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

[Guest cherzeca]

How big of a problem is Hensarling? 

 

http://www.nationalmortgagenews.com/news/compliance-regulation/hensarling-targets-gse-reform-dodd-frank-rollback-in-ambitious-agenda-1091018-1.html?utm_content=socialflow&utm_campaign=natmortgagenews-tw&utm_source=twitter&utm_medium=social

 

the way i look at hensarling and corker is that they were emboldened by an obama administration that shared their view on GSEs...different political party, but still same TBTF private capital preference. they shared this position in opposition to the low-income housing crowd in the dem party.

 

now, the trump administration "seems" to be more favorable for the GSEs to be resuscitated.  i think (hope) hensarling and corker will be more chastened re GSEs.  they will get their way with dodd frank reform, which corker says is coming up first, and less likely to be pounding the table on GSEs.

 

all of this of course is wild speculation

[SnarkyPuppy]

How big of a problem is Hensarling? 

 

http://www.nationalmortgagenews.com/news/compliance-regulation/hensarling-targets-gse-reform-dodd-frank-rollback-in-ambitious-agenda-1091018-1.html?utm_content=socialflow&utm_campaign=natmortgagenews-tw&utm_source=twitter&utm_medium=social

 

the way i look at hensarling and corker is that they were emboldened by an obama administration that shared their view on GSEs...different political party, but still same TBTF private capital preference. they shared this position in opposition to the low-income housing crowd in the dem party.

 

now, the trump administration "seems" to be more favorable for the GSEs to be resuscitated.  i think (hope) hensarling and corker will be more chastened re GSEs.  they will get their way with dodd frank reform, which corker says is coming up first, and less likely to be pounding the table on GSEs.

 

all of this of course is wild speculation

 

I think I'm ultimately worried he gets the Treasury position.  I'm less bullish on the overall "trump administration catalyst" than others seem to be given the variety of unknowns involved, but it seems Hensarling would be a big dent in that element of the "trump administration catalyst"

[Steve_Berk]

Why is Tim Howard so pessimistic about Trump and the GSE's? This is what he's saying on his blog:

 

"Needless to say the calculus in our epic battle has completely changed with the election of Donald Trump. At this moment it appears that the mandates and trust funds that we on this blog fought so hard to save are in grave peril.

It is becoming increasingly clear from sources close to Trump’s team that he will resolve the GSE issue early in his Presidency. He will claim much of the glory in declaring victory while setting the housing market on a path of growth. The Republicans will be sure to crush as much of the mandates and trust fund dollars as possible and cleverly lay the stage for their ultimate demise. Trump will lay claim to the increase in minority home ownership that will surely come as a result of releasing the GSEs and bringing private capital back into the market."

[waynepolsonAtoZ]

Just a note that the Tfud index on the preferreds is at 17.5052%, which is based on $284/$1,625, average closing price divided by the total redemption value of the FnF preferreds (ignoring the one with a redemption value of $105,000). It was at 10 percent not so long ago.

 

It does seem a little surreal and it could get dampened by a bad appeals court decision, but I'm hoping that that won't happen. Still, 17.5% implies that there is still plenty of upside here.

[TonyG]

Steve thats from the fake timhoward site.

[Sunrider]

Edit: Summary might be - in the medium term, i.e. To resolution of the GSE question, can the common do well without the prefs doing well from a risk/reward point of view?

 

Question to all:

 

Apart from preferences re taking returns (e.g. On pop in common with court win vs. Waiting for prefs to go back to par), is there a scenario, settlement, court outcome in which the prefs don't go back to par but the common does well?

 

In my mind, if the court cases go our way or there is a settlment, then eventually the GSEs will pay dividends again or seek to repurchase the prefs. So either one sits on prefs paying 25% ish on cost (e.g. FNMAI) or with a 4x return through the buyout at par.

