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

[merkhet]

I don't understand how there's much of a difference whether you return the excess payments or not on the senior preferred. Let's say they've overpaid by $187 billion over the last 4+ years versus paying the straight up 10% dividend.

 

Okay, so you deposit $187 billion into the companies' coffers.

 

Then you have a capital stack that looks like this:

 

Gov preferred stock - $187 billion

Jr. preferred stock - $34 billion

Pub. common stock - residual

 

So it doesn't matter if (A) the $187 billion is used to pay off the senior preferred stock or (B) the $187 billion is given back to the GSEs but is not accrued against the senior preferred stock.

 

Either way, everyone underneath the senior preferred stock (or who remains in the case of the pay off of the senior preferred stock) is "lacking capital."

 

It's not like the $187 billion of senior preferred stock magically disappears at the same time that the companies get back $187 billion of cash...

[doughishere]

I don't understand how there's much of a difference whether you return the excess payments or not on the senior preferred. Let's say they've overpaid by $187 billion over the last 4+ years versus paying the straight up 10% dividend.

 

Okay, so you deposit $187 billion into the companies' coffers.

 

Then you have a capital stack that looks like this:

 

Gov preferred stock - $187 billion

Jr. preferred stock - $34 billion

Pub. common stock - residual

 

So it doesn't matter if (A) the $187 billion is used to pay off the senior preferred stock or (B) the $187 billion is given back to the GSEs but is not accrued against the senior preferred stock.

 

Either way, everyone underneath the senior preferred stock (or who remains in the case of the pay off of the senior preferred stock) is "lacking capital."

 

It's not like the $187 billion of senior preferred stock magically disappears at the same time that the companies get back $187 billion of cash...

 

Merk, on point as usual. I never understood that either.

[BTShine]

For some reason I was under the impression that Berkowitz, or someone else, floated the idea that public shareholders just wanted the company back and they didn't care about getting back some of the overpayments made by the GSEs.  Ex: If GSE's overpaid by $50 Billion the Senior Preferred would still have their original balance of $187 instead of reducing that balance by $50 Bn to $137Bn.

 

Apologies if my memory is way off for this one. 

[merkhet]

For some reason I was under the impression that Berkowitz, or someone else, floated the idea that public shareholders just wanted the company back and they didn't care about getting back some of the overpayments made by the GSEs.  Ex: If GSE's overpaid by $50 Billion the Senior Preferred would still have their original balance of $187 instead of reducing that balance by $50 Bn to $137Bn.

 

Apologies if my memory is way off for this one.

 

I think very similar to that -- Berkowitz floated the idea of buying $1 trillion of assets with $52 billion of equity and borrowing the rest -- giving the NewCo a 5.2% cap ratio. $34 billion would come from making the prefs whole and the remaining $18 billion would be contributed by preferred holders -- likely through a rights offering so that those who didn't want to contribute didn't have to do so.

 

The remaining $4 trillion would have stayed with the GSEs and the legacy structure would remain.

[Guest cherzeca]

couple thoughts.

 

first, i believe fnma has $19B junior pref outstanding.

 

second, while it is immaterial whether excess dividends are to be returned to fnma in cash or applied to senior pref reduction, the senior pref will have to be retired in any event given its onerous rate and terms, so applying it to reduce the senior pref balance makes the most sense.

 

this will be the mother of all recapitalizations, both in complexity and size.  there are alot of moving parts, and we dont know yet what the trump administration's definition of success is.

 

for example, does it want to maximize value of warrants at expense of time it takes to recapitalize fnma? the more it holds onto its 80% warrants with no exercise price, the harder it is to raise common equity capital.

 

will it increase exercise price on its own motion, if it believes that this will increase fnma value because it increases prospects for fnma recapitalization, which in turns makes its warrant position more valuable?

 

will the junior pref continue to omit dividends, since they are non cumulative and there is no reason to pay dividends if the common does not expect dividends and future capital raises are to be in common, which would want the junior pref dividends to be omitted in any event?

