundamentally come separate from the legacy common holder. As a result its not treasury vs prfd but prfd vs common in a conversion scenario and at the bargaining table.

 

A nice sweetener for a prfd conversion would be a favorable conversion ratio and warrant with a lower strike price of common.

 

I'm guessing at this point that Tsy values getting their plan completed > maximizing their return. 

 

while Tsy might attempt to do both, one way to increase odds of a potential deal getting done is to give new shareholders a larger portion of the pro forma market cap, perhaps at the expense of Tsy's share (warrants).  after already making > $100bn, is it absolutely crucial to the decision makers whether the Tsy makes another $70 vs $40bn in a potential deal?

 

Then why are they happy to sweep 2-3B a quarter while they "formulate a plan"?

[Guest cherzeca]

@orthopa

 

I doubt moelis can present plans to and work with treasury and then change the terms at the last minute.

 

They had to sell it to govt to make treasury the maximum return. Presenting something too beneficial to juniors would dilute treasury too much and risk not being taken up.

 

Then again, who says it's moelis

 

Your right who says its moelis? You reference it in a previous reply to Midas.  ;)But every common shareholder is wringing that report in their hands and the vast majority of the reason why many have invested. 2nd most argued reason is treasury maximizing their return. I can tell you right now treasury without a doubt will maximize their return and I bet it will fundamentally come separate from the legacy common holder. As a result its not treasury vs prfd but prfd vs common in a conversion scenario and at the bargaining table.

 

A nice sweetener for a prfd conversion would be a favorable conversion ratio and warrant with a lower strike price of common.

 

I'm guessing at this point that Tsy values getting their plan completed > maximizing their return. 

 

while Tsy might attempt to do both, one way to increase odds of a potential deal getting done is to give new shareholders a larger portion of the pro forma market cap, perhaps at the expense of Tsy's share (warrants).  after already making > $100bn, is it absolutely crucial to the decision makers whether the Tsy makes another $70 vs $40bn in a potential deal?

 

this article gets at that in case you haven't read it:  https://seekingalpha.com/article/4252309-will-fannie-freddie-investors-finally-get-relief-potus-memo-collins-en-banc-smart-way

[SnarkyPuppy]

In case anyone is wondering what will happen-

 

https://www.americanbanker.com/opinion/give-fannie-freddie-the-same-capital-standards-as-everybody-else

[Guest cherzeca]

In case anyone is wondering what will happen-

 

https://www.americanbanker.com/opinion/give-fannie-freddie-the-same-capital-standards-as-everybody-else

 

if I understand pollock in this article correctly, he is calling for a $5T govt guarantee...which wont happen. pretty stupid suggestion for a smart guy

[Ahab]

I think people are reading too much into journalistic suggestions about high, bank-like capital requirements. The people working on the recap aren't stupid, they aren't going to sabotage the raise by pursuing completely unrealistic standards. Game theory suggests a compromise figure that lets the reform continue apace...

[rros]

I think people are reading too much into journalistic suggestions about high, bank-like capital requirements. The people working on the recap aren't stupid, they aren't going to sabotage the raise by pursuing completely unrealistic standards. Game theory suggests a compromise figure that lets the reform continue apace...

Pollock told Craig Philips in the recent interview he had assessed the IRR of Treasury at 11.5%. Philips, who tagged it at 12%, replied: "well... that is open to debate". Looks like Pollock *adopted* Craig Philips 12% IRR and wants to be inline with the Administration. I would not be surprised if there is another article tomorrow where he praises the benefits of a 2.5% capital level and just a small commitment fee to collect 1 or 2 billions a year for a credit line.

[james22]

I will, but at lower prices.

 

I'm pretty insensitive to price, given the range of outcomes.

 

I'll have to pay a higher price as uncertainty is resolved, but the risk/reward should only improve.

 

That's funny, as I'm sensitive to price given the range of outcomes!  :)

 

Really? If FNMA is $9-18 next year, I'll wish I'd have added today whether the shares were $2 or $4.

