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

[Guest cherzeca]

The reason I say that common & warrant positions are not necessarily pari passu is because of the issue of order of operations.

 

Can the warrants get a better result than the common? The answer is yes -- by simply converting last.

 

First dilute the common using junior preferreds. (The actual amount of conversion doesn't matter. Give them 20% of the eventual company and the common 0% or give junior preferreds 10% and common 10%. Set the slider wherever you want.) Then convert the warrants and dilute both the junior preferred and common.

 

Alternatively, you can dilute the common by doing a two-step recap. Raise outside capital and dilute commons. Then convert the warrants to dilute both new capital and old capital. Notably, you can even set this at a price that makes the outside capital relatively happy.

 

Let's assume $75 billion of capital requirements. So then you can raise $15 billion from outside capital to dilute the old common to almost nothing. Then you can immediately use the warrants at an upwards adjusted strike price to have the government inject $60 billion to the company. New capital owns 20% of the company, government owns 80% of the company, and old common owns very little.

 

Now it doesn't have to be that drastically bad for old common -- but my point is that the assumption that the common shareholders stand in the same place as the warrant holders may not necessarily hold true.

 

And, of course, this is why I prefer the preferreds. (No pun intended.) The preferreds at least have legal claims that can be used as leverage -- the common no longer has any leverage.

 

i am not sure i follow, quite frankly.  but let me ask you this question:

 

let's say fnma has 1B shares of common outstanding, then issues another 1B shares to raise more money.  does govt's warrant position go from 4B shares to 8B shares?

[Picasso]

I'm not sure I follow either. Order of dilution doesn't matter, the warrants will be diluted unless they're magic warrants. And if they're those kind of magic warrants then commons are worth zero.

[Guest roark33]

This will be my first comment on this subject (and probably last).....

 

Have you seen Fannie and Freddie discussed in any town hall meetings?  Is there a public outcry regarding the current status? 

 

No....

 

Politicians rarely get anything done without public outcry...

 

It ain't gonna happen...

[merkhet]

That's how I read Section 2.1, but if someone has a different read, I'd be open to hearing it.

 

https://www.treasury.gov/press-center/press-releases/Documents/warrantfnm3.pdf

[investorG]

The reason I say that common & warrant positions are not necessarily pari passu is because of the issue of order of operations.

 

Can the warrants get a better result than the common? The answer is yes -- by simply converting last.

 

First dilute the common using junior preferreds. (The actual amount of conversion doesn't matter. Give them 20% of the eventual company and the common 0% or give junior preferreds 10% and common 10%. Set the slider wherever you want.) Then convert the warrants and dilute both the junior preferred and common.

 

Alternatively, you can dilute the common by doing a two-step recap. Raise outside capital and dilute commons. Then convert the warrants to dilute both new capital and old capital. Notably, you can even set this at a price that makes the outside capital relatively happy.

 

Let's assume $75 billion of capital requirements. So then you can raise $15 billion from outside capital to dilute the old common to almost nothing. Then you can immediately use the warrants at an upwards adjusted strike price to have the government inject $60 billion to the company. New capital owns 20% of the company, government owns 80% of the company, and old common owns very little.

 

Now it doesn't have to be that drastically bad for old common -- but my point is that the assumption that the common shareholders stand in the same place as the warrant holders may not necessarily hold true.

 

And, of course, this is why I prefer the preferreds. (No pun intended.) The preferreds at least have legal claims that can be used as leverage -- the common no longer has any leverage.

 

once again, while technically possible, it is far more likely that before any recapitalization starts, asking people for tens and tens of billions of dollars of new capital, the warrants issue would be resolved in terms of setting a fixed amount of shares / exercise price.  the extra capital likely won't be raised all at once, so the first buyers of the extra shares will want some certainty and not have the threat of a rapidly escalating warrant shares potential staring them in the face.  i could be wrong but people like mnuchin, cohn, and mulvaney are incredibly talented at deal dynamics and execution, now we'll see how politically astute they are.

[investorG]

This will be my first comment on this subject (and probably last).....