 

i will say this:  mnuchin is the type of guy to attack this problem, and he will look at it like the experienced wall streeter that he is.  i think his definition of success is a recapped fnma which provides some warrant value for govt, but that given govt's return on fnma to date, i dont see him trying for the last warrant dollar on the table. but he will be infinitely more capable of cobbling together a deal here than any other guy mentioned for treasury secretary.

[Guest cherzeca]

For some reason I was under the impression that Berkowitz, or someone else, floated the idea that public shareholders just wanted the company back and they didn't care about getting back some of the overpayments made by the GSEs.  Ex: If GSE's overpaid by $50 Billion the Senior Preferred would still have their original balance of $187 instead of reducing that balance by $50 Bn to $137Bn.

 

Apologies if my memory is way off for this one.

 

I think very similar to that -- Berkowitz floated the idea of buying $1 trillion of assets with $52 billion of equity and borrowing the rest -- giving the NewCo a 5.2% cap ratio. $34 billion would come from making the prefs whole and the remaining $18 billion would be contributed by preferred holders -- likely through a rights offering so that those who didn't want to contribute didn't have to do so.

 

The remaining $4 trillion would have stayed with the GSEs and the legacy structure would remain.

 

some kind of spinoff might be a part of recap proposal, though it complicates an already complicated situation.  i know millstein likes spinoffs but i dont know that he will continue to be involved given that we have a capable deal guy at treasury now.

 

spinoffs can work to create a good bank/bad bank division, but i dont see that as being applicable with fnma.  plus, given the cross subsidization that is at the core of what fnma does, having size is a requirement to doing what it does.  fnma is right now one of the most profitable enterprises in the world, and spinning off anything now seems wrongheaded.

[waynepolsonAtoZ]

Millstein will be a consultant for someone, that's for sure. Maybe not for Treasury though.

 

Tsy has the equivalent of a "golden share" at this point.

 

There will be confusion about how Tsy can be "fully repaid" even though the SPS are still on the books.

 

There will be confusion about why Tsy shouldn't exercise the warrants, i.e., jounalists love to hate hedge funds.

 

There will be confusion about the idea of giving back money paid to Tsy after the fact. I don't think that will happen, even if there ever is a damages case.

[CorpRaider]

Yeah it seems to this casual observer that crediting the previously "swept"  funds against the outstanding preferred would look much more seemly to the press and outside observers than treasury stroking a check.

[BTShine]

Yeah it seems to this casual observer that crediting the previously "swept"  funds against the outstanding preferred would look much more seemly to the press and outside observers than treasury stroking a check.

 

Totally agree.

[Mephistopheles]

I don't understand how there's much of a difference whether you return the excess payments or not on the senior preferred. Let's say they've overpaid by $187 billion over the last 4+ years versus paying the straight up 10% dividend.

 

Okay, so you deposit $187 billion into the companies' coffers.

 

Then you have a capital stack that looks like this:

 

Gov preferred stock - $187 billion

Jr. preferred stock - $34 billion

Pub. common stock - residual

 

So it doesn't matter if (A) the $187 billion is used to pay off the senior preferred stock or (B) the $187 billion is given back to the GSEs but is not accrued against the senior preferred stock.

 

Either way, everyone underneath the senior preferred stock (or who remains in the case of the pay off of the senior preferred stock) is "lacking capital."

 

It's not like the $187 billion of senior preferred stock magically disappears at the same time that the companies get back $187 billion of cash...

 

What would help though is if they count the excess dividends as repayment of capital, and adjust the 10% accordingly. So if in 2013 they swept $100 billion, and owed only $18.7 as per 10%, then that $81.3 billion extra not only counts as repayment, but then in the next year the 10% counts only for about $100 billion. So the 2014 excess would be anything over $10bn in dividends, and so on.

 

I agree that having to pay $19 billion a year in dividends for all these years leaves nothing for the common, but there is certainly a range of possibilities in retroactive maneuvering.

[BTShine]

Agreed, it would be appropriate to reduce the balance of principle by the overpayment.

