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

[investorG]

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?? 

 

 

 

the president is loyal but if people get too greedy then they risk his ire.  some of you may disagree but my intuition tells me the preferred players wouldn't try to screw others in any negotiations in a potential political solution (unlike in legal where there could be a pro-preferred only outcome).  there are plenty of profits for all parties involved, including the taxpayer, if the gov't stops its unjust stealing. 

 

 

[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.

 

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.

 

Sure, but it makes more sense for the gov to convert them instead of reducing retained earnings. Their not going to pay off prfds when the company's are way short on capital. Converting is replacing and opens the opportunity for 10% capital raise at today's realistic rates.

[Ismael]

I'm getting common EV of $9.5pps if gov't immediately exercises warrants and recaps. 

If gov't allows FNMA to retain capital for two years then exercises warrants and recaps I get an EV of $10pps (discounted @15% for two years).

This all assumes $60B capital raise which from what I understand is on the high end.

If you think a gradual approach will be taken then the common looks like the better bet. 

Preferred will gradually lose value in that scenario (b/c no dividends), but common will increase in value. 

@ $60B capital raise, the return of the common and preferred look similar.  Are there any estimates of a larger capital raise than this?

If capital raise is smaller than $60B it looks like the common is the better bet.

[Flynnstone5]

I'm getting common EV of $9.5pps if gov't immediately exercises warrants and recaps. 

If gov't allows FNMA to retain capital for two years then exercises warrants and recaps I get an EV of $10pps (discounted @15% for two years).

This all assumes $60B capital raise which from what I understand is on the high end.

If you think a gradual approach will be taken then the common looks like the better bet. 

Preferred will gradually lose value in that scenario (b/c no dividends), but common will increase in value. 

@ $60B capital raise, the return of the common and preferred look similar.  Are there any estimates of a larger capital raise than this?

If capital raise is smaller than $60B it looks like the common is the better bet.

 

As cherzeca said there's no way they immediately exercise warrants. I'm hoping that capital buffer is between $80-$100B. Min 2.5% +DTA effect from anticipated tax cut. No way its $60B or less IMHO.

[BTShine]

At risk of either being criticized, wasting your time or worse I'd like to raise an idea.

 

If the GSE's go the route of raising significant capital very quickly, what is the chance of Berkshire joining the efforts?  Would it be crazy to see them commit $10+ Billion to the efforts?

 

I've been running through the options of who can commit many billions to the effort.  Banks, some hedge funds / private equity, Berkshire and a few other public companies came to mind.  How else would they raise the ~$50 Billion or so if required?

[Guest cherzeca]

At risk of either being criticized, wasting your time or worse I'd like to raise an idea.

 

If the GSE's go the route of raising significant capital very quickly, what is the chance of Berkshire joining the efforts?  Would it be crazy to see them commit $10+ Billion to the efforts?

 

I've been running through the options of who can commit many billions to the effort.  Banks, some hedge funds / private equity, Berkshire and a few other public companies came to mind.  How else would they raise the ~$50 Billion or so if required?

 

i've been thinking about this also.

 

first, with a rights offering, you have the existing shareholder base.

 

second, if the NWS senior prefs are wiped out and junior prefs are enticed to convert to common, you have a clean financing slate for new conventional senior pref that would be enticing to many institutional investors (pensions, insurance etc).  but you are right, more is needed.  but dont forget, if income rates go down, fnma can retain mucho dinero as long as dividends are foregone on all but any new senior prefs. 

 

let me put it this way, mnuchin calls in wall st, and says to bankers he has about $1B in fees to dole out, my guess is that you will see the bushes being beaten (so to speak)

[orthopa]

Found this today

 

http://seekingalpha.com/news/3242565-pence-appointment-makes-frannie-recap-release-less-likely-cowen

 

http://www.politico.com/blogs/donald-trump-administration/2017/02/pmark-calabria-chief-economist-trump-234845

 

https://www.alt-m.org/2017/02/06/the-treasury-should-revive-the-snow-plan-for-limiting-gse-debt-issuance/

 

Interesting to see Parrot quoted in the one article.

[DocSnowball]

At risk of either being criticized, wasting your time or worse I'd like to raise an idea.

 

If the GSE's go the route of raising significant capital very quickly, what is the chance of Berkshire joining the efforts?  Would it be crazy to see them commit $10+ Billion to the efforts?

 

I've been running through the options of who can commit many billions to the effort.  Banks, some hedge funds / private equity, Berkshire and a few other public companies came to mind.  How else would they raise the ~$50 Billion or so if required?

