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

[Eye4Valu]

I am a lawyer and always thought the proper venue/jurisdiction, together with the best odds, was in the Court of Federal Claims. If Mnuchin settles with Plaintiffs in a favorable manner, that's great. If he doesn't, I believe a favorable judgment will be obtained from Sweeney. She has already indicated that she doesn't let the U.S. steamroll over contractual rights. I also agree with Merkhet that the Perry decision wasn't entirely adverse to the preferreds, and is being glossed over by the media and this thread. My cost basis in FNMAS is 4.25, so I'm neither selling nor adding to my position here. I am not disheartened by the Perry decision and didn't expect Mnuchin to show all his cards this morning. I also think there is a decent chance SCOTUS would grant certiorari on Perry, and have no doubt that a petition for writ of certiorari will be forthcoming from the Plaintiffs.

[BeerBBQ]

I really find it bizarre that the common has been moving incrementally up while the prfd is doing the opposite. The market seems to be perceiving that both breach cases are not very strong. What's your take?

 

The two breach issues that I referenced both pertain to the preferred. The common does not have a case based on Perry. I haven't a clue why there is divergence between the security prices of the two.

 

This is part of the reason why I think preferreds are in a better position now relative to common.

Do you have an opinion on if this ruling has improved the negotiating leverage of either preferreds or common vs. each other and/or vs. others within negotiating framework?

 

[merkhet]

I think preferreds have better negotiating leverage than common post-Perry. But the preferreds now have less leverage than before.

 

None of that has any bearing on the likelihood to win the breach of contract case though. It seems pretty clear there was an anticipatory breach of the liquidation preference given the structure of the NWS. No opinion on the dividends.

[investorG]

I think preferreds have better negotiating leverage than common post-Perry. But the preferreds now have less leverage than before.

 

None of that has any bearing on the likelihood to win the breach of contract case though. It seems pretty clear there was an anticipatory breach of the liquidation preference given the structure of the NWS. No opinion on the dividends.

 

what's the remedy if breach of contract on liquidation preference does win?  thank you

[BeerBBQ]

see page 11

 

http://www.fairholmefundsinc.com/Documents/PublicConferenceCall20161118.pdf

 

[merkhet]

In general, it's what you would have expected to receive but for the breach.

[Guest cherzeca]

"I think preferreds have better negotiating leverage than common post-Perry. But the preferreds now have less leverage than before."

 

agree.  but i would say that while preferred still have some leverage based upon this perry decision, the common enjoy being parri passu with treasury's 80% position.

 

so if govt wants to keep its senior preferred stock at $117B for fnma, neither junior pref nor common have value.  and i dont see how treasury can return fnma to private ownership with a large capital buffer under this scenario.  so i dont think mnuchin goes this way.

 

if mnuchin thinks that the govt has been paid back at 10% dividend rate such that the senior pref have served their purpose (but now stand in the way of a recap), and sees govt's remaining value realization opportunity as its 80% warrant position, then the common obtains leverage by going along for whatever ride mnuchin wants to go to realize value from warrants.

 

as things stand now, common has very low legal leverage, but enjoys being able to ride the warrants' coattails.  the pref has some more legal leverage, but probably not enough to justify its current trading price...which implies that the junior pref holder thinks the commons' value derived from the warrants (that mnuchin wont trash treasury's own position) also benefits the junior pref

 

this is no longer a legal thesis, it's a mnuchin wont trash the warrrant value thesis, certainly for common and at least partially for junior pref.

 

EDIT:  at the risk of being redundant, simply put, if treasury owned no warrants, just the senior pref, the common would be worthless and the junior pref would be worth 10% of par, imo

[Flynnstone5]

I was reading comments from Jim Hodges (Value Investor Today). He believes Mnuchins comments this morning were negative, selling his positions in FnF. He is claiming that the NWS is a contractual obligation under SPSPA and that there is no clause to get out of this. Therefore, when tax reform triggers DTA adjustment, this will force a draw.

 

I thought this could be stopped with a 4th amendment between Treasury and FHFA, which some else noted, but he says that is incorrect as Corker bill changed that?

 

Some of the thread:

https://twitter.com/ValuInvstrToday/status/834822316924272641

[Guest cherzeca]

@flynn

 

even if he is right, he is right for 10 more months.  and he is not right.

