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

[no_free_lunch]

Good little primer video on Mnuchin here:

 

https://www.bloomberg.com/news/videos/2017-02-09/how-steven-mnuchin-got-the-treasury-job-video

 

[Cox022]

Mnuchin Delayed until Monday.

 

From The Hill:

 

The Senate is kicking a final vote on Steve Mnuchin's nomination to lead the Treasury Department to next week avoiding a rare Saturday morning vote.

 

Senate Majority Leader Mitch McConnell (R-Ky.) announced the schedule change from the Senate floor just before senators voted largely along party lines to move forward with Mnunchin's nomination.

 

Democrats don't have the ability to block President Trump's nominees on their own. They only need a simple majority and Republicans have 52 seats.

 

But they could have forced a rare weekend session and delayed a final vote on the longtime Goldman Sachs executive until approximately 8 a.m. Saturday. Under Senate rules, any one senator can object to a deal to speed up votes.

 

 

Instead, senators will have up to seven hours to debate Mnuchin's nomination on Monday, setting up a final vote by 7 p.m.

[Flynnstone5]

http://abovethelaw.com/2017/02/breaking-chuck-cooper-withdraws-from-the-solicitor-general-sweepstakes/

 

understandable, given he doesnt want to go through what his good friend sessions went through.  i suppose it is easier for cooper to talk to sessions about GSEs as private counsel than as SG with a conflict

 

 

This may be a foolish question from a non-lawyer, but could Cooper make a call to Sessions right now if he wanted to discuss GSE case details or is that not possible for whatever reason?

[orthopa]

http://abovethelaw.com/2017/02/breaking-chuck-cooper-withdraws-from-the-solicitor-general-sweepstakes/

 

understandable, given he doesnt want to go through what his good friend sessions went through.  i suppose it is easier for cooper to talk to sessions about GSEs as private counsel than as SG with a conflict

 

not to mention why put yourself through the questions regarding conflict of interest with the Fairholme case. That would obviously be coming and why upset what could go smoothly with mnunchin etc.

[Cox022]

Been thinking about the common a lot lately.  [Following applies to both GSEs but I use FNMA in my examples]

 

I.  In my opinion, most discussions on the common under-appreciate the risk of the common being worth zero.  This is still a small possibility, but there's still a big difference between a small possibility and an impossibility. 

 

II.  However, the typical bearish comment on the commons is the 'extreme dilution they are likely to face'.  Some estimates on this suggest the common could be worth $5 in this scenario. 

 

III.  On the upside....It's reasonable to think Mnuchin wants to balance the following objectives: maximize money for the Tsy, attract new capital to capitalize FNMA, protect the taxpayer, and deal with the old shareholders/plaintiffs of FNMA/FNMAS.  All of this balancing requires a middle of the road approach which I think ends up being good for FNMA/FNMAS. 

 

I see a way for Mnuchin to reduce the quantity of the warrants, raise a partial percentage of the new capital desired, and let FNMA retain earnings to fulfill the remaining percentage.  If they take this balanced approach, the government can still retain the majority the warrants' dollar value even if they cancel a big portion of its underlying shares [ill avoid explaining the math but I'll say they would end up owning less warrants but the individual value of each one would be much higher].  I'm not saying this is the most likely outcome, but there's a reasonablel chance of it. 

 

The other options Mnuchin has are on the extremes and do not fulfill all his objectives, though some are better than others.  For instance, keeping all of the warrants as they are is an obstacle to raising new capital, but cancelling them altogether would leave the Tsy with nothing.  Also, the more new capital raised would dilute the Gov's own stake, but not raising any capital defeats the purpose altogether.

 

IV.  All in all, if the chance for the common being worthless is small but meaningful, the bear case is they are worth $ mid single digits, and the bull case is there is a decent chance there is less dilution from warrants and new capital...add all that up and the common still looks like an attractively priced option.

[Luke 532]

Mnuchin cloture passes 53-46.  He's going to be the Secretary of Treasury, you can count on it... just have to wait until the vote Monday around 7pm to make it official.

 

I know it's not over until it's over, but come on... this situation is like being up by 25 points midway through the 3rd quarter of the Super Bowl... it's in the bag!  ;)

[Flynnstone5]

Been thinking about the common a lot lately.  [Following applies to both GSEs but I use FNMA in my examples]

 

I.  In my opinion, most discussions on the common under-appreciate the risk of the common being worth zero.  This is still a small possibility, but there's still a big difference between a small possibility and an impossibility. 

 

II.  However, the typical bearish comment on the commons is the 'extreme dilution they are likely to face'.  Some estimates on this suggest the common could be worth $5 in this scenario. 