 

i've been thinking about this also.

 

first, with a rights offering, you have the existing shareholder base.

 

second, if the NWS senior prefs are wiped out and junior prefs are enticed to convert to common, you have a clean financing slate for new conventional senior pref that would be enticing to many institutional investors (pensions, insurance etc).  but you are right, more is needed.  but dont forget, if income rates go down, fnma can retain mucho dinero as long as dividends are foregone on all but any new senior prefs. 

 

let me put it this way, mnuchin calls in wall st, and says to bankers he has about $1B in fees to dole out, my guess is that you will see the bushes being beaten (so to speak)

 

Buffett is on record about what he doesn't like - the non cumulative nature of preferreds, and the companies taking on too much risk in the past and focusing too much on quarterly earnings at the time he sold them. Berkshire certainly has the cash on hand to fire the "Elephant gun" and finance a very large part of the deal, the reinsurance market is well within their core circle of competence, it is a time when there are few undervalued investments around. This would certainly beat buying more of his least favorite industries in tech and airlines lol. The word lolapalooza effect comes to mind

[Ismael]

@Flynnstone5, maybe I am a little slow, but I don't understand how the GSEs can raise capital while the warrant overhang is in place.  It seems like the warrants need to go, either by exercising them, or by restructuring them to the point that common holders aren’t exposed to the dilution risk in the future.  I don't know why the gov't would just give them up or even take a haircut on them without being compensated to do so.  I also don’t understand why the GSE’s couldn’t raise equity if the gov’t converts the warrants.  I can see the selling pressure the gov’t would create while it unwinds its position, but I don’t see how that materially changes the economics.  Below is my most likely capital raise scenario. 

 

1. Exercise warrants (or restructure and sell to large institutional buyers or whatever other creative solution to warrants issue gets dreamed up)

2. Convert preferred to common (I don’t want this to happen until the warrants get sorted out)

3. Rights offering to current shareholders ($20Bish)

4. Retain earnings four years ($40B)

5. Preferred raise ($20B)

 

Preferred or common, the investment still looks compelling and I want to add to my position, but I don’t want to expose myself to the risk of losing a large portion of my money.  I’m having a hard time seeing how this investment does poorly.  I guess the administration could make a drug deal to get a vote they need for something else, and then the investment case goes back to the courts.  How likely is that?  Is there another risk I’m not seeing?

 

[rros]

At risk of either being criticized, wasting your time or worse I'd like to raise an idea.

 

If the GSE's go the route of raising significant capital very quickly, what is the chance of Berkshire joining the efforts?  Would it be crazy to see them commit $10+ Billion to the efforts?

 

I've been running through the options of who can commit many billions to the effort.  Banks, some hedge funds / private equity, Berkshire and a few other public companies came to mind.  How else would they raise the ~$50 Billion or so if required?

 

i've been thinking about this also.

 

first, with a rights offering, you have the existing shareholder base.

 

second, if the NWS senior prefs are wiped out and junior prefs are enticed to convert to common, you have a clean financing slate for new conventional senior pref that would be enticing to many institutional investors (pensions, insurance etc).  but you are right, more is needed.  but dont forget, if income rates go down, fnma can retain mucho dinero as long as dividends are foregone on all but any new senior prefs. 

 

let me put it this way, mnuchin calls in wall st, and says to bankers he has about $1B in fees to dole out, my guess is that you will see the bushes being beaten (so to speak)

 

Buffett is on record about what he doesn't like - the non cumulative nature of preferreds, and the companies taking on too much risk in the past and focusing too much on quarterly earnings at the time he sold them. Berkshire certainly has the cash on hand to fire the "Elephant gun" and finance a very large part of the deal, the reinsurance market is well within their core circle of competence, it is a time when there are few undervalued investments around. This would certainly beat buying more of his least favorite industries in tech and airlines lol. The word lolapalooza effect comes to mind

Number 1 issue is solvable: Buffett negotiates cumulative preferreds for Berkshire. The second too: companies become utilities. Problem with Buffett getting involved is that both commons and Jrs. get buffetted.

[orthopa]

@Flynnstone5, maybe I am a little slow, but I don't understand how the GSEs can raise capital while the warrant overhang is in place.  It seems like the warrants need to go, either by exercising them, or by restructuring them to the point that common holders aren’t exposed to the dilution risk in the future.  I don't know why the gov't would just give them up or even take a haircut on them without being compensated to do so.  I also don’t understand why the GSE’s couldn’t raise equity if the gov’t converts the warrants.  I can see the selling pressure the gov’t would create while it unwinds its position, but I don’t see how that materially changes the economics.  Below is my most likely capital raise scenario. 

