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

[Midas79]

@Wiggins

 

Citi's pref conversion was an offer made to all shareholders, of which most accepted. If the same happens with FnF, no 2/3 vote will be necessary because each shareholder would be free to convert or not.

 

However, if the re-IPO investors really do want the capital structure flattened before investing, that gives FHFA urgency to get all of them converted. I think the easiest (and cheapest) way to do that is just offer more and more commons until everyone accepts. If enough do, the rest (outside of FNMAS and FMCKJ) can be redeemed.

 

Redemption on a large scale, though, makes no sense at all, even if it's financed with more prefs. Re-IPO investors that want to buy commons want there to be as few prefs as possible in front of them in the capital structure. Conversion to common accomplishes the same goal while not costing any money.

 

As far as whether div rates will matter in the conversion, I can see it going either way. A holder of FNMAT will scoff at getting the same percentage of par as FNMAO, but if they get a good enough deal in absolute terms it might not matter.

 

To prepare for this, I choose to own the middle of the div structure: I don't own any FNMAT/FNMAS/FMCKJ, but I also am staying away from the low-div floaters because the 4-6% fixed-div series aren't much more expensive. My main holding is FNMAM (same price as other Fannie 50s with a higher div rate), and I have started picking up chunks of FMCKK at what I perceive to be good prices.

 

FNMAG, FMCKL, and FNMAH are overpriced compared to the rest of the prefs in my opinion. So are FNMAT/FNMAS/FMCKJ if things happen the way I think they will.

 

I do agree that FNMAS should gain a good chunk of value if it still exists on 1/1/2021.

[Midas79]

I posted this elsewhere but I'll do so here too to see if anyone has ideas or theories about this.

 

Last September, FHFA and Treasury agreed to lift the caps above which FnF have to pay all net worth to Treasury, from $3B for each company before that date, to $25B for Fannie and $20B for Freddie.

https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/FNM/LTR-Agree/FNM-2019-Ltr-Agreement_09-27-2019.pdf

https://www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/9-27-19_FRE-Capital-Agreement.pdf

 

At the time I couldn't figure out why they used those numbers. Freddie is around 2/3 the size of Fannie, but its cap is 4/5 as much. That's enough of a difference to make one pause.

 

Also, Fannie's total par value of its junior prefs is $19.130B, and Freddie's is $14.109B.

 

Now I have a theory: the fact that the difference between the letter agreement cap for each company and its total junior pref par value is almost identical is no coincidence. Said difference is $5.870B for Fannie and $5.991B for Freddie; the $121M difference between those amounts to a rounding error given the round $25B and $20B numbers in the letter agreements.

 

Of course, I don't really know what this could mean. It could very well just be coincidence.

[Guest cherzeca]

"I think the easiest (and cheapest) way to do that is just offer more and more commons until everyone accepts. If enough do, the rest (outside of FNMAS and FMCKJ) can be redeemed."

 

GSEs making an exchange offer only need 2/3rds acceptance of a class to an exchange offer in order to make it work, since the accepting holders would give an exit consent emasculating the preferred, so that this will force 100% to accept

[Guest Covid-19_Survivor]

@Wiggins

 

Citi's pref conversion was an offer made to all shareholders, of which most accepted. If the same happens with FnF, no 2/3 vote will be necessary because each shareholder would be free to convert or not.

 

However, if the re-IPO investors really do want the capital structure flattened before investing, that gives FHFA urgency to get all of them converted. I think the easiest (and cheapest) way to do that is just offer more and more commons until everyone accepts. If enough do, the rest (outside of FNMAS and FMCKJ) can be redeemed.

 

Redemption on a large scale, though, makes no sense at all, even if it's financed with more prefs. Re-IPO investors that want to buy commons want there to be as few prefs as possible in front of them in the capital structure. Conversion to common accomplishes the same goal while not costing any money.

 

As far as whether div rates will matter in the conversion, I can see it going either way. A holder of FNMAT will scoff at getting the same percentage of par as FNMAO, but if they get a good enough deal in absolute terms it might not matter.

 

To prepare for this, I choose to own the middle of the div structure: I don't own any FNMAT/FNMAS/FMCKJ, but I also am staying away from the low-div floaters because the 4-6% fixed-div series aren't much more expensive. My main holding is FNMAM (same price as other Fannie 50s with a higher div rate), and I have started picking up chunks of FMCKK at what I perceive to be good prices.

 

FNMAG, FMCKL, and FNMAH are overpriced compared to the rest of the prefs in my opinion. So are FNMAT/FNMAS/FMCKJ if things happen the way I think they will.