[Flynnstone5]

@flynn

 

even if he is right, he is right for 10 more months.  and he is not right.

 

Thanks for the response. I thought the same, but shocked by his sudden change in sentiment.

[BeerBBQ]

 

the pref has some more legal leverage, but probably not enough to justify its current trading price...which implies that the junior pref holder thinks the commons' value derived from the warrants (that mnuchin wont trash treasury's own position) also benefits the junior pref

 

this is no longer a legal thesis, it's a mnuchin wont trash the warrrant value thesis, certainly for common and at least partially for junior pref.

 

EDIT:  at the risk of being redundant, simply put, if treasury owned no warrants, just the senior pref, the common would be worthless and the junior pref would be worth 10% of par, imo

 

Why don’t you think the legal leverage justifies current trading price? I was thinking that the legal leverage, capital structure priority, contractual nature of prefs, and the relationships of those who will be negotiating on behalf of the prefs (esp relative to common) would mean that a higher pref price would be justified. (obviously market disagrees with that assessment)

 

As an aside, I think many have assumed that Trump wants to maximize the value of the warrants (I have thought that too) but it may be that his “must have” is reform, recap, and release because of the potential positive impact from housing for his growth agenda and he might be willing to give up the warrant value to achieve bigger agenda goals.

 

I may be misunderstanding what you are saying but are you saying that junior prefs derive value from common share value? I’m confused as t oif treasury trashes warrant value thesis, how junior prefs get hurt?

 

 

[orthopa]

 

 

this is no longer a legal thesis, it's a mnuchin wont trash the warrrant value thesis, certainly for common and at least partially for junior pref.

 

EDIT:  at the risk of being redundant, simply put, if treasury owned no warrants, just the senior pref, the common would be worthless and the junior pref would be worth 10% of par, imo

 

Exactly, Im surprised you guys are still debating possible legal outcomes. The man says he knows nothing about the lawsuits and deferred to the DOJ on that. He said in this building they are dealing with housing reform going forward. I think you start to place your chips on Sweeney if Mnuchin liquidates shareholders, other then that the court cases mean squat.

 

Remember the court cases are a product of an administration who would never sit at a table with other stakeholders and had no interest in housing reform. I would argue that you would never even see the lawsuits come about if this administration was in place instead of Obamas. These lawsuits are stale hold overs that wont be anywhere near completion when mnuchin decides what he wants to do and housing reform takes place.

[investorG]

I was reading comments from Jim Hodges (Value Investor Today). He believes Mnuchins comments this morning were negative, selling his positions in FnF. He is claiming that the NWS is a contractual obligation under SPSPA and that there is no clause to get out of this. Therefore, when tax reform triggers DTA adjustment, this will force a draw.

 

I thought this could be stopped with a 4th amendment between Treasury and FHFA, which some else noted, but he says that is incorrect as Corker bill changed that?

 

Some of the thread:

https://twitter.com/ValuInvstrToday/status/834822316924272641

 

dta is 34bn.  corp rate likely gets cut from 35pct to 25-27pct.  that's 30pct reduction which means a writeoff of ~10bn. 

 

how convenient, they have a 5bn pending draw plus two more quarters of -- depending on some things --- of over 5bn of income.

 

a fine reason to stop the sweep, and one that the opponents should not protest.

 

or if they keep sweeping, they could do a quick 4th amendment later this year? or just have a draw -- if they are going to kill the sr preferred in 2018 by the admin or whenever by congress, does it matter if it's 187bn or 200bn? 

 

 

[Guest cherzeca]

@beer

 

if the sole recovery path is by lawsuit, junior prefs are looking many years still down the road until you see actual money, and my expectation is that the amount will be a very low % of par.  see eg Starr v AIG.  common gets a lower amount than junior pref.

 

so if there is value to be found, it can be found in a recap of some kind.  now, suppose mnuchin wanted to keep the senior pref outstanding at $117B for fnma, and exchange all of that for common through some sort of cramdown, and tell junior pref and common, look to your court damage remedy.  junior pref and common would have no value arising from the capital structure.  this assumes that fnma equity value is about $120B ($10B net income X 12PE).

 

so if that is mnuchin's recap path, then both fnma common and pref are a short.