 

Have you seen Fannie and Freddie discussed in any town hall meetings?  Is there a public outcry regarding the current status? 

 

No....

 

Politicians rarely get anything done without public outcry...

 

It ain't gonna happen...

 

ok roark you may be right.  mnuchin said twice yesterday that 'hopefully' a bipartisan solution can be found. 

 

but what if it isn't despite mnuchin's best efforts?  in jan 2018 he + mel watt can do some or all of the following on their own:  stop the sweep, retire the sr preferred, adjust the warrants, and eventually after capital is raised, remove them from conservatorship ---- would the stock price be above $3 in that scenario?

 

one risk to my above statement is if congress passed a veto-proof bill specifically preventing this -- which among other things would likely require a plunge in trump's popularity by republican voters.

[SnarkyPuppy]

The only reason I haven't sold is because of Mnuchin's connection to Berkowitz and Paulson (questionable whether he still owns).  And if I'm being honest, it's hard to assess how strong of a relationship Mnuchin has with Berkowitz and it's impossible to know whether Paulson still owns anything.  Further, while some have argued against this, I'm not comfortable that some form of large plaintiff settlement could potentially happen, leaving retail shareholders with the bag. 

 

Very strongly leaning towards selling, but this is of course very difficult given the fact that it's so obvious that he will simply convert the junior prefs, increase warrant strike, recap through a rights offering + retained earnings.  But the idea of trying to figure out all potential negative actions is a hurdle I'm having trouble jumping over. 

 

Additionally, seems likely there will be a writedown in the DTAs causing another draw based on Mnuchin's timeline discussed yesterday.  Because of the language in Corkers omnibus preventing effectively any modification of the SPSA (likely inclusive of the NWS), it's not entirely clear whether the NWS can be amended through a 4th amendment (I understand that the consensus on this board is that it can, but I'm not comfortable). 

[Mephistopheles]

Further, while some have argued against this, I'm not comfortable that some form of large plaintiff settlement could potentially happen, leaving retail shareholders with the bag. 

 

Yep, a concern I've raised repeatedly. I feel this possibility doesn't get discussed enough. Maybe better to sell some and buy Fairholme (and short Sears and Joe, lol)?

[Flynnstone5]

The only reason I haven't sold is because of Mnuchin's connection to Berkowitz and Paulson (questionable whether he still owns).  And if I'm being honest, it's hard to assess how strong of a relationship Mnuchin has with Berkowitz and it's impossible to know whether Paulson still owns anything.  Further, while some have argued against this, I'm not comfortable that some form of large plaintiff settlement could potentially happen, leaving retail shareholders with the bag. 

 

Very strongly leaning towards selling, but this is of course very difficult given the fact that it's so obvious that he will simply convert the junior prefs, increase warrant strike, recap through a rights offering + retained earnings.  But the idea of trying to figure out all potential negative actions is a hurdle I'm having trouble jumping over. 

 

Additionally, seems likely there will be a writedown in the DTAs causing another draw based on Mnuchin's timeline discussed yesterday.  Because of the language in Corkers omnibus preventing effectively any modification of the SPSA (likely inclusive of the NWS), it's not entirely clear whether the NWS can be amended through a 4th amendment (I understand that the consensus on this board is that it can, but I'm not comfortable).

 

Valid concerns and as clear as the solution would seem to be somehow the goal post just keeps moving. With respect to large P settlement, I don't think it's possible for only Berkowitz prfd shares getting paid whatever while other prfd shareholders get screwed. I think the legal experts here have covered this, but renewed thoughts from some of those would certainly be welcomed.

 

I've read additional material from Tim Howard and Adam Spittler, in addition to this board, and it seems very clear that the NWS can be amended and congress does not need to be involved. The language specifically says that, but some have said that the Corker bill was package into another bill that was passed.

 

This is the only one I am aware of: https://www.congress.gov/bill/114th-congress/house-bill/2029/text

 

SEC. 702. LIMITATIONS ON SALE OF PREFERRED STOCK.