 

I do agree that FNMAS should gain a good chunk of value if it still exists on 1/1/2021.

 

Dude, a 3/4ths majority could amend FNMAS's divi to 4% with justifiable cause, of which tons exist here. The majority, you know - that majority who have been fighting for our rights and simply want a just settlement after purchasing their shares at clips far, far, far, far lower than par. They won't be greedy and FNMAS on 1/1/2021 may become a meaningless exercise in hope and greed.

 

25/50/100,000, bank on it.

 

Interesting: On 6/1/08 FNMAO w/ its 4.53% divi (at time) closed at 25.5. FNMAS w/ its 7.75% divi closed at 25.55. Your opinion is nonsense. We've all been stuck in limbo for a decade and just want our principle back.

 

2nd edit: LOL at comparison to C. Like the two are in any way comparable.

[Wiggins]

thanks for the comments on this everyone (@Midas, @Covid, @cherzeca)

 

@Midas,

Thanks for your reply above. It makes a lot of sense to me. I actually have the same general strategy as you, owning mostly mid-range fixed dividend JPS, some 25s and some 50s. That has been my core position for years. I have also picked up FMCKJ and FNMAS along the way when they were low. I have wondered about my strategy on those two that I outlined above, so I'm glad to also have your well-reasoned perspective to add to my own. I have done very well trading in and out of commons (99% luck, 1% skill).

 

@cherzeca

I think the most important comments ever made on COBF are the ones that promulgate inclusivity of opinions over excessive stifling of marginal commentary. I know you support this.

[beaufort]

I posted this elsewhere but I'll do so here too to see if anyone has ideas or theories about this.

 

Last September, FHFA and Treasury agreed to lift the caps above which FnF have to pay all net worth to Treasury, from $3B for each company before that date, to $25B for Fannie and $20B for Freddie.

https://www.fhfa.gov/Conservatorship/Documents/Senior-Preferred-Stock-Agree/FNM/LTR-Agree/FNM-2019-Ltr-Agreement_09-27-2019.pdf

https://www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/9-27-19_FRE-Capital-Agreement.pdf

 

At the time I couldn't figure out why they used those numbers. Freddie is around 2/3 the size of Fannie, but its cap is 4/5 as much. That's enough of a difference to make one pause.

 

Also, Fannie's total par value of its junior prefs is $19.130B, and Freddie's is $14.109B.

 

Now I have a theory: the fact that the difference between the letter agreement cap for each company and its total junior pref par value is almost identical is no coincidence. Said difference is $5.870B for Fannie and $5.991B for Freddie; the $121M difference between those amounts to a rounding error given the round $25B and $20B numbers in the letter agreements.

 

Of course, I don't really know what this could mean. It could very well just be coincidence.

 

@Midas

To be clear, is your theory that JPS holders get redeemed for cash?  Without a simultaneous very large capital raise, Calabria isn't preserving and conserving to soundness.  My initial take was that Mnuchin and Calabria didn't think either Fannie or Freddie would earn past the 25B and 20B amounts. 

 

If both FnF go back to a similar business model as pre 2008, with strong underwriting, they will be superb businesses.  I have always thought that the major JPS holders will want a sizeable piece of the businesses moving forward, along with new common.

[Guest Covid-19_Survivor]

Powell, Tepper, and now this guy: https://twitter.com/i/events/1260623451313721344

 

Should be a fun week.

[Luke 532]

Powell, Tepper, and now this guy: https://twitter.com/i/events/1260623451313721344

 

Should be a fun week.

 

I don't see the direct connection to Fannie/Freddie, am I missing something?

[Guest Covid-19_Survivor]

Powell, Tepper, and now this guy: https://twitter.com/i/events/1260623451313721344

 

Should be a fun week.

 

I don't see the direct connection to Fannie/Freddie, am I missing something?

 

Well, besides that forbearance thingy you're right - the direction of the markets should have little to do with us. If flippers exit or lighten because of general market concerns 10 to 1 they have no idea what they bought here.

[Midas79]

@Wiggins

 

I have tried to time the pref/common back-and-forth trade in the past, and I have just about broken even. I suppose I shouldn't complain, but it tells me that I'm no good at it.

 

Of course, that doesn't stop me from continuing to try. Right now the commons are underperforming enough that I'm tempted to take another spin at the wheel. Are you still doing this trade, and are you on the common side?

