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

[Guest cherzeca]

@hard

 

where did you see that?

[hardincap]

he commented on the wsj article linked in the quote

 

fraenkel was chief research officer at fairholme

[Guest cherzeca]

I just put the following attachment together which lays out the capital structures per both GSE's 9/30 Financials. 

 

It then shows a few scenarios while making assumptions pertaining to capital ratios (2.5%), equity raise per share, warrants dilution, etc.

 

Can someone smarter than me please have a look and explain to me how a reduction to the "Sr Pref Govt (Redemption Value)" line item would impact this analysis?  I have to run to dinner but will work on it later if nobody is able to.

 

snarky, let me say this very slowly and very clearly.  listen.

 

there is no recap w/o rolling back NWS. no one puts a buck in w/o that.

 

now, run the sr pref line down to $10B, which is about what it will be with a NWS rollback (w 1% interest on overpaid amounts).

 

now redo and see if that doesnt spell mother.

[Mephistopheles]

Fyi that article wasn't written by Carney lol

[rros]

Fyi that article wasn't written by Carney lol

Let's all wait for confirmation hearings.

Corker -if senator and not Sec. of State- will make his "jack-lew" maneuver and commit Mnuchin to say it is the job of Congress to deal with the GSEs and Treasury should stay out. That would a Trump moment to drain the swamp. Hopefully, Mnuchin will not bow down.

[SnarkyPuppy]

I just put the following attachment together which lays out the capital structures per both GSE's 9/30 Financials. 

 

It then shows a few scenarios while making assumptions pertaining to capital ratios (2.5%), equity raise per share, warrants dilution, etc.

 

Can someone smarter than me please have a look and explain to me how a reduction to the "Sr Pref Govt (Redemption Value)" line item would impact this analysis?  I have to run to dinner but will work on it later if nobody is able to.

 

snarky, let me say this very slowly and very clearly.  listen.

 

there is no recap w/o rolling back NWS. no one puts a buck in w/o that.

 

now, run the sr pref line down to $10B, which is about what it will be with a NWS rollback (w 1% interest on overpaid amounts).

 

now redo and see if that doesnt spell mother.

 

Apologies if I'm being dense.  The supposed rollback for sweeps in excess of the 10% dividend would simply be debit to the accumulated deficit account, effectively increasing net worth?  I believe that's what you're saying...which would effectively reduce/remove any need for a capital raise if $100bn is simply added to Fannie's equity.  Am I on the right track with your line of thinking?

[Guest cherzeca]

i'm thinking that the senior preferred principal amount would go away...or down to about $10B before any new capital issuances.

 

so you would have a $10B/yr net income company=>over $100B equity value and only $20-30B of equity senior to the common.  which is why if there is to be a recap, common wont be a zero. cause if there is to be a recap, no one will fund into fnma if the senior pref stays outstanding

[SnarkyPuppy]

i'm thinking that the senior preferred principal amount would go away...or down to about $10B before any new capital issuances.

 

so you would have a $10B/yr net income company=>over $100B equity value and only $20-30B of equity senior to the common.  which is why if there is to be a recap, common wont be a zero. cause if there is to be a recap, no one will fund into fnma if the senior pref stays outstanding

 

Got it - this is helpful, thanks. 

 

Just to humor my final understanding - how would the capital structure be modified from an accounting perspective (I just want to have the full picture in numbers under this scenario).  You would reduce the Sr Pref Equity position obviously, but what would the corresponding entry be?  If you reduce the St Pref surely that causes your residual equity balance to go down so the other side of the entry would only bring it back to where it is now?

[Sunrider]

Not sure if I understand the question correctly (or that my answer is right):

 

1. NWS reversed basically means that cash is returned to GSEs, so BS now has a cash position and the equity position also gets bumped (as they swept their retained earnings)

 

2. You then begin to adjust, reducing the liability accrued for pref div for the first year and the cash, then you reduce the senior pref by the amount you would've had available in that year beyond paying the senior pref div

 

3. Repeat 2 until you've gone through all the money 'swept' back to the GSEs in (1)

 

Of course, there may be a shortcut to this if there is an outcome in which warrant prices get adjusted, junior pref is converted, etc.

???

C.

 

i'm thinking that the senior preferred principal amount would go away...or down to about $10B before any new capital issuances.