 

    (a) Definitions.--In this section:

            (1) Secretary.--The term ``Secretary'' means the Secretary

        of the Treasury.

            (2) Senior preferred stock purchase agreement.--The term

        ``Senior Preferred Stock Purchase Agreement'' means--

                    (A) the Amended and Restated Senior Preferred Stock

                Purchase Agreement, dated September 26, 2008, as such

                Agreement has been amended on May 6, 2009, December 24,

                2009, and August 17, 2012, respectively, and as such

                Agreement may be further amended and restated, entered

                into between the Department of the Treasury and each

                enterprise, as applicable; and

 

[[Page 129 STAT. 3025]]

 

                    (B) any provision of any certificate in connection

                with such Agreement creating or designating the terms,

                powers, preferences, privileges, limitations, or any

                other conditions of the Variable Liquidation Preference

                Senior Preferred Stock of an enterprise issued or sold

                pursuant to such Agreement.

 

    (b) Limitations on Sale of Preferred Stock.--Notwithstanding any

other provision of law or any provision of the Senior Preferred Stock

Purchase Agreement, until at least January 1, 2018, the Secretary may

not sell, transfer, relinquish, liquidate, divest, or otherwise dispose

of any outstanding shares of senior preferred stock acquired pursuant to

the Senior Preferred Stock Purchase Agreement, unless Congress has

passed and the President has signed into law legislation that includes a

specific instruction to the Secretary regarding the sale, transfer,

relinquishment, liquidation, divestiture, or other disposition of the

senior preferred stock so acquired.

    © Sense of Congress.--It is the Sense of Congress that Congress

should pass and the President should sign into law legislation

determining the future of Fannie Mae and Freddie Mac, and that

notwithstanding the expiration of subsection (b), the Secretary should

not sell, transfer, relinquish, liquidate, divest, or otherwise dispose

of any outstanding shares of senior preferred stock acquired pursuant to

the Senior Preferred Stock Purchase Agreement until such legislation is

enacted.

[Luke 532]

"Mnuchin at Treasury Likely Lifts Chances of GSE Lawsuit Settling" -Bloomberg

 

FWIW, Nathan Dean at Bloomberg thinks chances of settlement have increased... and this was after the Feb. 21st court ruling came out.

(see attached)

[investorG]

it's nice to not hit refresh 20+ times every Tuesday and Friday morning.

[Luke 532]

it's nice to not hit refresh 20+ times every Tuesday and Friday morning.

 

LOL.  No more carpal tunnel syndrome :-)

[DocSnowball]

This investment (while very engaging) may be injurious to health! Ask Perry et al. Following every twist is too stressful.

 

Why did anyone think Mnuchin would announce something big after Berkowitz sent out a letter saying the fight will go on the previous evening? Also taking time allows Mnuchin to negotiate from a better place and divert attention to other issues. 

 

While I still have full faith in the thesis, being a novice I have no idea whether and when restructuring will occur and reward retail and institutional investors, or liquidation will occur and what the liquidation value may come. My simplistic view is to sit back and relax, and let this be like a binary biotech investment waiting for a drug trial result - no one knows the end results, the success is favorable based on the base rates (rates of Trump administration stiffing its supporters, of Trump administration favoring its own and investors interests over big Government, and finally of Courts protecting property rights if they finally agree a liquidation has occurred). Versus forces wanting to kill the GSEs but unable to for all this time. Bayes theorem is still on our side. Too much noise becomes a call for action for the non-expert like the last week is showing. Also the Kelly formula can't work unless you let the position run its full course, correct? Otherwise all you get is 30% gains and 100% losses.

 

For me as a student, this case is a coming of age as an investor. Cheers to everyone's good health on this thread!

[orthopa]

This will be my first comment on this subject (and probably last).....

 

Have you seen Fannie and Freddie discussed in any town hall meetings?  Is there a public outcry regarding the current status? 

 

No....

 

Politicians rarely get anything done without public outcry...

 

It ain't gonna happen...

 

I dont think 90% or more of the public even knows what fannie mae does let alone knowledgeable enough to bitch about it at a town hall meeting.