 

III.  On the upside....It's reasonable to think Mnuchin wants to balance the following objectives: maximize money for the Tsy, attract new capital to capitalize FNMA, protect the taxpayer, and deal with the old shareholders/plaintiffs of FNMA/FNMAS.  All of this balancing requires a middle of the road approach which I think ends up being good for FNMA/FNMAS. 

 

I see a way for Mnuchin to reduce the quantity of the warrants, raise a partial percentage of the new capital desired, and let FNMA retain earnings to fulfill the remaining percentage.  If they take this balanced approach, the government can still retain the majority the warrants' dollar value even if they cancel a big portion of its underlying shares [ill avoid explaining the math but I'll say they would end up owning less warrants but the individual value of each one would be much higher].  I'm not saying this is the most likely outcome, but there's a reasonablel chance of it. 

 

The other options Mnuchin has are on the extremes and do not fulfill all his objectives, though some are better than others.  For instance, keeping all of the warrants as they are is an obstacle to raising new capital, but cancelling them altogether would leave the Tsy with nothing.  Also, the more new capital raised would dilute the Gov's own stake, but not raising any capital defeats the purpose altogether.

 

IV.  All in all, if the chance for the common being worthless is small but meaningful, the bear case is they are worth $ mid single digits, and the bull case is there is a decent chance there is less dilution from warrants and new capital...add all that up and the common still looks like an attractively priced option.

 

I agree with much of your point. It makes a great deal of sense IMO for a conversion of prfd to common, but in order to get everyone on board the common has to maintain a value that makes sense.

 

It gives the gov the ability to put off large divs towards retained earnings, it allows them to issue a full 10% of new prfd at low rates, and if they're willing to adjust their warrants then they enable some further recap and still make a good chunk of money. Ends virtually all suits. and enables a full recap in relatively short term - 3-4 years. This strikes me as a reasonable solution given variables and is not as difficult to achieve recap as many seem to think.

[Guest cherzeca]

Been thinking about the common a lot lately.  [Following applies to both GSEs but I use FNMA in my examples]

 

I.  In my opinion, most discussions on the common under-appreciate the risk of the common being worth zero.  This is still a small possibility, but there's still a big difference between a small possibility and an impossibility. 

 

II.  However, the typical bearish comment on the commons is the 'extreme dilution they are likely to face'.  Some estimates on this suggest the common could be worth $5 in this scenario. 

 

III.  On the upside....It's reasonable to think Mnuchin wants to balance the following objectives: maximize money for the Tsy, attract new capital to capitalize FNMA, protect the taxpayer, and deal with the old shareholders/plaintiffs of FNMA/FNMAS.  All of this balancing requires a middle of the road approach which I think ends up being good for FNMA/FNMAS. 

 

I see a way for Mnuchin to reduce the quantity of the warrants, raise a partial percentage of the new capital desired, and let FNMA retain earnings to fulfill the remaining percentage.  If they take this balanced approach, the government can still retain the majority the warrants' dollar value even if they cancel a big portion of its underlying shares [ill avoid explaining the math but I'll say they would end up owning less warrants but the individual value of each one would be much higher].  I'm not saying this is the most likely outcome, but there's a reasonablel chance of it. 

 

The other options Mnuchin has are on the extremes and do not fulfill all his objectives, though some are better than others.  For instance, keeping all of the warrants as they are is an obstacle to raising new capital, but cancelling them altogether would leave the Tsy with nothing.  Also, the more new capital raised would dilute the Gov's own stake, but not raising any capital defeats the purpose altogether.

 

IV.  All in all, if the chance for the common being worthless is small but meaningful, the bear case is they are worth $ mid single digits, and the bull case is there is a decent chance there is less dilution from warrants and new capital...add all that up and the common still looks like an attractively priced option.

+1

[orthopa]

This was posted on stocktwits FWIW ... not mine

 

https://www.docdroid.net/qLK4Xi3/fnma-valuation-scenerios.pdf.html

[Mephistopheles]

This was posted on stocktwits FWIW ... not mine

 

https://www.docdroid.net/qLK4Xi3/fnma-valuation-scenerios.pdf.html

 

So this assumes that the warrants are reversed or the strike price goes up to $10 minimum. Bold predictions imo, but nice spreadsheet.

[Flynnstone5]

This was posted on stocktwits FWIW ... not mine

 

https://www.docdroid.net/qLK4Xi3/fnma-valuation-scenerios.pdf.html

 

So this assumes that the warrants are reversed or the strike price goes up to $10 minimum. Bold predictions imo, but nice spreadsheet.