 

so you would have a $10B/yr net income company=>over $100B equity value and only $20-30B of equity senior to the common.  which is why if there is to be a recap, common wont be a zero. cause if there is to be a recap, no one will fund into fnma if the senior pref stays outstanding

 

Got it - this is helpful, thanks. 

 

Just to humor my final understanding - how would the capital structure be modified from an accounting perspective (I just want to have the full picture in numbers under this scenario).  You would reduce the Sr Pref Equity position obviously, but what would the corresponding entry be?  If you reduce the St Pref surely that causes your residual equity balance to go down so the other side of the entry would only bring it back to where it is now?

[Guest cherzeca]

i'm thinking that the senior preferred principal amount would go away...or down to about $10B before any new capital issuances.

 

so you would have a $10B/yr net income company=>over $100B equity value and only $20-30B of equity senior to the common.  which is why if there is to be a recap, common wont be a zero. cause if there is to be a recap, no one will fund into fnma if the senior pref stays outstanding

 

Got it - this is helpful, thanks. 

 

Just to humor my final understanding - how would the capital structure be modified from an accounting perspective (I just want to have the full picture in numbers under this scenario).  You would reduce the Sr Pref Equity position obviously, but what would the corresponding entry be?  If you reduce the St Pref surely that causes your residual equity balance to go down so the other side of the entry would only bring it back to where it is now?

 

this would essentially be pro forma entries.  every dollar that went out the door as a NWS dividend in excess of the 10% requirement would still be out the door, so you dont debit/credit cash, but you instead debit (reduce) the senior pref outstanding line.  real simple

[SnarkyPuppy]

i'm thinking that the senior preferred principal amount would go away...or down to about $10B before any new capital issuances.

 

so you would have a $10B/yr net income company=>over $100B equity value and only $20-30B of equity senior to the common.  which is why if there is to be a recap, common wont be a zero. cause if there is to be a recap, no one will fund into fnma if the senior pref stays outstanding

 

Got it - this is helpful, thanks. 

 

Just to humor my final understanding - how would the capital structure be modified from an accounting perspective (I just want to have the full picture in numbers under this scenario).  You would reduce the Sr Pref Equity position obviously, but what would the corresponding entry be?  If you reduce the St Pref surely that causes your residual equity balance to go down so the other side of the entry would only bring it back to where it is now?

 

this would essentially be pro forma entries.  every dollar that went out the door as a NWS dividend in excess of the 10% requirement would still be out the door, so you dont debit/credit cash, but you instead debit (reduce) the senior pref outstanding line.  real simple

 

Right.  So debit Senior Pref Outstanding.  What's the credit?

 

Said another way:

On the 9/30 FNMA Balance Sheet, reducing (debiting) the $117bn simply by the full amount for simplicity brings the senior pref equity balance to $0.  Presumably Accumulated Deficit would be credited by the same amount (increased) bringing the net impact to the financials to $0.  I'm conceptually missing how the 4.1bn Equity balance changes? 

 

I think the answer is that FNMA would have retained earnings in excess of the $117bn liquidation preference?

[Mephistopheles]

What are the risks to the jr. preferred thesis at this point? I'm trying to kill the companies. Here's what I've come up with so far.

 

1. An adverse ruling in both the Court of Claims and D.C. Court of Appeals before Trump gets a chance to settle. The Takings case hasn't reached that point yet, but the Appeals case may decide any moment to affirm Lamberth, which would work against us. But even in that unlikely scenario, we can still get a Trump settlement out of Sweeney's Court; so overall I don't see the Courts as a substantial risk right now.

 

2. An adverse law passed by Congress, similar to Corker's provision last year which disallows the Treasury to sell its stake until 2018. What if they pass a law that makes the NWS permanent, disallowing Treasury from ever changing the terms? Again I think this is highly unlikely as there simply isn't time. Any such law would then be vetoed by Trump and would have to win by 2/3 in Congress, I think, which doesn't have that strong of a Republican stronghold. Again, not a substantial risk.

 

3. Trump gets impeached, or doesn't even make it to inauguration day. This one I am concerned about more than anything else. There's an op-ed in the NYT today from a Republican elector pushing for the electorate to choose an establishment Republican such as Kasich, when they decide in the next few weeks. Trump is a petulent child who just can't help but control himself, and I'm afraid that the Republican Congress may lose patience sooner rather than later. Of course, it's a tricky call for them. They can give Pence the job and be happy temporarily, but face a major populist backlash in 2018 from Trump and his supporters, so I feel they'd rather not mess with that. But still, the guy is insane and imo is the single biggest wild card for our investment.