 

but i am long both.  why?  because i think mnuchin is smart enough to know that if treasury tries to milk the senior pref for future value and cram down both junior pref and common (and treasury's warrants),  he will have a hard time raising another $60B in capital (though as has been pointed out, in effect, wc fields might argue otherwise).

 

so by recapping with the warrants, mnuchin has done two things:  he has used the senior pref to get the repayment at 10% that the treasury deserves (since this is the original deal), but no more, and he is using the warrants to say that he respects the junior pref and common shareholders' rights, which will let him raise that additional money, and let him realize alot of value from the warrants.

 

the warrants were always the common's card to play in the event the cases wimp out (as they have to date).

[Sunrider]

@beer

 

if the sole recovery path is by lawsuit, junior prefs are looking many years still down the road until you see actual money, and my expectation is that the amount will be a very low % of par.  see eg Starr v AIG.  common gets a lower amount than junior pref.

 

so if there is value to be found, it can be found in a recap of some kind.  now, suppose mnuchin wanted to keep the senior pref outstanding at $117B for fnma, and exchange all of that for common through some sort of cramdown, and tell junior pref and common, look to your court damage remedy.  junior pref and common would have no value arising from the capital structure.  this assumes that fnma equity value is about $120B ($10B net income X 12PE).

 

so if that is mnuchin's recap path, then both fnma common and pref are a short.

 

but i am long both.  why?  because i think mnuchin is smart enough to know that if treasury tries to milk the senior pref for future value and cram down both junior pref and common (and treasury's warrants),  he will have a hard time raising another $60B in capital (though as has been pointed out, in effect, wc fields might argue otherwise).

 

so by recapping with the warrants, mnuchin has done two things:  he has used the senior pref to get the repayment at 10% that the treasury deserves (since this is the original deal), but no more, and he is using the warrants to say that he respects the junior pref and common shareholders' rights, which will let him raise that additional money, and let him realize alot of value from the warrants.

 

the warrants were always the common's card to play in the event the cases wimp out (as they have to date).

 

Chris

Shouldn't that argument tip you back towards common (compared to your statement the other day that you're rebalancing towards pref)?

[merkhet]

I don't think the warrants & the common are necessarily pari passu.

 

Let's just assume that we're @ 1/1/2018, and there's $0 of capital. Also assume that to safely run a $3 trillion asset book, you'd need something on the level of 2.5% capital or $75 billion.

 

If the government just exercises the warrants for a nominal amount (call it zero), then the government would own 80% and the common would own 20%, and they'd call it a day except there's $0 in capital, so at some point both would have to get diluted during an equity raise.

 

However, I think you could also easily see a structure where the government raises the strike such that they put in $60 billion of cash and the junior preferred put in $15 billion of cash such that the government owns ~80% of the company and the junior preferred owns ~20% of the company and the common owns the residual -- which would be very little.

 

You might also see other, more fair, structures where everyone gets converted to common at the same time, and then you do a rights offering where everyone gets to participate.

 

But I wouldn't necessarily just assume the warrants are pari passu w/ the common.

 

And I don't think that the junior preferreds are looking at a poor % par recovery based on the breach of K case. Starr vs. AIG revolved around the fact that (A) but for the actions of the Fed at that time, the shares would be worthless and (B) the shares were common shares. Here, but for the NWS, the preferreds would not be worthless, and they have a contract w/ the companies for their liquidation preference. Very different situation, IMHO.

[Guest cherzeca]

@merkhet and others

 

one of my heuristic devices is to work backwards from a good result, figure out what are the steps by which one has gotten to that good result from where you are here and now, and analyze the feasibility of those steps.

 

now, imo, obtaining a desirable result through legal action is still possible, but using my heuristic device, just not that feasible.  for example if myron steele in the hindes/jacobs case can convince judge sleet to follow judge brown and not the majority (sleet is in a different circuit so he doesnt have to follow perry majority), then its legal game back on (but legal realists understand that having the same threshold legal issues decided one way in one circuit court of appeals leaves another district judge hardpressed to decide another way in another circuit...but it happens, there are often different results in different circuits).  and if steele loses that with judge sleet, he has another shot with the 3rd circuit court of appeals.

 

this legal advocacy will be pursued to keep the pressure on the govt for the rest of the year, but imo the value of that legal action is not so much in obtaining a damage remedy as it is to keep the pressure on treasury to move beyond the status quo...and mnuchin has been consistent and clear that the status quo is unacceptable.