 

Hadn't seen this, but I like the basis. I just don't see where such an adj. on warrants is such a far out idea. We know they're going to be adjusted in order to be able to raise capital and as a likely part of settlement. Doesn't Trump/Mnuchin desire to achieve overall larger goals outweigh the idea that they choose massive dilution as the answer?

[Mephistopheles]

This was posted on stocktwits FWIW ... not mine

 

https://www.docdroid.net/qLK4Xi3/fnma-valuation-scenerios.pdf.html

 

So this assumes that the warrants are reversed or the strike price goes up to $10 minimum. Bold predictions imo, but nice spreadsheet.

 

Hadn't seen this, but I like the basis. I just don't see where such an adj. on warrants is such a far out idea. We know they're going to be adjusted in order to be able to raise capital and as a likely part of settlement. Doesn't Trump/Mnuchin desire to achieve overall larger goals outweigh the idea that they choose massive dilution as the answer?

 

Well they can always raise some additional capital on top and also convert the junior prefs...and allow a retained earnings buildup as well. Based on their ideas regarding financial regulation, I wouldn't be surprised if all they do is retained earnings + reverse the 10% dividend back to 2012 (include excess dividends as Sr pref repayments). That should allow a minimum amount of capital while still maximizing the value of the warrants at $0 strike. Imo they will keep the strike at $0 as that not only makes a great political headline but helps fund his infrastructure ambitions.

[rros]

This was posted on stocktwits FWIW ... not mine

 

https://www.docdroid.net/qLK4Xi3/fnma-valuation-scenerios.pdf.html

 

So this assumes that the warrants are reversed or the strike price goes up to $10 minimum. Bold predictions imo, but nice spreadsheet.

 

Hadn't seen this, but I like the basis. I just don't see where such an adj. on warrants is such a far out idea. We know they're going to be adjusted in order to be able to raise capital and as a likely part of settlement. Doesn't Trump/Mnuchin desire to achieve overall larger goals outweigh the idea that they choose massive dilution as the answer?

 

Well they can always raise some additional capital on top and also convert the junior prefs...and allow a retained earnings buildup as well. Based on their ideas regarding financial regulation, I wouldn't be surprised if all they do is retained earnings + reverse the 10% dividend back to 2012 (include excess dividends as Sr pref repayments). That should allow a minimum amount of capital while still maximizing the value of the warrants at $0 strike. Imo they will keep the strike at $0 as that not only makes a great political headline but helps fund his infrastructure ambitions.

Do you really think these guys will go for a gradual approach? I haven't seen anything "gradual" in the last few weeks lol.

 

The bet for the next 4 years will be "shock and surprise". You won't go wrong betting on that. But would not know how this relates to our investment.

[Ismael]

My base case valuation of fnma common.  Of course, there could be some creative deals that could improve or worsen the results for the common based off of the various interests of the negotiators.  It would be interesting to hear thoughts on how negotiated outcomes would differ from this base case.  I have a feeling the administration is going to want to maximize their near term return and use the proceeds on infrastructure spending. 

 

Assumptions:

1. Gov’t immediately exercises warrants

2. Senior Preferred is considered paid back with NWS

3. $9B earnings/yr available to common after dividend payments to preferred

4. $60B capital raise after gov’t exercises warrants

 

Per share valuation at various PE ratios for capital raise

a. @ 10PE = 200% dilution at $5/share

b. @ 12PE = 150% dilution at $7.5/share

c. @ 14PE = 100% dilution at $11/share

d. @ 16PE = 50% dilution at $14/share

 

*The government’s share of the commons would be between $23B-$65B in the valuation scenarios above. 

 

[Guest cherzeca]

@ismael (can i call you ismael?)

 

govt wont exercise warrants all upfront. would make more sense for govt to say wont exercise any warrants for x years in order to raise regulatory capital first. no one wants to buy common in a capital raise knowing that govt could sell 5B shares of common right after you bought to kill price

[investorG]

My base case valuation of fnma common.  Of course, there could be some creative deals that could improve or worsen the results for the common based off of the various interests of the negotiators.  It would be interesting to hear thoughts on how negotiated outcomes would differ from this base case.  I have a feeling the administration is going to want to maximize their near term return and use the proceeds on infrastructure spending. 

 

Assumptions:

1. Gov’t immediately exercises warrants

2. Senior Preferred is considered paid back with NWS

3. $9B earnings/yr available to common after dividend payments to preferred

4. $60B capital raise after gov’t exercises warrants

 

Per share valuation at various PE ratios for capital raise

a. @ 10PE = 200% dilution at $5/share

b. @ 12PE = 150% dilution at $7.5/share

c. @ 14PE = 100% dilution at $11/share

d. @ 16PE = 50% dilution at $14/share

 

*The government’s share of the commons would be between $23B-$65B in the valuation scenarios above.