 

Halt mortgage approvals, buying and selling, and shut down the "liquidity" of the housing market in the US and then the simpletons may start to get rowdy

[orthopa]

The only reason I haven't sold is because of Mnuchin's connection to Berkowitz and Paulson (questionable whether he still owns).  And if I'm being honest, it's hard to assess how strong of a relationship Mnuchin has with Berkowitz and it's impossible to know whether Paulson still owns anything.  Further, while some have argued against this, I'm not comfortable that some form of large plaintiff settlement could potentially happen, leaving retail shareholders with the bag. 

 

Very strongly leaning towards selling, but this is of course very difficult given the fact that it's so obvious that he will simply convert the junior prefs, increase warrant strike, recap through a rights offering + retained earnings.  But the idea of trying to figure out all potential negative actions is a hurdle I'm having trouble jumping over. 

 

Additionally, seems likely there will be a writedown in the DTAs causing another draw based on Mnuchin's timeline discussed yesterday.  Because of the language in Corkers omnibus preventing effectively any modification of the SPSA (likely inclusive of the NWS), it's not entirely clear whether the NWS can be amended through a 4th amendment (I understand that the consensus on this board is that it can, but I'm not comfortable).

 

I think your over thinking it.

 

I think you see Paulson leave the Administration as an adviser if he is betrayed. Why would he have sold his shares already? The guy lobbied for years to have fannie out of govt control and govt ownership (sound familiar?), took a chance on trump, likely had a huge amount of influence in the decision of secretary of the treasury and finally got his guy in.

 

This is binary for him too. Either he gets betrayed and fucked by his former partner and fellow trump economic advisor or he make billions of dollars.

 

The koolaid drinker in me bets on the latter.

[Guest cherzeca]

That's how I read Section 2.1, but if someone has a different read, I'd be open to hearing it.

 

https://www.treasury.gov/press-center/press-releases/Documents/warrantfnm3.pdf

 

that's how i read it too merkhet.  i didnt realize that.  so if junior pref exchanges for common, for example, the number of govt warrants increases.  i agree that govt warrants and common are not parri passu.  i have never seen this for a public company.

 

this also makes it impossible to issue more common stock, imo.  who wants to pay up for a share of common stock knowing that he is also funding a free .8 share warrant for govt?  so if there is to be a recap, this provision has to change, because there is no recap.  taking it one step further, no junior pref holder would exchange for common  for the same reason, which govt may want to do, so this provision (if used by treasury) makes any kind of workout that restores equity value unworkable.

[Guest cherzeca]

@luke

 

who is nathan dean?

[Cardboard]

Being new to the story... Why is almost everyone assuming that the preferreds have to be converted into common shares? Do they have to be redeemed or they all are perpetual? If they were simply left outstanding, we are looking at an annual payment of roughly $1 billion/year for Fannie which they obviously can cover.

 

Regarding new capital, both companies obviously don't need any since the government with their Sweep takes everything home and they come back the year after taking again a similar sum with them making the same amount of profits. While I understand that they will need a cushion for leaner years, how much would that be considering that they would build that back relatively quickly without the NWS and their operations being more tightly regulated as they are now. Is Bassel or other applying to them?

 

Cardboard

[Luke 532]

@luke

 

who is nathan dean?

 

Financial Services Policy Analyst for Bloomberg

[Picasso]

That's how I read Section 2.1, but if someone has a different read, I'd be open to hearing it.

 

https://www.treasury.gov/press-center/press-releases/Documents/warrantfnm3.pdf

 

that's how i read it too merkhet.  i didnt realize that.  so if junior pref exchanges for common, for example, the number of govt warrants increases.  i agree that govt warrants and common are not parri passu.  i have never seen this for a public company.

 

this also makes it impossible to issue more common stock, imo.  who wants to pay up for a share of common stock knowing that he is also funding a free .8 share warrant for govt?  so if there is to be a recap, this provision has to change, because there is no recap.  taking it one step further, no junior pref holder would exchange for common  for the same reason, which govt may want to do, so this provision (if used by treasury) makes any kind of workout that restores equity value unworkable.