 

so back to my heuristic device, the most feasible way that i see for a good result to happen is for mnuchin to propose a restructuring (his word in november) that would enhance the value of the warrants.  if this happens, as a common and junior pref holder, anything that creates value for the warrants creates value for the common and junior pref.

 

now does this particular restructuring make political, housing policy and financial sense?  i think so.  no doubt politicians might choose another way if it were up to them, but if they couldnt get it done over 4 years when the obama administration was pleading for them to do something, i dont see a very strong political opposition (especially now that a pol cant say without a straight face that treasury hasnt been repaid). the best thing for housing policy is a capital rich guarantor not named the US treasury, and the best way to get that is with GSEs rebuilt financially, and i think mnuchin is financially canny enough to appreciate that restructuring and refinancing the GSEs can be done in a way that makes treasury alot of money from the warrants to boot.

 

it is way to early to pencil out conversion scenarios, but i simply know that if the senior pref is retired as having done its job by paying the treasury back its investment with a very nice 10% return, with 5.5B shares of common stock outstanding on a fully diluted basis and $19B par of junior pref, there is a way for treasury to make money from warrants, have GSEs raise new capital and leave plenty for junior pref and common (even if warrant exercise price stays at zero).

[investorG]

I don't think the warrants & the common are necessarily pari passu.

 

Let's just assume that we're @ 1/1/2018, and there's $0 of capital. Also assume that to safely run a $3 trillion asset book, you'd need something on the level of 2.5% capital or $75 billion.

 

If the government just exercises the warrants for a nominal amount (call it zero), then the government would own 80% and the common would own 20%, and they'd call it a day except there's $0 in capital, so at some point both would have to get diluted during an equity raise.

 

However, I think you could also easily see a structure where the government raises the strike such that they put in $60 billion of cash and the junior preferred put in $15 billion of cash such that the government owns ~80% of the company and the junior preferred owns ~20% of the company and the common owns the residual -- which would be very little.

 

You might also see other, more fair, structures where everyone gets converted to common at the same time, and then you do a rights offering where everyone gets to participate.

 

But I wouldn't necessarily just assume the warrants are pari passu w/ the common.

 

And I don't think that the junior preferreds are looking at a poor % par recovery based on the breach of K case. Starr vs. AIG revolved around the fact that (A) but for the actions of the Fed at that time, the shares would be worthless and (B) the shares were common shares. Here, but for the NWS, the preferreds would not be worthless, and they have a contract w/ the companies for their liquidation preference. Very different situation, IMHO.

 

while not provable, it's far greater odds that common + warrants are pari passu than they are not.

 

in addition the post suggests a conversion ratio of jr preferred to common of something like 10:1, where the jr preferred gets 20pct of the new company and common 'residual'.  once again, while anything is possible -- and a good reason to hold a balance of the two securities --- highly unlikely unless the preferred wins a ruling with big time real (not fake) winnings that the common doesn't get and the 2 securities diverge a ton in the meantime.

[Seahug]

Who do people assume w/ a reduction in corporate tax rate, the DTA ($33.5bn YE2016 for FNMA) will need to be written down?

 

Doesn't this just extend the number of years to utlize the asset?

 

I can understand if corporate income tax goes to zero...

 

[SnarkyPuppy]

Who do people assume w/ a reduction in corporate tax rate, the DTA ($33.5bn YE2016 for FNMA) will need to be written down?

 

Doesn't this just extend the number of years to utlize the asset?

 

I can understand if corporate income tax goes to zero...

 

https://twitter.com/ValuInvstrToday/status/834799983245328384

[Seahug]

Hmm ok thanks, I see that.

 

But I've seen companies (LVLT for ex) hold DTAs for years as long as there's hope for profitability

 

 

[tng]

Who do people assume w/ a reduction in corporate tax rate, the DTA ($33.5bn YE2016 for FNMA) will need to be written down?

 

Doesn't this just extend the number of years to utlize the asset?

 

I can understand if corporate income tax goes to zero...

 

Extending the number of years means you have to write it down for accounting purposes because of time value of money. The asset isn't damaged, it's an accounting loss.

[randallchsu]

Looks like we are trying to jump over a 7-foot bars

[merkhet]

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.

[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.

Then, one has to ask... can Ackman be that idiot?