 

while possible, it's unlikely those price targets you mentioned are achieved.  Entry points should matter.

 

Maybe not. What's your price target?

 

But it's also unlikely you'll be able to buy at prices much lower than today (at the same risk/reward).

 

Return is what matters.

 

I accept that I'll get a lesser expected return on the dollars I invest after a favorable en banc ruling than were I to invest today, but it'll be a positive expected return nonetheless.

[investorG]

I will, but at lower prices.

 

I'm pretty insensitive to price, given the range of outcomes.

 

I'll have to pay a higher price as uncertainty is resolved, but the risk/reward should only improve.

 

That's funny, as I'm sensitive to price given the range of outcomes!  :)

 

Really? If FNMA is $9-18 next year, I'll wish I'd have added today whether the shares were $2 or $4.

 

while possible, it's unlikely those price targets you mentioned are achieved.  Entry points should matter.

 

Maybe not. What's your price target?

 

But it's also unlikely you'll be able to buy at prices much lower than today (at the same risk/reward).

 

Return is what matters.

 

I accept that I'll get a lesser expected return on the dollars I invest after a favorable en banc ruling than were I to invest today, but it'll be a positive expected return nonetheless.

 

A double digit stock price, imo, requires the warrants to go away / be reduced, among other things.  which is possible.

 

otherwise, the private equity or IPO investors in a potential deal likely won't be comfortable giving away $100bn+ (~10bn existing combined FnF shares including warrants) of the combined pro forma market cap to the current commoners + govt.  there's uncertainty with congress and perhaps a new administration in 2021 which means new money likely would want a large margin of safety to plow in the many tens of billions needed. 

[investorG]

In case anyone is wondering what will happen-

 

https://www.americanbanker.com/opinion/give-fannie-freddie-the-same-capital-standards-as-everybody-else

 

doubtful; 6% Roe isn't likely going to get the enthusiasm necessary for such a large potential capital raise. as another poster says, the guys in charge are likely to see through the outside recommendation extremes (on both sides).

[investorG]

@orthopa

 

I doubt moelis can present plans to and work with treasury and then change the terms at the last minute.

 

They had to sell it to govt to make treasury the maximum return. Presenting something too beneficial to juniors would dilute treasury too much and risk not being taken up.

 

Then again, who says it's moelis

 

Your right who says its moelis? You reference it in a previous reply to Midas.  ;)But every common shareholder is wringing that report in their hands and the vast majority of the reason why many have invested. 2nd most argued reason is treasury maximizing their return. I can tell you right now treasury without a doubt will maximize their return and I bet it will fundamentally come separate from the legacy common holder. As a result its not treasury vs prfd but prfd vs common in a conversion scenario and at the bargaining table.

 

A nice sweetener for a prfd conversion would be a favorable conversion ratio and warrant with a lower strike price of common.

 

I'm guessing at this point that Tsy values getting their plan completed > maximizing their return. 

 

while Tsy might attempt to do both, one way to increase odds of a potential deal getting done is to give new shareholders a larger portion of the pro forma market cap, perhaps at the expense of Tsy's share (warrants).  after already making > $100bn, is it absolutely crucial to the decision makers whether the Tsy makes another $70 vs $40bn in a potential deal?

 

Then why are they happy to sweep 2-3B a quarter while they "formulate a plan"?

 

I think Calabria already told us -- for some reason he only wants to potentially adjust the agreement with Tsy one time and that time is not now. 

[SHDL]

One would have to wonder if we have met or coming very close to the all in moment if one is inclined to do so. Best would be to hold out till midterms later this year then go for the gusto. Seems like time is the biggest impediment to ROI at this point. If you were willing to put 5-10% etc of your portfolio with what we as investors knew 2-3 years ago it seems like a significant increase in exposure would be in order relative to what is thought/known now.

 

I was willing to put up to 10% of my portfolio with a coin flip of whether or not they were going to be "wound down". Where we sit now an increase in exposure should be in order no?