 

I accept that the common (more liquid, etc.) may well see a lot of upside in the market (and that there is lots of value that should go towards it if NWS reversed, even after covering senior and junior pref) - and thus it may well do a lot better than prefs in price terms initially - but over the term to a resolution on the business model, don't the prefs seem to be the better risk/return (take some high yield before eventually being bought out)?

 

Thanks!

[Guest cherzeca]

Edit: Summary might be - in the medium term, i.e. To resolution of the GSE question, can the common do well without the prefs doing well from a risk/reward point of view?

 

Question to all:

 

Apart from preferences re taking returns (e.g. On pop in common with court win vs. Waiting for prefs to go back to par), is there a scenario, settlement, court outcome in which the prefs don't go back to par but the common does well?

 

In my mind, if the court cases go our way or there is a settlment, then eventually the GSEs will pay dividends again or seek to repurchase the prefs. So either one sits on prefs paying 25% ish on cost (e.g. FNMAI) or with a 4x return through the buyout at par.

 

I accept that the common (more liquid, etc.) may well see a lot of upside in the market (and that there is lots of value that should go towards it if NWS reversed, even after covering senior and junior pref) - and thus it may well do a lot better than prefs in price terms initially - but over the term to a resolution on the business model, don't the prefs seem to be the better risk/return (take some high yield before eventually being bought out)?

 

Thanks!

 

fwiw, i think if you didnt think there was a credible pathway to settlement and release from C but did think there would be a favorable ct outcome, you would be in common.  if you think there is also a real possibility of C release, then you would find the pref to be about as attractive as common.  if you think the ct decision is risky, you should be in pref.

[investorG]

Does the election of trump and recent stock price move reduce the urgency of the courts to side with the plaintiffs / people?   

 

If clinton had won, the courts might have viewed themselves as the people's last big hope for justice, and more likely produced a plaintiff-friendly verdict, all things equal?

 

as we all know very smart people can disagree on merits of this case, leaving some level of subjectivity

[muscleman]

Does the election of trump and recent stock price move reduce the urgency of the courts to side with the plaintiffs / people?   

 

If clinton had won, the courts might have viewed themselves as the people's last big hope for justice, and more likely produced a plaintiff-friendly verdict, all things equal?

 

as we all know very smart people can disagree on merits of this case, leaving some level of subjectivity

 

In contrast I think the courts are waiting for the election results to decide how to rule so it can side with the administration.

If you followed the FBI investigation into Hillary's email scandal, you know there is no separation of power in the Obama administration.

 

 

 

[Steve_Berk]

i seriously doubt that the outcome will be materially affected by the adminstration. i think they already knew how they were going to decide the case before the election. however, i do actually agree that they may feel more emboldened to strengthen the language of the opinion to the extent that they want to criticize the adminstration.

 

Does the election of trump and recent stock price move reduce the urgency of the courts to side with the plaintiffs / people?   

 

If clinton had won, the courts might have viewed themselves as the people's last big hope for justice, and more likely produced a plaintiff-friendly verdict, all things equal?

 

as we all know very smart people can disagree on merits of this case, leaving some level of subjectivity

 

In contrast I think the courts are waiting for the election results to decide how to rule so it can side with the administration.

If you followed the FBI investigation into Hillary's email scandal, you know there is no separation of power in the Obama administration.

[Guest wellmont]

Judges are political animals right? if you don't think so why was the supreme court such a big issue with this election? As such, I believe the judges now have more unfettered freedom to make a ruling against the OA, than they had prior to Nov 9, 2016. There are a few REPUB in congress that represent threats to change. However, I look at who is influencing DJT at the moment. And I see names like icahn, paulson, mnuchin (who strikes me as potentially radically free markets), and Scaramouchi. those are going to be important voices, imo.

[Sunrider]

Edit: Summary might be - in the medium term, i.e. To resolution of the GSE question, can the common do well without the prefs doing well from a risk/reward point of view?

 

Question to all:

 

Apart from preferences re taking returns (e.g. On pop in common with court win vs. Waiting for prefs to go back to par), is there a scenario, settlement, court outcome in which the prefs don't go back to par but the common does well?