 

@beaufort

 

No, I don't see a redemption happening at all. Exchanging those shares for commons accomplishes the same goal (clearing out the capital structure for the re-IPO commons) while costing nothing instead of dozens of billions. I agree that the juniors will want to be in commons post-release due to the fantastic profitability of the business.

 

I have a different view on the caps. I think they were put in place to put FHFA and Treasury on the clock; they need to get the PSPA amendment done before the caps are hit or the NWS restarts, which is major egg on Calabria's face due to his insistence on FnF building capital.

 

The caps should be hit late this year, and a PSPA amendment finally killing the NWS at that time coincides with the timelines of ACG Analytics and other investors. I think the cap levels relative to the par value of the juniors is a coincidence, but I don't feel the same way about those levels as a function of FnF's earnings.

[Guest Covid-19_Survivor]

"The pace of new forbearance plans has slowed considerably – there was an average net increase of just under 26K per day over the past week. That’s a reduction of more than 85% of the rate we saw back in early April."

 

https://www.calculatedriskblog.com/2020/05/black-knight-47-million-homeowners-now.html

[Wiggins]

@Midas

I'm not in commons at all anymore because I think we are closer to the finish line and it's a bit risky. But like you, perhaps I will get back in a little bit if it stays favorable or becomes more favorable. My miracle trade (again, 99% luck, 1% skill) was in the fall of 2018 when I loaded up on commons. I then rode them from the low $1s to the high $3s where I sold most. The skill (if you can call it that), was my thesis on this trade based on reasoning for tax losses. At the time, the preferred and commons were significantly lower than they had been earlier in the year, and they were hitting new lows. I knew there would be a lot of selling pressure at tax loss season, which there was. I also thought that in January they would pop up because most people knew the thesis was still intact. For those who wished to harvest tax losses, they key is to do it a bit early (e.g. October or early November) and then buy back in BEFORE the end of the year.  I had some tax loss harvesting on some of my positions and that's what I did. This way, you can harvest losses, sit out the required 30 days, but still buy back in before the pop in January. In fact, for those on this thread that are familiar with Benjamin Graham's epic book, he devotes a whole chapter to this strategy. I also lucked out because I was still sitting on that position when the Collins decision came out. Luck, luck, luck. By the way, I find it kind of annoying when people talk about the trade that worked out well after the fact. So, sorry for that as it's not my style. (the trick is to predict, lol!) I only tell the story because I was asked and also I thought some people here would find the tax-loss reasoning interesting, and again it's a Benjamin Graham feature.

[Wiggins]

https://taibbi.substack.com/p/the-bailout-miscalculation-that-could?r=5c7vv&utm_campaign=post&utm_medium=email&utm_source=copy

 

old news to the informed readers here but it's nice to see Taibbi staying involved with this topic

[Guest Covid-19_Survivor]

@Midas

I'm not in commons at all anymore because I think we are closer to the finish line and it's a bit risky. But like you, perhaps I will get back in a little bit if it stays favorable or becomes more favorable. My miracle trade (again, 99% luck, 1% skill) was in the fall of 2018 when I loaded up on commons. I then rode them from the low $1s to the high $3s where I sold most. The skill (if you can call it that), was my thesis on this trade based on reasoning for tax losses. At the time, the preferred and commons were significantly lower than they had been earlier in the year, and they were hitting new lows. I knew there would be a lot of selling pressure at tax loss season, which there was. I also thought that in January they would pop up because most people knew the thesis was still intact. For those who wished to harvest tax losses, they key is to do it a bit early (e.g. October or early November) and then buy back in BEFORE the end of the year.  I had some tax loss harvesting on some of my positions and that's what I did. This way, you can harvest losses, sit out the required 30 days, but still buy back in before the pop in January. In fact, for those on this thread that are familiar with Benjamin Graham's epic book, he devotes a whole chapter to this strategy. I also lucked out because I was still sitting on that position when the Collins decision came out. Luck, luck, luck. By the way, I find it kind of annoying when people talk about the trade that worked out well after the fact. So, sorry for that as it's not my style. (the trick is to predict, lol!) I only tell the story because I was asked and also I thought some people here would find the tax-loss reasoning interesting, and again it's a Benjamin Graham feature.

 

I wish you guys and gals flipping this stuff the best of luck, but since there's a double -> triple at risk from any number of sources I just won't play that game.