[Mephistopheles]

Looking back at Bruce Berkowitz' interview on CNBC from September where he announced support for Trump, he mentioned that he's making his decision based on those who will be working in his administration including running Treasury. I wonder if Mnuchin was in consideration back then, and if Berkowitz was referring to him, and in regards to FNMA. Clearly Bruce's prediction came true, haha. I'm really looking forward to this being resolved quickly.

 

 

[doughishere]

I wonder if Dan is going to leave Fairholme and go back to the Treasury. /s

[SnarkyPuppy]

Ben Carson appointed head of Housing and Urban Development.

 

Per Carson's site, https://www.bencarson.com/assets/docs/prescription-for-responsible-and-efficient-government.pdf

 

"Beyond completely overhauling the operating budgets of departments and agencies, we must also scale back or eliminate numerous federal programs that are wasteful, inefficient or unnecessary. A number of blueprints already exist for implementing these reforms. In particular, the U.S. House of Representatives’ Committee on the Budget has approved a plan – titled “A Balanced Budget for a Stronger America” – that identifies $5.5 trillion of spending cuts that can be made over the next decade. Savings would come from repealing Obamacare, eliminating corporate welfare, reducing government interference in the energy industry, privatizing housing giants Fannie Mae and Freddie Mac and other measures.  "

 

Per the referenced “A Balanced Budget for a Stronger America” - http://budget.house.gov/uploadedfiles/fy2017_a_balanced_budget_for_a_stronger_america.pdf

 

"Eight years after the federal government bailed out Fannie Mae and Freddie Mac, taxpayers remain exposed to more than $5 trillion in outstanding commitments by these two government sponsored enterprises. This budget envisions the eventual elimination of the mortgage giants by calling for the privatization of their operations and an end to their government guarantee and taxpayer subsidies."

 

Seems this is clearly directionally where we are headed.

[hardincap]

http://www.wsj.com/articles/dont-hold-your-breath-on-fannie-mae-and-freddie-mac-1480878666

 

whats the deal with wsj/carney continually writing negative pieces on the gses? do these authors legitimately believe what they're writing and are writing on their own accord or are there subterranean (top down) forces at play? serious question

 

 

[investorG]

i suspect many hedge fund owners of fnma preferred, especially in the illiquid ones, have been shorting the common in the last 48 hours to lock in gains and, possibly, in their minds in light of the research reports / dilution, win on both sides. 

 

i see it differently, as discussed in a prior post.

[SnarkyPuppy]

Seems evident to me that privatization plans hinted by mnuchin/carson are consistent with Republican proposals for privatization and is the very likely outcome.  Seems probable that in this scenario (release, private recap, removal of govt guarantee), prefs are made whole and commons are likely wiped (short of favorable legal outcomes).  Probably reiterating what everyone has been saying here, but this further solidifies that idea. 

 

Understand that there are serious risks with going full private route (articulated well by Tim Howard), but I'm not confident that his concerns will be recognized.

 

The thesis that "there is no replacement for the GSEs" seems at risk if predicated by a government implied guarantee. 

 

Preferreds still remain attractive given liq pref and clear interconnectedness between mnuchin/pref holders

[BTShine]

Hardincap,

 

Serious answer here. Yesterday Josh Rosner, via his twitter account, posted some treasury docs that implied treasury was planning to get media on their side before announcing their plans.  Therefore one theory would be Carney, Timriaros, etc became biased to the side of treasury.

 

Link here:

 

This is clearly conspiracy theory-esque, yet sometimes these can be crumbs that lead to something bigger.

[BeerBBQ]

Seems probable that in this scenario (release, private recap, removal of govt guarantee), prefs are made whole and commons are likely wiped (short of favorable legal outcomes). 

 

 

 

Why are commons wiped out in that scenario?

 

[Guest cherzeca]

Ben Carson appointed head of Housing and Urban Development.