 

In my mind, if the court cases go our way or there is a settlment, then eventually the GSEs will pay dividends again or seek to repurchase the prefs. So either one sits on prefs paying 25% ish on cost (e.g. FNMAI) or with a 4x return through the buyout at par.

 

I accept that the common (more liquid, etc.) may well see a lot of upside in the market (and that there is lots of value that should go towards it if NWS reversed, even after covering senior and junior pref) - and thus it may well do a lot better than prefs in price terms initially - but over the term to a resolution on the business model, don't the prefs seem to be the better risk/return (take some high yield before eventually being bought out)?

 

Thanks!

 

fwiw, i think if you didnt think there was a credible pathway to settlement and release from C but did think there would be a favorable ct outcome, you would be in common.  if you think there is also a real possibility of C release, then you would find the pref to be about as attractive as common.  if you think the ct decision is risky, you should be in pref.

 

Chris - thanks. Not quite what I was asking, so let me rephrase - in all of the scenarios you outline, the pref would ultimately have to do well also - the common may react sooner but ultimately the pref is ahead in the priority structure. So if there is a settlement, the prefs will have to get 'paid off' first (in whatever way), if there's a release from C, the equity appreciates but the GSE's still need capital - so either a deal to convert the prefs or more equity raising (possibly through the warrants) - no dividends to common before dividends flow to prefs, so again, whilst they may react first, they can't have value before the prefs have 'value' ... is that not correct?

 

Thanks.

[Guest cherzeca]

Edit: Summary might be - in the medium term, i.e. To resolution of the GSE question, can the common do well without the prefs doing well from a risk/reward point of view?

 

Question to all:

 

Apart from preferences re taking returns (e.g. On pop in common with court win vs. Waiting for prefs to go back to par), is there a scenario, settlement, court outcome in which the prefs don't go back to par but the common does well?

 

In my mind, if the court cases go our way or there is a settlment, then eventually the GSEs will pay dividends again or seek to repurchase the prefs. So either one sits on prefs paying 25% ish on cost (e.g. FNMAI) or with a 4x return through the buyout at par.

 

I accept that the common (more liquid, etc.) may well see a lot of upside in the market (and that there is lots of value that should go towards it if NWS reversed, even after covering senior and junior pref) - and thus it may well do a lot better than prefs in price terms initially - but over the term to a resolution on the business model, don't the prefs seem to be the better risk/return (take some high yield before eventually being bought out)?

 

Thanks!

 

fwiw, i think if you didnt think there was a credible pathway to settlement and release from C but did think there would be a favorable ct outcome, you would be in common.  if you think there is also a real possibility of C release, then you would find the pref to be about as attractive as common.  if you think the ct decision is risky, you should be in pref.

 

Chris - thanks. Not quite what I was asking, so let me rephrase - in all of the scenarios you outline, the pref would ultimately have to do well also - the common may react sooner but ultimately the pref is ahead in the priority structure. So if there is a settlement, the prefs will have to get 'paid off' first (in whatever way), if there's a release from C, the equity appreciates but the GSE's still need capital - so either a deal to convert the prefs or more equity raising (possibly through the warrants) - no dividends to common before dividends flow to prefs, so again, whilst they may react first, they can't have value before the prefs have 'value' ... is that not correct?

 

Thanks.

 

sorry.  i would put it this way:  the scenario in which the pref does not do well is also a scenario where the common also does not do well.  i can see where the pref does well and the common does less well, and also where the pref does well, and the common does better. 

[waynepolsonAtoZ]

 

"sorry.  i would put it this way:  the scenario in which the pref does not do well is also a scenario where the common also does not do well.  i can see where the pref does well and the common does less well, and also where the pref does well, and the common does better."

 

The common would do better if there is less earnings dilution, preferred would do better if there is more.