 

i respect all of you but i come out differently.

 

if you weren't against the GSE shut down (a very popular recent stance) then you didn't get a proposed seat at the important table ---- mnuchin, blackwell, ross, icahn, mulvaney, carson, (cooper -- almost).  paulson out there too.  trump also courted GSE opponents like corker and hensarling during the transition. 

 

he is likely going to propose tax cuts and infrastructure that likely will cost, even on dynamic scoring, well over a trillion dollars for 10 years. our debt is already 20trn and rising.  based on the above proposed team, along with ackman's visible support, is he really going to go out of his way to stiff the common holders by requiring max capital raised max quick with full warrant participation, after being told by his team of the theft by the prior admin??

 

i'm with flynnstone's view of the situation, something where everyone wins is a good aim. 

 

monday's vote is obviously important.

 

good luck everyone!

 

 

[Ismael]

@Cherzeca,

 

haha, yes, call me ismael. 

 

I was thinking the government has to exit its warrant position before the capital raise because no one would want to provide capital knowing that they could get diluted 80% at anytime.  I can see the problem with the pricing pressure created by the government trying to exit its common position (the gov't wouldn't want low prices either).  I imagine it would be similar to how it exited its AIG position, however AIG wasn't trying to raise capital.  I'm sure there are a number of creative solutions to this problem.  Hopefully my valuation captures the general economics of the situation. 

 

The government could create a known selling schedule and sell its position over time, but it will take time to unwind and capital providers will want a premium to compensate for the selling pressure for the first few years.  This may push the per share value to the lower valuations.

 

Maybe the government changes the warrants so they must be exercised during a certain time frame (relatively soon) for a certain $ amount and then sells the warrants to the eventual capital providers.  The warrant exercise would raise the needed capital.  There wouldn't be any selling pressure on the common from the government.  The government would get capital in a short time frame.  Would this be enough to push the value to the higher end of the range? 

 

 

 

 

[Ismael]

One other thing I have been thinking about is how important the GSEs are to the administration?  Is the administration willing to give concessions on the GSE issue in order to gain votes on one of their big promises to their voters? 

[Desert_Rat]

I think for optics sake, they get out of all holdings almost immediately. If the issue is government control of FnF, saying 'we're not involved in financing homes anymore' doesn't jive with owning most of the two companies. That means, possibly, the senior preferred are sold back to FnF at face, $1b. That one's easy. The warrants are too, although I have no idea how they would be priced. But I guess that wouldn't really matter if the goal is separation.

 

All junior preferred would then be called with no dividends issued during the transition. Paying that $40b will take a while but it will be FnF controlling it.

The common would be subject to those costs/time plus capital requirements.

 

and i'd be ecstatic

 

 

[Flynnstone5]

I think for optics sake, they get out of all holdings almost immediately. If the issue is government control of FnF, saying 'we're not involved in financing homes anymore' doesn't jive with owning most of the two companies. That means, possibly, the senior preferred are sold back to FnF at face, $1b. That one's easy. The warrants are too, although I have no idea how they would be priced. But I guess that wouldn't really matter if the goal is separation.

 

All junior preferred would then be called with no dividends issued during the transition. Paying that $40b will take a while but it will be FnF controlling it.

The common would be subject to those costs/time plus capital requirements.

 

and i'd be ecstatic

 

I just don't think an immediate recap makes any sense. There's nothing wrong with them coming out with a plan that takes 3-4 years until complete resolution. It would make zero sense to call the prfd's as that only worsens the capital picture. Why would they structure some payout for prfd and reduce retained earnings when they can convert to common and avoid div payments? The more I look at this, the more I see value in the common shares as a key. Maybe I'm 100% wrong and just don't get it.

 

When I look at the massive dilution to common as a potential path and what the gov would make, ramifications etc. as opposed to a much more intelligent plan that makes the gov just as much money, why not go with the plan that encourages future investment, higher pps and protects all shareholders.

[Desert_Rat]

I think for optics sake, they get out of all holdings almost immediately. If the issue is government control of FnF, saying 'we're not involved in financing homes anymore' doesn't jive with owning most of the two companies. That means, possibly, the senior preferred are sold back to FnF at face, $1b. That one's easy. The warrants are too, although I have no idea how they would be priced. But I guess that wouldn't really matter if the goal is separation.