 

This is amazing, the government actually issued magic warrants.  No wonder they did 79.9%, they basically get the benefit of owning the entire business without placing any of its debt on the government balance sheet.  It also makes the existing common equity worthless because no capital would ever make its way back to common equity holders except for the ones that own those warrants.  I don't have a view on the preferred yet but I can't imagine why anyone would speculate on purchasing the equity with those kinds of warrant rights.  It also makes me wonder, with a deal like that why would the government want to make any changes?  It's basically 100% ownership even without the NWS.  It seems like a bet on Mnuchin not screwing over his buddies and if we're talking about the NWS being un-American, that sounds pretty un-American too.

[Guest cherzeca]

@picasso

 

while mnuchin is a cypher, he has been consistent that the status quo, govt ownership and conservatorship, is unacceptable.  he wants these GSEs to be privately owned.

 

now come back from being privately owned to today, knowing that these are magic warrants.  you cant make that trip unless you change the terms of the warrants.  now, how mnuchin resolves this is anyone's guess, he could wipe out the entire capital structure and start fresh with a primary share offering, and pay junior pref their takings remedy in 5 years.

 

if you think that you take a pass on this.

 

 

[Midas79]

That's how I read Section 2.1, but if someone has a different read, I'd be open to hearing it.

 

https://www.treasury.gov/press-center/press-releases/Documents/warrantfnm3.pdf

 

that's how i read it too merkhet.  i didnt realize that.  so if junior pref exchanges for common, for example, the number of govt warrants increases.  i agree that govt warrants and common are not parri passu.  i have never seen this for a public company.

 

this also makes it impossible to issue more common stock, imo.  who wants to pay up for a share of common stock knowing that he is also funding a free .8 share warrant for govt?  so if there is to be a recap, this provision has to change, because there is no recap.  taking it one step further, no junior pref holder would exchange for common  for the same reason, which govt may want to do, so this provision (if used by treasury) makes any kind of workout that restores equity value unworkable.

 

I agree. As a preferred shareholder that can't forcibly be converted to common, I first need to know if and under what terms the warrants will be exercised before I accept any offer. Changing the language to a fixed number of shares would be a great first step.

 

If the strike price also gets changed I would know both that Treasury intends to exercise the warrants and how much capital would be injected into the GSEs.

[rros]

The reason I say that common & warrant positions are not necessarily pari passu is because of the issue of order of operations.

 

Can the warrants get a better result than the common? The answer is yes -- by simply converting last.

 

First dilute the common using junior preferreds. (The actual amount of conversion doesn't matter. Give them 20% of the eventual company and the common 0% or give junior preferreds 10% and common 10%. Set the slider wherever you want.) Then convert the warrants and dilute both the junior preferred and common.

 

Alternatively, you can dilute the common by doing a two-step recap. Raise outside capital and dilute commons. Then convert the warrants to dilute both new capital and old capital. Notably, you can even set this at a price that makes the outside capital relatively happy.

 

Let's assume $75 billion of capital requirements. So then you can raise $15 billion from outside capital to dilute the old common to almost nothing. Then you can immediately use the warrants at an upwards adjusted strike price to have the government inject $60 billion to the company. New capital owns 20% of the company, government owns 80% of the company, and old common owns very little.

 

Now it doesn't have to be that drastically bad for old common -- but my point is that the assumption that the common shareholders stand in the same place as the warrant holders may not necessarily hold true.

 

And, of course, this is why I prefer the preferreds. (No pun intended.) The preferreds at least have legal claims that can be used as leverage -- the common no longer has any leverage.

 

i am not sure i follow, quite frankly.  but let me ask you this question:

 

let's say fnma has 1B shares of common outstanding, then issues another 1B shares to raise more money.  does govt's warrant position go from 4B shares to 8B shares?