[Wiggins]

@Midas

I'm not in commons at all anymore because I think we are closer to the finish line and it's a bit risky. But like you, perhaps I will get back in a little bit if it stays favorable or becomes more favorable. My miracle trade (again, 99% luck, 1% skill) was in the fall of 2018 when I loaded up on commons. I then rode them from the low $1s to the high $3s where I sold most. The skill (if you can call it that), was my thesis on this trade based on reasoning for tax losses. At the time, the preferred and commons were significantly lower than they had been earlier in the year, and they were hitting new lows. I knew there would be a lot of selling pressure at tax loss season, which there was. I also thought that in January they would pop up because most people knew the thesis was still intact. For those who wished to harvest tax losses, they key is to do it a bit early (e.g. October or early November) and then buy back in BEFORE the end of the year.  I had some tax loss harvesting on some of my positions and that's what I did. This way, you can harvest losses, sit out the required 30 days, but still buy back in before the pop in January. In fact, for those on this thread that are familiar with Benjamin Graham's epic book, he devotes a whole chapter to this strategy. I also lucked out because I was still sitting on that position when the Collins decision came out. Luck, luck, luck. By the way, I find it kind of annoying when people talk about the trade that worked out well after the fact. So, sorry for that as it's not my style. (the trick is to predict, lol!) I only tell the story because I was asked and also I thought some people here would find the tax-loss reasoning interesting, and again it's a Benjamin Graham feature.

 

I wish you guys and gals flipping this stuff the best of luck, but since there's a double -> triple at risk from any number of sources I just won't play that game.

 

@Covid

Both the common AND the preferred shares in GSEs are speculative investments. In fact, according to "The Intelligent Investor" virtually all stocks are speculative. Everyone's risk tolerance is different. I try not to waste everyone's time by posting all of my personal preferences and risk tolerances unless specifically asked.

[beaufort]

@Midas

Interesting speculation re net worth caps. 

[Midas79]

@Wiggins

 

That's a great story and strategy, I'm glad you shared it.

 

What I meant by trading the commons and prefs, though, was selling one class to buy the other at what I hope to be advantageous times while being cash-neutral. Basically betting on the direction of the FNMAS:FNMA ratio. It's approaching 5:1, which is around the highest it has been since late 2018.

https://stockcharts.com/h-sc/ui?s=FNMAS:FNMA&p=d&yr=2&mn=0&dy=0&id=p6911660031c

It seems that the commons are always the first to overreact to good news, so even for a 100%-pref investor like me, it might be worth swapping a bit over to commons to potentially gain on good news like a capital rule actually being released or a positive Supreme Court decision in Selia. The chart I linked to shows two big plunges (the kind that swapping prefs to commons would take advantage of): Watt's term ending and the Fifth Circuit en banc decision.

 

The real money to be made 18 months ago, in hindsight of course, was to swap prefs to commons in late 2018 and swap back in March 2019.

 

Edit: and if you don't mind my asking, why didn't you do the same thing at the end of 2019 as you did in 2018?

 

@beaufort

 

I am 99% sure that the caps' relation to junior pref par value is a coincidence. I just found it interesting and decided to post it.

[Guest cherzeca]

@Midas

Interesting speculation re net worth caps.

 

I have thought about it some and I think it is a coincidence. 

[DRValue]

Anyone have a link to the arrowood dismissal?

[Guest cherzeca]

Anyone have a link to the arrowood dismissal?

 

https://ecf.cofc.uscourts.gov/doc1/01513723106

 

crappy argument and crappy opinion. given Fairholme and collins, this is no great loss.  it is a shame Sweeney was spending her time on this and not on Washington federal.

[DRValue]

Anyone have a link to the arrowood dismissal?

 

https://ecf.cofc.uscourts.gov/doc1/01513723106

 

crappy argument and crappy opinion. given Fairholme and collins, this is no great loss.  it is a shame Sweeney was spending her time on this and not on Washington federal.

 

Thanks. You answered my next question too.  :)

[Midas79]

Anyone have a link to the arrowood dismissal?

 

https://ecf.cofc.uscourts.gov/doc1/01513723106

 

crappy argument and crappy opinion. given Fairholme and collins, this is no great loss.  it is a shame Sweeney was spending her time on this and not on Washington federal.

 

What's crappy about it? At least, is there anything crappy about it that wasn't crappy in the Fairholme opinion? It's mostly a copy-and-paste outside Section V (Standing).

 

I do agree that it's no big loss. She dismissed Arrowood's direct claims for basically the same reason she dismissed Fairholme's direct claims. I would expect her to dismiss all other similar direct claims (breaches of fiduciary duty and implied-in-fact contract).

 

I also think that the Washington Federal case is in grave danger of being dismissed in its entirety. If Sweeney decides that she lacks jurisdiction over any direct claims, doesn't that case just go poof like Arrowood?