 

Aside from #3, I simply can't think of a way this doesn't turn out well. Looking at it from a 10,000 ft. level: We have a major party from the Plaintiff class, Paulson, who's been a supporter of the President-elect and worked closely with the head of the Treasury, the Defendant, who just so happens to have openly said he favors exactly what the Plaintiffs have been asking for. How often does that happen? It can't get any more clearer imo, at least for the jr. preferred.

 

Can anyone think of something that I may be missing?

[Guest cherzeca]

@snarky

 

 

"Right.  So debit Senior Pref Outstanding.  What's the credit?"

 

if you need the credit, you credit (reduce) cash.  when i said it was pro forma accounting, you would recharacterize the excess cash dividend distribution as a principal repayment.

 

equity capital doesnt change.

[SnarkyPuppy]

@snarky

 

 

"Right.  So debit Senior Pref Outstanding.  What's the credit?"

 

if you need the credit, you credit (reduce) cash.  when i said it was pro forma accounting, you would recharacterize the excess cash dividend distribution as a principal repayment.

 

equity capital doesnt change.

 

I guess I'm missing the final connection between how no change to equity capital in our example would result in the companies not requiring a capital raise?  I'll take it away and try to figure it out - I sense I'm the one who's uninformed here. 

[investorG]

another reason why the warrants may be in jeopardy:

 

the government has earned 60bn from the GSEs.  the next closest return from the crisis bailouts was less than 15bn.

 

those with a fresh look (new administration) might not see the urgency for squeezing more out. 

 

especially as there are other ways to reward the govt forward looking (besides having a healthy housing mkt) such as the backstop reinsurance fee the GSEs will likely have to pay the govt until they are fully capitalized in a few years.

 

 

[Guest cherzeca]

@snarky

 

 

"Right.  So debit Senior Pref Outstanding.  What's the credit?"

 

if you need the credit, you credit (reduce) cash.  when i said it was pro forma accounting, you would recharacterize the excess cash dividend distribution as a principal repayment.

 

equity capital doesnt change.

 

I guess I'm missing the final connection between how no change to equity capital in our example would result in the companies not requiring a capital raise?  I'll take it away and try to figure it out - I sense I'm the one who's uninformed here.

 

gses will need a huge capital raise. 

[SnarkyPuppy]

@snarky

 

 

"Right.  So debit Senior Pref Outstanding.  What's the credit?"

 

if you need the credit, you credit (reduce) cash.  when i said it was pro forma accounting, you would recharacterize the excess cash dividend distribution as a principal repayment.

 

equity capital doesnt change.

 

I guess I'm missing the final connection between how no change to equity capital in our example would result in the companies not requiring a capital raise?  I'll take it away and try to figure it out - I sense I'm the one who's uninformed here.

 

gses will need a huge capital raise.

 

So we've been on the same page this entire time

[Guest cherzeca]

What are the risks to the jr. preferred thesis at this point? I'm trying to kill the companies. Here's what I've come up with so far.

 

1. An adverse ruling in both the Court of Claims and D.C. Court of Appeals before Trump gets a chance to settle. The Takings case hasn't reached that point yet, but the Appeals case may decide any moment to affirm Lamberth, which would work against us. But even in that unlikely scenario, we can still get a Trump settlement out of Sweeney's Court; so overall I don't see the Courts as a substantial risk right now.

 

2. An adverse law passed by Congress, similar to Corker's provision last year which disallows the Treasury to sell its stake until 2018. What if they pass a law that makes the NWS permanent, disallowing Treasury from ever changing the terms? Again I think this is highly unlikely as there simply isn't time. Any such law would then be vetoed by Trump and would have to win by 2/3 in Congress, I think, which doesn't have that strong of a Republican stronghold. Again, not a substantial risk.

 

3. Trump gets impeached, or doesn't even make it to inauguration day. This one I am concerned about more than anything else. There's an op-ed in the NYT today from a Republican elector pushing for the electorate to choose an establishment Republican such as Kasich, when they decide in the next few weeks. Trump is a petulent child who just can't help but control himself, and I'm afraid that the Republican Congress may lose patience sooner rather than later. Of course, it's a tricky call for them. They can give Pence the job and be happy temporarily, but face a major populist backlash in 2018 from Trump and his supporters, so I feel they'd rather not mess with that. But still, the guy is insane and imo is the single biggest wild card for our investment.