Commoners, don't panic. Every time there is a dilution mkt cap increases. We are recapping, right? That is the goal in this conversion. How much common gets will depend on the strike price at which the government converts. Which will also determine how many commons the Jrs. are converted into -respecting their liquidation preference-. But to make it short, if Jrs. are converting at liquidation preference that adds approx. 37 billion in mkt capitalization (regardless of the share count which depends on strike price). All it matters is the share count determined by the strike price set by the government. It does not matter who is diluted first or if warrants are diluted last over a total of Jrs.+commons. Sharpen your pencils.

 

If government converts today at current price $3 for Fannie, it will add 8.33 shares from Jrs (or 16.66 for the 50s) and it will add 48 bill shares to set a mkt cap of apprx. 156 bill. No upside for the common. But Jrs. get their full value. This could be a worst case. If government converts at $20, commons get $20, Jrs. add 1.25 shares to the count (2.5 for the 50s) and government adds 7+ billion shares. Rounded up numbers and double dipping (exercising warrants AFTER jrs. are converted).

 

The problem here is that Stegman, in this scenario, is correct. Treasury is injecting almost all the capital (remember? at the expense of the taxpayer). And who will buy Treasury's shares when the upside has been realized at $20 strike?

 

To improve this equation Jrs. must be converted at less than liquidation (less share count on first dip) and strike price of government at a lower price.

[Guest Schwab711]

That's how I read Section 2.1, but if someone has a different read, I'd be open to hearing it.

 

https://www.treasury.gov/press-center/press-releases/Documents/warrantfnm3.pdf

 

that's how i read it too merkhet.  i didnt realize that.  so if junior pref exchanges for common, for example, the number of govt warrants increases.  i agree that govt warrants and common are not parri passu.  i have never seen this for a public company.

 

this also makes it impossible to issue more common stock, imo.  who wants to pay up for a share of common stock knowing that he is also funding a free .8 share warrant for govt?  so if there is to be a recap, this provision has to change, because there is no recap.  taking it one step further, no junior pref holder would exchange for common  for the same reason, which govt may want to do, so this provision (if used by treasury) makes any kind of workout that restores equity value unworkable.

 

This is amazing, the government actually issued magic warrants.  No wonder they did 79.9%, they basically get the benefit of owning the entire business without placing any of its debt on the government balance sheet.  It also makes the existing common equity worthless because no capital would ever make its way back to common equity holders except for the ones that own those warrants.  I don't have a view on the preferred yet but I can't imagine why anyone would speculate on purchasing the equity with those kinds of warrant rights.  It also makes me wonder, with a deal like that why would the government want to make any changes?  It's basically 100% ownership even without the NWS.  It seems like a bet on Mnuchin not screwing over his buddies and if we're talking about the NWS being un-American, that sounds pretty un-American too.

 

I think it's common for warrants issued in recap situations to have anti-dilution protection. Either way, it definitely looks like the gov't set themselves up at the time of issuance so they can win with both camps in the headlines. I think the gov't will almost certainly be the last to exercise in any situation and the tax payers will likely be the real winners when the dust settles. It really looks like the gov't planned to get credit from and play both sides from the jump.

 

Where I see incentives pointing:

If the govt changes the terms of the warrants or exercises before anyone else then it is at a direct cost to the tax payers. That might create bad headlines/PR and a slim change of a noticeable negative reaction. I would guess admins consider these risks when dictating policy. The majority of the country (from every political lean) still hate the banks/financial industry (from the POV of POTUS, a pro-tax payer solution could help boost opinion with Bernie supporters (and improve dem support/approval)). Also, Trump's base has large overlap with middle class tax payers (say, the bottom 50% of federal tax payers') and the national deficit is a relatively important issue to these folks. On a net basis, I think incentives point to the tax payers being the ultimate victor because it helps the current admin meet promises and boost approval (and what POTUS admin wouldn't want that).

 

Who knows though.

[Picasso]

But these are $0 strike warrants.  Most anti-dilution provisions will reduce the strike or allow for participation in any new equity raise.  When you have a $0 strike with no limits on the increase in warrant issuance in front of any equity raise, it makes the equity totally uninvestable.  I don't think I've ever seen that before.  It's such a great deal for the warrant holders that I can't imagine why they would amend the terms.