[Wiggins]

@Midas

re: "why didn't you do the same thing at the end of 2019 as you did in 2018?"

The conditions were different. In 2018 the securities had gone down a lot over the year, so there was selling pressure for tax-loss harvesting. Additionally, the commons were really, really low (too much, IMO). One or both went below $1. In 2019 they didn't really lose value over the whole year, so there were likely few losses to be booked by most people. And I don't think there's a lot of selling pressure otherwise because people are waiting for recap or a ruling catalyst, so they're staying in. I should make a distinction between this strategy and the one discussed in Graham's book. In The Intelligent Investor it talks about a strategy to buy stocks in December and sell them in January, regardless of any other factors. There were a few years where people made money but soon a lot of people caught on and overall the practice is roundly discredited. What I am talking about is integrating multiple other factors into the tax-balancing strategy that many people do at year's end already; it's really a distinct strategy. The securities have to be down a lot so that many people are likely wanting to harvest the losses (hence the selling pressure), AND the thesis has to be solid so that folks will get back in them in the new year (buying pressure). All those factors were solidly present in late 2018 for the commons to my thinking.

 

As far as rotating between preferred and common according to a ratio like you're talking about, I guess I do that a little bit and the late 2018 was part of that (some of the funds I rolled into commons came from preferreds, while some other funds came from gains I was forced to book).  But I don't employ it as a general strategy because I have no great predicting strategy for it and it seems rather arbitrary and random. Plus, the spreads on preferreds make it difficult. Speaking of spreads, if you were patient you possibly could make money off of buying and selling the preferreds and working the spreads, but I have neither patience nor time for that personally, even if I could make it work which I doubt I could. Lastly, I am worried for the commons that there could be a sudden announcement for conversion of preferreds into common, and it'd be unfortunate if you weren't holding preferreds at that time. Are you worried about that? And isn't that what happened with Citi?

[Guest cherzeca]

"I also think that the Washington Federal case is in grave danger of being dismissed in its entirety. If Sweeney decides that she lacks jurisdiction over any direct claims, doesn't that case just go poof like Arrowood?"

 

good question.  my response is that Fairholme/arrowood's direct claims are with respect to what conservator did...so in the federal circuit's view a shareholder's complaint about what the conservator did is espousing the corporation's claim against the conservator, hence derivative's .  Washington federal claims are with respect to the whole appointment of the conservator.  I have not gone back to read the Washington federal papers but I suspect you are right, wash fed is making a direct claim.  not sure claims re the "appointment of conservator" fits under the same standing analysis as claims re the "acts of a conservator" 

 

edit:  yes, wash fed pleads direct claim, but distinguishes facts re imposition of conservatorship in its claim from fairholme' facts, dismissing direct claim. https://ecf.cofc.uscourts.gov/doc1/01513673776

 

edit:  I say crappy opinion because Sweeney addresses in Arrowood the conservator authority issue and says circuit courts have dismissed claim...apparently written before collins, and not revised after collins. in wash fed, supplemental brief linked above specifically points to collins as holding shareholders have a direct claim for damages arising from an ultra vires conservator act.

[Midas79]

@Wiggins

 

Thanks for the explanation. It makes perfect sense.

 

Yes, Citi's conversion took the market completely by surprise: the pref:common ratio in the exchange offer was more than 3 times that of the day before the announcement was made. Being caught off guard, i.e. with a large common position, when a FnF share exchange hits could be devastating compared to just owning all prefs. In fact, that's essentially the reason I only own the prefs most of the time, and never go below 90% (vis a vis the commons).

 

I wrote a post about Citi's conversion last year, it might answer some of your other questions if you haven't read it yet.

https://www.cornerofberkshireandfairfax.ca/forum/general-discussion/fnma-and-fmcc-preferreds-in-search-of-the-elusive-10-bagger/msg382592/#msg382592

 

@cherzeca

 

I see your point that Washington Federal's claims are a very different animal than those made by basically all of the other cases. I just wonder if Sweeney will paint Washington Federal's claims with the same brush, whether it's out of laziness or that she really does think it's the proper thing to do.

 

I think you have a much better idea than I do about the similarities and differences between the cases. Which part appears to have been written before Collins and not revised since? The Collins decision was in September, while Sweeney's Fairholme decision was in December. So if she failed to update something as a result of Collins, she did so in both the Fairholme and Arrowood cases. It also means she had written her opinion before September, right? 3+ months would be a long time to sit on that.