 

Aside from #3, I simply can't think of a way this doesn't turn out well. Looking at it from a 10,000 ft. level: We have a major party from the Plaintiff class, Paulson, who's been a supporter of the President-elect and worked closely with the head of the Treasury, the Defendant, who just so happens to have openly said he favors exactly what the Plaintiffs have been asking for. How often does that happen? It can't get any more clearer imo, at least for the jr. preferred.

 

Can anyone think of something that I may be missing?

 

"a wise man makes plans. but only a fool thinks that things will go according to plan."

my father

[Guest cherzeca]

@snarky

 

 

"Right.  So debit Senior Pref Outstanding.  What's the credit?"

 

if you need the credit, you credit (reduce) cash.  when i said it was pro forma accounting, you would recharacterize the excess cash dividend distribution as a principal repayment.

 

equity capital doesnt change.

 

I guess I'm missing the final connection between how no change to equity capital in our example would result in the companies not requiring a capital raise?  I'll take it away and try to figure it out - I sense I'm the one who's uninformed here.

 

gses will need a huge capital raise.

 

So we've been on the same page this entire time

 

not when you show a sr pref line of $117B

[SnarkyPuppy]

@snarky

 

 

"Right.  So debit Senior Pref Outstanding.  What's the credit?"

 

if you need the credit, you credit (reduce) cash.  when i said it was pro forma accounting, you would recharacterize the excess cash dividend distribution as a principal repayment.

 

equity capital doesnt change.

 

I guess I'm missing the final connection between how no change to equity capital in our example would result in the companies not requiring a capital raise?  I'll take it away and try to figure it out - I sense I'm the one who's uninformed here.

 

gses will need a huge capital raise.

 

So we've been on the same page this entire time

 

not when you show a sr pref line of $117B

 

Result seems to be the exact same thing, but point taken

[SnarkyPuppy]

And I guess back to my initial point - regardless of how you account for the reduction of the Sr Pref Balance from the capital structure, Fannie Mae will likely still only have roughly ~$4bn in capital against $3.2bn in assets which is about a 13bps capital ratio.  250bps capital ratio seems to be in the general range of likely outcomes. 

 

I don't really see how anything above $7-8 per share is possible under this scenario.

[Guest cherzeca]

@snarky

 

now move off of accounting and do a pro forma valuation, and tell me what you think fnma common is worth, before you take into account any dilution from future capital raises

[Mephistopheles]

"a wise man makes plans. but only a fool thinks that things will go according to plan."

my father

 

Agreed, hence I'm trying hard to kill the companies. :)

[investorG]

And I guess back to my initial point - regardless of how you account for the reduction of the Sr Pref Balance from the capital structure, Fannie Mae will likely still only have roughly ~$4bn in capital against $3.2bn in assets which is about a 13bps capital ratio.  250bps capital ratio seems to be in the general range of likely outcomes. 

 

I don't really see how anything above $7-8 per share is possible under this scenario.

 

lots of assumptions go into a common price target, many of which are completely unknowable right now:  a) what happens with the warrants  b) capital ratio target, and by when  c) what type of capital is raised, at what price, and over what time frame  d) long term earnings power  and e) PE multiple  f) court case outcomes  g) trump admin's true priorities and congress' reactions h) probably others i'm not thinking of

 

an appropriate range is $0 - $75, imo, with a base case somewhere around Ackman's targets.

[SnarkyPuppy]

And I guess back to my initial point - regardless of how you account for the reduction of the Sr Pref Balance from the capital structure, Fannie Mae will likely still only have roughly ~$4bn in capital against $3.2bn in assets which is about a 13bps capital ratio.  250bps capital ratio seems to be in the general range of likely outcomes. 

 

I don't really see how anything above $7-8 per share is possible under this scenario.

 

lots of assumptions go into a common price target, many of which are completely unknowable right now:  a) what happens with the warrants  b) capital ratio target, and by when  c) what type of capital is raised, at what price, and over what time frame  d) long term earnings power  and e) PE multiple

 

an appropriate range is $0 - $75, imo, with a base case somewhere around Ackman's targets.

 

The spreadsheet I attached includes a-e).  Capital ratio target seems reasonably placed at 2.5% if you triangulate different sources but of course you can adjust.  I believe Ackman uses 2.5%.