 

I'm about 80/20 preferred to common. I'm expecting the recap to take some time and the dilution issue to put downward pressure on the common.

 

If we know for sure commons are ok then I'll go all in common if the price is weak enough for a multi bagger return on a sure thing.

 

Anyone adding to their position with the recent news?

 

Or waiting for something more "sure" - a court decision, an endorsed plan, etc.?

 

(Count me in the second group - still a speculative position for me.)

 

I'm torn between adding because outcome appears to be getting more positive than what it was a year ago

 

and

 

Reducing exposure because the price reflects those developments, we've been burned by rallies before, and it's what prudent risk/portfolio management would advise.

 

I think I'm gonna settle in the middle and just hold what I already have recognizing that the 2-3x appreciation we've seen increased the position for me.

 

I bought a few more preferred shares this year.  Not too much though.

 

For position sizing I’m currently using a model where, within a year or so, the investment “works out” with probability p, in which case I get back a fraction f of par, or it doesn’t (with probability 1-p), in which case I get x.  My (subjective) belief at the moment is that p >= 80% and that the distribution of f should be no worse than a uniform distribution between 50% and 100%.  I have no idea what x is but I know it’s >= 0.  So I ran some simulations using my most conservative/pessimistic assumptions (p=.8, f~U[.5, 1.], x=0), and from that I got an optimal portfolio allocation (in the Kelly sense, assuming there are no competing investment opportunities) of about 25%.  That number is of course very sensitive to the inputs, but having played around with them, I decided that I feel fine with, say, a 10-20% position, so that is where I’m at. 

 

My general view of this bet is that the expected return may no longer be spectacular but it is still pretty high among those opportunities where one can reasonably expect a very low (in fact close to zero) beta.  I happen to be somewhat macro bearish at the moment so for me that is a big plus.

[Guest cherzeca]

@shdl

 

re your view that there will be a uniform distribution between 50-100% of par, I think you have to analyze what the drivers of the return will be.  those drivers include legal (collins en banc result principally), capital markets (will the market be receptive to an offering or will we go into a china-trade induced bear market), negotiating tactics (there are several very large sophisticated holders of preferred shares who I believe are in it to win it, ie 100% of par, most likely on a conversion into common rather than cash retirement basis), requisite capital level to escape conservatorship and so on.  as a for instance, if through negotiation or simply the desire by treasury to successfully execute the release from conservatorship, treasury agrees to provide a credit for taxes, or simply pays back, $25B that it has received above the 10% moment, that is a huge jumpstart at replenishing capital, which would have an outsized effect on executing the release, which would have an outsized effect on our return. one may wonder why treasury would be so gracious, but one may also consider what treasury has to do to get this transaction done, and that may be one of those things.

 

it seems to me that gauging the return distribution is a multivariable, dynamic and nonlinear exercise, with many actors and factors that probably requires chaos theory math if one could ever gather all of the factors. so this makes the use of heuristics sensible to me (I can't handle chaos theory much less advanced algebra) and TINA (there is no alternative) seems like a good one to me.  didn't think it would take this long for TINA to prevail though.

 

[SnarkyPuppy]

Why do some seem to think that Tsy and FHFA will agree to execute an IPO 5x the size of the largest IPO of all time under terms that are unreasonable and not certain to garner full private capital buy-in (i.e. unreasonably high capital requirements)? 

 

These guys aren't going to close their eyes and hope for the best under this much spotlight.  If they genuinely go with recap approach they will acknowledge reality.  Reasonable capital requirements and treat prior private capital fairly while providing a decent rate of return for new investors. 

 

I can't do chaos math theory but if you remove the noise and think about this using first principles, incentives, and invert the final outcome - what are you worried about? 

 

There won't be a failed IPO attempt - just isn't a plausible downside scenario. 

[rros]

Why do some seem to think that Tsy and FHFA will agree to execute an IPO 5x the size of the largest IPO of all time under terms that are unreasonable and not certain to garner full private capital buy-in (i.e. unreasonably high capital requirements)? 