[Sunrider]

 

sorry.  i would put it this way:  the scenario in which the pref does not do well is also a scenario where the common also does not do well.  i can see where the pref does well and the common does less well, and also where the pref does well, and the common does better.

 

 

Thanks Chris - that does answer my question in a round-about way  ;D

[doughishere]

anybody hear the damages talk on the conference call?

 

 

Direct Link:

https://app.voicebase.com/autonotes/private_detail/33205817/hash=bJeXYGltZ2PLSWaWyWxmNknWyPmZpolmZsmmeWkZpmxGdmx8eSZG1pbJ1sm8qa?vbt=1927&vbs=OK

[deadspace]

anybody hear the damages talk on the conference call?

 

 

Direct Link:

https://app.voicebase.com/autonotes/private_detail/33205817/hash=bJeXYGltZ2PLSWaWyWxmNknWyPmZpolmZsmmeWkZpmxGdmx8eSZG1pbJ1sm8qa?vbt=1927&vbs=OK

 

I was surprised that dividends already payed out will be subtracted from the par value of the preferred shares and that is considered acceptable.  TIme value of money would suggest that after all these years par value shuld be at least HIGHER than the $25 figure

[muscleman]

anybody hear the damages talk on the conference call?

 

 

Direct Link:

https://app.voicebase.com/autonotes/private_detail/33205817/hash=bJeXYGltZ2PLSWaWyWxmNknWyPmZpolmZsmmeWkZpmxGdmx8eSZG1pbJ1sm8qa?vbt=1927&vbs=OK

 

I was surprised that dividends already payed out will be subtracted from the par value of the preferred shares and that is considered acceptable.  TIme value of money would suggest that after all these years par value shuld be at least HIGHER than the $25 figure

 

That seems ridiculous to me. The preferred are not zero coupon bonds. Dividends previously paid out should be return on capital not return of capital. Damage should be at least par.

[Guest cherzeca]

this discussion of restitution has been taken completely out of context.

 

first, restitution, or unjust enrichment, is the least likely measure of damages for breach of contract.  expectancy, or par, is the most likely. restitution, in equity, is only used by judges as a fallback measure if the contract remedy of expectancy is for some reason unavailable.

 

second, even if restitution, then as pointed out, dividends would likely not count as a clawback to a damage award, simply because they are paid in recognition of the time vale of money. yes govt would claim it as a deduct to the restitution award, and i doubt that claim would be upheld

 

thompson was winging it here.

[merkhet]

this discussion of restitution has been taken completely out of context.

 

first, restitution, or unjust enrichment, is the least likely measure of damages for breach of contract.  expectancy, or par, is the most likely. restitution, in equity, is only used by judges as a fallback measure if the contract remedy of expectancy is for some reason unavailable.

 

second, even if restitution, then as pointed out, dividends would likely not count as a clawback to a damage award, simply because they are paid in recognition of the time vale of money. yes govt would claim it as a deduct to the restitution award, and i doubt that claim would be upheld

 

thompson was winging it here.

 

Oddly enough, though, it's the second time it's been mentioned by a Cooper & Kirk partner.

[Eye4Valu]

Would gladly take $20 per share for my FNMAS. Anything more is icing on the cake.

[deadspace]

 

sorry.  i would put it this way:  the scenario in which the pref does not do well is also a scenario where the common also does not do well.  i can see where the pref does well and the common does less well, and also where the pref does well, and the common does better.

 

 

Thanks Chris - that does answer my question in a round-about way  ;D

 

When you look at the dynamics on the ground though I can say more scenarios where the preferred shares are more valuable than common.........  Here are two SEVERELY undercapitalized companies that are integral to the functioning of the mortgage markets.  If they are to survive the company is not going to be paying out the preferred shares with cash - but is going to want to convert the preferred shares to common.  In that scenario the preferred shareholders should be asking for something MORE than par to accept common over cash with very favourable valuation assumptions.  In any recapitalization the preferred shareholders will be in the drivers seat and this could be worth much more than common stock after all is said and done (post common dilution)

[Guest wellmont]

i don't think pref is in driver seat at all. the divs are non cum. and they won't be turned on again until the firm is recapped and has a strong capital base. that could take years. these will languish with no dividends. there is every incentive for pref to convert to common and create a win win scenario. there is no incentive for the firm to pay dividends on the pref. zero. why would they when everybody in DC is telling them they need to add capital. I believe the end game for fairx and other hedge fund owners is to convert to common stock at favorable terms (win win).