 

1. Exercise warrants (or restructure and sell to large institutional buyers or whatever other creative solution to warrants issue gets dreamed up)

2. Convert preferred to common (I don’t want this to happen until the warrants get sorted out)

3. Rights offering to current shareholders ($20Bish)

4. Retain earnings four years ($40B)

5. Preferred raise ($20B)

 

Preferred or common, the investment still looks compelling and I want to add to my position, but I don’t want to expose myself to the risk of losing a large portion of my money.  I’m having a hard time seeing how this investment does poorly.  I guess the administration could make a drug deal to get a vote they need for something else, and then the investment case goes back to the courts.  How likely is that?  Is there another risk I’m not seeing?

 

I have thought about this a lot as I'm sure others have. Only "black swan" event I can see really screwing those speculatively buying now in either common or preferred is Mnunchin changing his mind and doing a 180 on what he has said before. That or he takes a harsher then expected stance on shareholders to the point that they want to continue to pursue the legal route because any deal worked out is unattractive to plaintiffs.

 

This would necessitate Mnunchin to:

 

1. Turn his back on Paulson/Berkowitz/Icahn etc and whatever relationship they have with himself and trump.

2. Put the gov/Trump administration at risk for what the hidden documents may or may not show if anything.

3. Potentially go against his own beliefs regarding the mortgage market/housing policy etc due to heavy pressure from within the gov

4. Take a much harsher stance on shareholders then what the administration including himself, Trump, Cohn has previously projected.

 

As I mentioned before and as I think we can all agree now this really is no longer an investment with a legal catalyst. It all rests with one person. We can all infer nearly the same things from what we have read, heard, seen etc over the last 3-4 months. The most we can do is take the man and admin. at their word for now.

 

 

[Cox022]

Great discussion.  Very intelligent to wonder 'what are we missing?'  Sometimes it's easy to get too locked in with the magnifying glass and miss a bigger picture. 

 

This short vid is great on Mnuchin, shared by no_free_lunch: https://www.bloomberg.com/news/videos/2017-02-09/how-steven-mnuchin-got-the-treasury-job-video

 

Basically Trump took a liking to Mnuchin because Mnuchin made a killing off of OneWest.  Some part of Mnuchin's incentives must be to deliver a great deal for POTUS.  As we've previously discussed, this ought to be good for GSE investors as well.

 

We cant know for sure, but I'm curious how Mnuchin's purchase of IndyMac might influence his thinking.  There he made a good deal that worked out well for him, but arguably also well for the FDIC.  Now, Mnuchin is on the other side of the deal.  Does that shed light on the possibilities? And how does that influence him?  I dont know.  I can see it both ways.  One, he knows there's plenty of value to be created to please everyone.  Or two, he's the former wolf that is now the shepard. 

 

 

[Ismael]

I agree the only risk I can think of entails Mnuchin doing an about face and turning a cold shoulder to the GSEs.  From what he has said and what he has done, it would have to be something external that makes him change his tact.  “Relatively fast” means he wants to work something out with current shareholders and his past tells us he has no problem letting hedge funds earn a little money in order to fix the GSE problem.  There is a lurking risk that some political force makes him change his goals with respect to the GSEs.  It could get pretty bad if this political force arises and this thing gets decided in the courts.  In that case you would have two administrations from different parties that are both hostile to the shareholders.  I have a hard time believing the judges deciding the case wouldn’t (at least a little bit) be influenced by the politics surrounding the GSEs.  I guess this risk is what we are getting paid to bear.  Not a bad return, but the tail risk makes it tough to load up. 

 

@BTshine, Good call, Buffett would be all over this.  Its right up his alley. 

[orthopa]

In the Bloomberg piece it said Mnunchin was rewarded for his loyalty on the campaign trail with the treasury position.  Trump was also impressed with how much money he made at Onewest.

 

Now trump/mnunchin just need to be faithful to Paulson/Berkowitz and be impressed with how much money they made with Fannie.

[no_free_lunch]

  Is there another risk I’m not seeing?

 

I think the biggest risk is some type of wind down and opening up to private competition.  That is what the republicans were talking about and the majority of people in the house / senate are still likely in favor of that.  If you hold other financials it could be a windfall for them so it might mitigate your loss a bit if it happens.