 

All junior preferred would then be called with no dividends issued during the transition. Paying that $40b will take a while but it will be FnF controlling it.

The common would be subject to those costs/time plus capital requirements.

 

and i'd be ecstatic

 

I just don't think an immediate recap makes any sense. There's nothing wrong with them coming out with a plan that takes 3-4 years until complete resolution. It would make zero sense to call the prfd's as that only worsens the capital picture. Why would they structure some payout for prfd and reduce retained earnings when they can convert to common and avoid div payments? The more I look at this, the more I see value in the common shares as a key. Maybe I'm 100% wrong and just don't get it.

 

When I look at the massive dilution to common as a potential path and what the gov would make, ramifications etc. as opposed to a much more intelligent plan that makes the gov just as much money, why not go with the plan that encourages future investment, higher pps and protects all shareholders.

 

Because most of the preferred require outdated dividend payments, and FnF can't just continue making $billions$ and not pay them. Best to replace them, in time, at realistic rates.

[BeerBBQ]

The preferred shareholders obviously will have some very connected people at the negotiating table.  Who will be at the table fighting for common equity shareholders?  Assuming Icahn still owns shares, is there anyone else outside of he and Ackman who have weight in terms of advocating on behalf of common shareholders? Seems the common shareholders have the smallest voices at the table right now??

 

I think Ackman should proactively announce he is taking over the financing of the Washington Federal lawsuit. Since he clearly is willing to spend years and real $$ fighting for what he believes in, the various constituents involved in the negotiation would have to take him seriously and his negotiating position would be improved.

 

If retained earnings are allowed to build for only 3 years (vs. ackman's proposed 7), even if required capital is a generous 2%, the upside to common is quite limited (assuming the preferreds get an advantageous conversion price due to their seemingly better access to the decision makers).  I'm wondering if the seemingly current weak negotiating positon of the common shareholders is also part of the reason for the lack of appreciation relative to preferreds?? 

 

 

 

 

[investorG]

I think for optics sake, they get out of all holdings almost immediately. If the issue is government control of FnF, saying 'we're not involved in financing homes anymore' doesn't jive with owning most of the two companies. That means, possibly, the senior preferred are sold back to FnF at face, $1b. That one's easy. The warrants are too, although I have no idea how they would be priced. But I guess that wouldn't really matter if the goal is separation.

 

All junior preferred would then be called with no dividends issued during the transition. Paying that $40b will take a while but it will be FnF controlling it.

The common would be subject to those costs/time plus capital requirements.

 

and i'd be ecstatic

 

I just don't think an immediate recap makes any sense. There's nothing wrong with them coming out with a plan that takes 3-4 years until complete resolution. It would make zero sense to call the prfd's as that only worsens the capital picture. Why would they structure some payout for prfd and reduce retained earnings when they can convert to common and avoid div payments? The more I look at this, the more I see value in the common shares as a key. Maybe I'm 100% wrong and just don't get it.

 

When I look at the massive dilution to common as a potential path and what the gov would make, ramifications etc. as opposed to a much more intelligent plan that makes the gov just as much money, why not go with the plan that encourages future investment, higher pps and protects all shareholders.

 

Because most of the preferred require outdated dividend payments, and FnF can't just continue making $billions$ and not pay them. Best to replace them, in time, at realistic rates.

 

absolutely they could continue making billions and not pay them.  they are in a big capital hole currently.

 

redemption of preferreds are very unlikely in the menu of options. it's going backwards from a goal of more capital. 

 

there's some small chance, imo, of a tender offer for preferred only if it's at a discount to par, since that would generate core common equity capital on the balance sheet.  but i doubt the big preferred holders want that given other possibilities; if clinton had won this tender offer option was possible in order to settle the lawsuits imo.

[Desert_Rat]

I was very unclear when I said All junior preferred would then be called. I don't mean immediately, I mean as part of a transitional plan. Their dividends would remain suspended, then capital requirements are met, then they gotta do something with them. Calling them at that point does make sense.

[investorG]

One other thing I have been thinking about is how important the GSEs are to the administration?  Is the administration willing to give concessions on the GSE issue in order to gain votes on one of their big promises to their voters?

 

can't know for sure but look at their appointments so far and i'd say its important.  bloomberg is reporting that cohn (who based on his pedigree is probably dominating inside the WH) has taken over the tax cuts issue (likely due to mnuchin's comments on cnbc in nov, and the subsequent naming of the 'mnuchin rule' by wyden of no absolute cuts for the wealthy) leaving the competitive heat on mr mnuchin, if confirmed, to get the housing situation done right.