 

Citi did a below par swap of pref for common in 2009 that worked out extremely well for those who swapped out of the pref.

[Seahug]

Hi! I am a long time lurker and owner of FNMAS. At current market it's about 7% of my portfolio.

 

Was wondering about calculations on the preferred value vs common?  I realize there are many moving parts.

 

On a rough basis say FNMA makes $10bn a year, at 15x PE = $150bn total equity value. But it needs to raise say $75bn (2.5% of 3tn assets) as a capital requirement. So remaining equity value is 75bn (150bn total less 75 to be raised), less $20bn assuming all junior prefs get par = $55bn equity value for 100% including 80% govt share. So $55bn/5.8bn existing shares (less the capital raise) = $9.5/share or about 3x current common share price.

 

So upside of pref seems higher than common?

 

However if govt returns excess profit over 10% (not sure if ackman assumes return of principal, as he says $59bn will be returned based on his 2014 presentation; but lets say only the excess over principal + 10% will be returned), say $10bn not sure the numbers but I believe its in teens, for every $10bn that will be an increase of $1.72 to common. At the same time, the capital requirement could be 3 or 4% rather than 2.5%.

 

On a risk reward basis the prefs seem better. Unless the sweep is totally invalidated. Assuming the AIG deal which more realistic (need to repay principal + interest and govt keeps the shares), the numbers come out to 3-4x for common and at these levels 4x for the prefs.

 

Also I don't know why FNMAT trades at a higher price (7.5/25) vs FNMAS (5.5/25). FNMAT coupon is 8.5% vs FNMAS higher of 7.75 or 3 mo libor + 4.5%. Both are noncum. Actually if both are reinstated and are dividend paying FNMAS will actually earn more because FNMAT can be called at anytime, while FNMAS has discrete calls every 5 years. Next one is Dec 2020 followd by Dec 2025.

 

Also in case we lose the Perry or Fairholme case, I suppose prices would collapse. But given the change in administration, would you add?

 

Would appreciate any thoughts?

 

Cheers!

 

 

[Sunrider]

Seahug - I think it depends a bit on what you think will happen (see cherzeca and others' posts). Also, the value depends on how you calculate it. The calc you provide is a bit of short-hand. Below, some up-to-date figures (to the extent I found them) that I pondered over the weekend:

 

1. FNMA - until Dec 2016 they will have had to pay about 54 - 57bn to Treasury as dividends on the senior preferred (go with 57). The outstanding is 117bn; paid 154.4 by year end

 

2. FMCC - 33 to 35bn (call it 35) as dividends, 71bn outstanding; paid 99.138bn

 

So for FNMA, if you assume that NWS reversed and applied to 10% dividend payment, then 97.4bn remain that can be applied to repay the senior, bringing it down 18.7bn. There are 19.13bn of junior prefs outstanding (so call it 38bn in value to prefs). If you assume the business can sustainably make 10bn, at a 10x or 12x you get to your 100 - 120bn in value. Another way to calculate it would be 10bn - ca. 1.3 - 1.4bn of junior pref dividends (once senior repaid, which would take to about end 2019/20, if it can earn 11bn/year till then), so call that 8.5bn or so income attributable to common at that point ... apply a multiple to that. With warrants, unless they are restructured, you have 5.89bn shares outstanding, so that puts you into the $15 - $20 per share price range (after senior prefs are gone) for a 10x - 14x multiple.

 

C.

 

These figures will be different if the warrants are restructured, the prefs are restructured, etc. (and possibly materially so).