[Desert_Rat]

I'm surprised no one here shares my opinion that the biggest risk is the GOP, which, on the whole, just wants us dead. Housing reform, of which FnF is a part of, will take a majority to implement. Doesn't matter what Mnuchin thinks, although he could throw a knuckleball and save us alone.

 

If I can hear a credible reason why this is baloney I'll think hard about going all in. It's the biggest risk, imo.

 

 

[Mephistopheles]

I'm surprised no one here shares my opinion that the biggest risk is the GOP, which, on the whole, just wants us dead. Housing reform, of which FnF is a part of, will take a majority to implement. Doesn't matter what Mnuchin thinks, although he could throw a knuckleball and save us alone.

 

If I can hear a credible reason why this is baloney I'll think hard about going all in. It's the biggest risk, imo.

 

 

 

I think the GOP bends to Trump on this one, just like they have on free trade almost overnight.

 

Bigger risk, at least imo, is some sort of shady deal that benefits Trump's friends at the expense of the rest of us. That's what's keeping me from going all in.

[DocSnowball]

What about basing position size by Kelly or half Kelly?

[Jurgis]

What about basing position size by Kelly or half Kelly?

 

OK. What is the probability of pref return to par?

[DocSnowball]

Over a one year timeframe, assuming current value of equities invested in preferred

 

1. Restructuring with return to par :50%

Value 2.5x

 

2. Status quo or settlement only favoring plaintiffs 25% (cases go on w same or new plaintiffs)

Value 0.5x. Loss 0.5

 

3. Liquidation without just compensation or other black swan scenario:25%

Value 0 , Loss 1

 

Edge

0.50*2.5  + (0.25*-0.5) + (0.25*-1)

1.25 - 0.375

0.875

 

Odds

2.5

 

Edge/Odds = 0.875/2.5 = 0.35

 

Disclosure Newbie

[Guest cherzeca]

"2. Status quo or settlement only favoring plaintiffs 25% (cases go on w same or new plaintiffs)

Value 0.5x. Loss 0.5"

 

this is essentially a greenmail solution.  since Ps own securities that every holder of those securities hold, the only way for Ps to get value that others dont get is through greenmail. 

 

this wont happen. zero chance.

 

plus you ignore that certain claims are class action, so that all holders would have to agree to the greenmail.

 

there are many things to worry about re settlement/court decision etc, but greenmail is not one of them.

[Mephistopheles]

"2. Status quo or settlement only favoring plaintiffs 25% (cases go on w same or new plaintiffs)

Value 0.5x. Loss 0.5"

 

this is essentially a greenmail solution.  since Ps own securities that every holder of those securities hold, the only way for Ps to get value that others dont get is through greenmail. 

 

this wont happen. zero chance.

 

plus you ignore that certain claims are class action, so that all holders would have to agree to the greenmail.

 

there are many things to worry about re settlement/court decision etc, but greenmail is not one of them.

 

Are you saying that it's zero chance only because some cases are class action, or because of other reasons too? Curious to know your thinking.

 

In regards to the class action case, couldn't greenmail still be possible if: a) plaintiffs drop all charges in the class action, b) agree to a completely separate deal with Treasury? So it wouldn't be a settlement as part of the case rather its own separate deal.

[DocSnowball]

Other activist investors (including some on this board who have the human and financial capital to become activist) are also a margin of safety against greenmail, since the goal of a settlement would be to put the cases behind.

 

I also realize that Berkowitz is over the 35% I reach by full Kelly, ,and he may be over 50% by next weekend, so he's seeing less risk than I am perceiving.

[HalfMeasure]

Other activist investors (including some on this board who have the human and financial capital to become activist) are also a margin of safety against greenmail, since the goal of a settlement would be to put the cases behind.

 

I also realize that Berkowitz is over the 35% I reach by full Kelly, ,and he may be over 50% by next weekend, so he's seeing less risk than I am perceiving.

 

Berkowitz is also in a different situation than you are. The position has grown as a percentage of his portfolio due to recent capital appreciation but also investors redeeming funds. When investors redeemed, he liquidated other positions while leaving Fannie/Freddie untouched. For the capital gains in the portfolio on Fannie/Freddie, there are tax implications that portfolio allocation decision different for Berkowitz than someone allocating today. As well, he's footing a legal bill it and has his reputation attached. In sum, his position has grown into being 35% (was not originally) and due to size and other factors is less liquid than others.

[Desert_Rat]

I think the point was that he owns a ton of it.