 

These guys aren't going to close their eyes and hope for the best under this much spotlight.  If they genuinely go with recap approach they will acknowledge reality.  Reasonable capital requirements and treat prior private capital fairly while providing a decent rate of return for new investors. 

 

I can't do chaos math theory but if you remove the noise and think about this using first principles, incentives, and invert the final outcome - what are you worried about? 

 

There won't be a failed IPO attempt - just isn't a plausible downside scenario.

+1

[muscleman]

Why do some seem to think that Tsy and FHFA will agree to execute an IPO 5x the size of the largest IPO of all time under terms that are unreasonable and not certain to garner full private capital buy-in (i.e. unreasonably high capital requirements)? 

 

These guys aren't going to close their eyes and hope for the best under this much spotlight.  If they genuinely go with recap approach they will acknowledge reality.  Reasonable capital requirements and treat prior private capital fairly while providing a decent rate of return for new investors. 

 

I can't do chaos math theory but if you remove the noise and think about this using first principles, incentives, and invert the final outcome - what are you worried about? 

 

There won't be a failed IPO attempt - just isn't a plausible downside scenario.

 

The big difference between this and other IPOs is that this is a really profitable company while others like Uber are endless money pits.

 

In addition, they could do the IPO step by step. Do 20 bn first. Cancel NWS. This would cause the P/E ratio to be really low. Then as price goes up, they could do a few more.

[james22]

if I was running the recap, I would first do an institutional private placement, before doing a public underwriting, and ask brk to backstop the PP...giving him warrants to agree to buy any amount not raised in the PP.  maybe PP=$20B. then with that as a successful first step, I would do a follow on $30B public offering. that would be a very good two step. so I can see Buffett being very helpful and willing, for a pound of flesh

 

Yes, please.

[SHDL]

@shdl

 

re your view that there will be a uniform distribution between 50-100% of par, I think you have to analyze what the drivers of the return will be.  those drivers include legal (collins en banc result principally), capital markets (will the market be receptive to an offering or will we go into a china-trade induced bear market), negotiating tactics (there are several very large sophisticated holders of preferred shares who I believe are in it to win it, ie 100% of par, most likely on a conversion into common rather than cash retirement basis), requisite capital level to escape conservatorship and so on.  as a for instance, if through negotiation or simply the desire by treasury to successfully execute the release from conservatorship, treasury agrees to provide a credit for taxes, or simply pays back, $25B that it has received above the 10% moment, that is a huge jumpstart at replenishing capital, which would have an outsized effect on executing the release, which would have an outsized effect on our return. one may wonder why treasury would be so gracious, but one may also consider what treasury has to do to get this transaction done, and that may be one of those things.

 

it seems to me that gauging the return distribution is a multivariable, dynamic and nonlinear exercise, with many actors and factors that probably requires chaos theory math if one could ever gather all of the factors. so this makes the use of heuristics sensible to me (I can't handle chaos theory much less advanced algebra) and TINA (there is no alternative) seems like a good one to me.  didn't think it would take this long for TINA to prevail though.

 

Yes, there are a lot of interesting moving parts here...  Like I said, I view f~U[.5, 1] as a pessimistic lower bound and I think the “true” distribution is skewed more towards 100% of par for reasons that you and others mention.  I’m waiting for more evidence to come in before making a move though.  If I’m reading the situation right, there should be a window of opportunity to make a profitable trade between the time the news comes out and the time the price catches up. 

[HalfMeasure]

if I was running the recap, I would first do an institutional private placement, before doing a public underwriting, and ask brk to backstop the PP...giving him warrants to agree to buy any amount not raised in the PP.  maybe PP=$20B. then with that as a successful first step, I would do a follow on $30B public offering. that would be a very good two step. so I can see Buffett being very helpful and willing, for a pound of flesh

 

Yes, please.

 

I reckon Buffett would be willing to buy the whole business if he were allowed. I think he's very fond of the core mortgage guarantee business.

[james22]

It seems such an obvious solution. I'd love to see it happen.