 

Per Carson's site, https://www.bencarson.com/assets/docs/prescription-for-responsible-and-efficient-government.pdf

 

"Beyond completely overhauling the operating budgets of departments and agencies, we must also scale back or eliminate numerous federal programs that are wasteful, inefficient or unnecessary. A number of blueprints already exist for implementing these reforms. In particular, the U.S. House of Representatives’ Committee on the Budget has approved a plan – titled “A Balanced Budget for a Stronger America” – that identifies $5.5 trillion of spending cuts that can be made over the next decade. Savings would come from repealing Obamacare, eliminating corporate welfare, reducing government interference in the energy industry, privatizing housing giants Fannie Mae and Freddie Mac and other measures.  "

 

Per the referenced “A Balanced Budget for a Stronger America” - http://budget.house.gov/uploadedfiles/fy2017_a_balanced_budget_for_a_stronger_america.pdf

 

"Eight years after the federal government bailed out Fannie Mae and Freddie Mac, taxpayers remain exposed to more than $5 trillion in outstanding commitments by these two government sponsored enterprises. This budget envisions the eventual elimination of the mortgage giants by calling for the privatization of their operations and an end to their government guarantee and taxpayer subsidies."

 

Seems this is clearly directionally where we are headed.

 

mnuchin is quite clear that he does not want to "eliminate the mortgage giants" and it seems hensarling even no longer wants to also.  i think the shorting common to lock in gains might be an explanation since it makes no sense to sell gain positions in early december.  i also think there is a lot of hot day trader money in common, and so volatility will be extreme both ways.

[Guest cherzeca]

Seems probable that in this scenario (release, private recap, removal of govt guarantee), prefs are made whole and commons are likely wiped (short of favorable legal outcomes). 

 

 

 

Why are commons wiped out in that scenario?

 

why would mnuchin or trump want to wipe out a position govt owns 80% of?

[Steve_Berk]

this is also what I don't understand and is pretty much the basis of my large stake in the common shares. I'm not that interested in the day to day market movement, although seeing everything go up 45% in one day was a real thrill. I still believe that we'll get a remand in Perry, and also find it hard to imagine a solution that completely wipes out the common, although maybe that's just the limits of my imagination.

 

BTW, if you consider full dilution from the warrants, what has been the general estimated range for the value of the common. I thought it was somewhere around $15 give or take, but not sure.

 

 

Seems probable that in this scenario (release, private recap, removal of govt guarantee), prefs are made whole and commons are likely wiped (short of favorable legal outcomes). 

 

 

 

Why are commons wiped out in that scenario?

 

why would mnuchin or trump want to wipe out a position govt owns 80% of?

[SnarkyPuppy]

Sorry, maybe "wipe" was incredulous - you're both much more informed on the topic.  But if we assume the approach is full privatization, I think Tim Howard's post with respect to Demarco's proposals (risk transfer mechanisms) is relevant.  Effectively "first loss capital" would have to be raised at 3.5% of assets  = $158bn.  Tim Howard argues that the proposed sources of the risk-sharing capital are largely insufficient to reach the $158bn (probably can only account for ~$20bn of the $158bn); in this event is the solution not an offering of common stock significantly diluting the shares (consistent with KBW analysis) effectively making them a poor investment?

[BeerBBQ]

at 60bp g-fee, Ackman suggested 14x $15 net income would be around $23. A more conservative 10x multiple would put you at $17.

 

Tim Howard (ex CFO) suggests 10x his net income number of $10.6B (I think he uses a lower g-fee?) and then adds 10% for favorable surprises and subtracts 20% for negative surprises and gets about $15-20 on a fully diluted share count.

 

 

 

 

[SnarkyPuppy]

at 60bp g-fee, Ackman suggested 14x $15 net income would be around $23. A more conservative 10x multiple would put you at $17.

 

Tim Howard (ex CFO) suggests 10x his net income number of $10.6B (I think he uses a lower g-fee?) and then adds 10% for favorable surprises and subtracts 20% for negative surprises and gets about $15-20 on a fully diluted share count.

 

My understanding is 60bp g-fee is only relevant with a government implicit guarantee- is this incorrect?  Definitely possible I'm incorrect.

 

^ just reviewed Ackman's deck and looks like I'm likely wrong on this in his scenario (although his scenario isn't full privatization which seems to be where things are directionally headed)