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

[Cox022]

The board was discussing risks that some of us see on the horizon. I’m an enthusiastic owner of these securities but here are some items that I worry about.

 

My lingering worry is that old shareholders are left behind in any restructuring/reform plan and are left with the court cases for resolution.  Really strange things happen in bankruptcies and reorganizations that seem hard to predict beforehand.

 

A related worry is that the government warrants are not attached to the hip of the common stock (not pari passu)…meaning the warrants become valuable to the Government in a new structure with the common stock left behind for some different fate.  I don’t have strong footing on this issue to know how likely it is.  If we ask nicely, maybe Merkhet & cherzeca can tell us if they have updated their views on this issue since commenting on it a long time ago.

 

 

I don’t post much, so since I’m here: 2 other thoughts. 

 

Here’s a thought I have about the common stock since the Moellis plan debuted.  As a logical exercise, should a common holder reasonably expect a better outcome from the common stock than the one demonstrated by the Moellis plan?  I think all common holders should contemplate that question.

 

RNC Document.  If the principles in the RNC document take hold that would be an extremely favorable shift in momentum.  I’m stating the obvious but with added color.  That the cornerstone of any discussion on the future of the GSE’s starts with ‘these entities are worth $100B to us’ is a huge shift in psychology.  Any plan for the GSE’s that hurts us has to then answer the question: why is your proposal so good that we should forego $100B?  As we have all discussed since the beginning: it’s in these fools’ interest to capture the value of the GSE’s, and many of us have wondered if they would figure this out. 

 

Is it too hopeful to expect the words on this document permeate into the thinking of the GOP?  Maybe but the fact that they were written is a lot more signal than it is noise!

 

[Guest cherzeca]

@cox

 

I have been thinking about the rnc resolution. It either means nothing (no legal authority) or it means a lot (completely changes the psychological perception). My own view is that corker etc will not come up with something antagonistic to GSEs that is sensible and practical. The more that the moelis blueprint (which the rnc resolution implicitly favors) is viewed as a practical reform (or fix in mnuchin speak) the more likely it or something like it gets approved (especially after the passage of time) whether by congress or administratively.

 

As for ratchet in govt warrants I think that was a status quo maintenance mechanism put in by a hostile administration. Whether this administration uses its leverage to extract value from the public seems unlikely to me, but it certainly is possible

[Cox022]

Thanks cherz.

[merkhet]

Nothing has changed in my thinking re the warrants' possible "cram-down" of common stock. Trump likes to get a good deal, and he likes to win. In his mind, in order for him to win, someone else needs to lose -- maybe that's the prior administration, maybe that's common stock holders.

 

I am significantly more comfortable holding the preferred than common.

[SnarkyPuppy]

One argument for why shareholders cannot practically get wiped is that litigation would remain outstanding and effectively a contingent liability for the government.  Could that same argument not be made in a recap/release scenario?  I haven't been following the legal cases closely but my understanding is there is a suit questioning the inherent constitutionality of HERA. 

 

If the preferreds are swapped to commons as part of satisfying the preferred litigants needs and removing litigation risk (and adequately capitalizing the GSEs), could the common shareholders not continue down the path of challenging HERA with damages > $13 per share?  Seems like a contingent liability would still exist here for the govt. 

 

[DocSnowball]

Also, in the two scenarios in the Moelis blueprint, the one in which Govt ends up with $100 billion is also the one where commons achieve the higher valuation, as compared with the $75 billion scenario

[Guest cherzeca]

@emily

 

Gses have much smaller whole loan portfolios than they used to so their results are far less dependent on interest arbitrage.  Now g fees drive results and they don't change based upon rates

[Midas79]

Thank you. I read that warrants were issued at $0.001 when the market price then was $0.20. Is that legal to issue warrants at 20,000% lower price than the market value at the time?

 

With all due respect, I think you are reading iHub too much. The warrants are perfectly legal because they are part of the SPSPA contract. Similar warrants were exercised with AIG so precedent exists.

 

From the sealed documents we learned that the purpose of the warrants was to depress the stock price and make the companies look like they were in worse shape than they actually were, but as for the legality of exercise it is beside the point.

 

Many posters on iHub have latched on to a specific common valuation (Ackman's $23-47 common valuation with warrant exercise is a popular version) and will blast any idea that leads to them getting anything less. There is precious little logic on that board.

[SnarkyPuppy]

One argument for why shareholders cannot practically get wiped is that litigation would remain outstanding and effectively a contingent liability for the government.  Could that same argument not be made in a recap/release scenario?  I haven't been following the legal cases closely but my understanding is there is a suit questioning the inherent constitutionality of HERA. 

 

If the preferreds are swapped to commons as part of satisfying the preferred litigants needs and removing litigation risk (and adequately capitalizing the GSEs), could the common shareholders not continue down the path of challenging HERA with damages > $13 per share?  Seems like a contingent liability would still exist here for the govt.

 

apologies for pushing my own question but seriously curious if anyone has a mitigant to this?  Other than low risk that HERA is overturned and retrospective damage is assessed

[waynepolsonAtoZ]

"If so, wouldn't Fannie and Freddie make lot more money?"

 

As a general matter, if the Treasury goes up then FnF would have substantial deriv gains related to their hedging of their interest rate risk.

[TonyG]

http://mba.informz.net/MBA/data/images/GSE%20Reform%20Joint%20letter%20921.pdf

 

"As noted by the Congressional Budget Office (CBO) in 2016, allowing Fannie Mae and Freddie Mac to create a capital cushion simply converts a potential future draw on federal funds into an immediate draw and such an action would effectively increase the size of taxpayer exposure to future losses."

 

anyone want to explain that line? I've read it over 10 times and can't understand it.

[mrholty]

http://mba.informz.net/MBA/data/images/GSE%20Reform%20Joint%20letter%20921.pdf

 

"As noted by the Congressional Budget Office (CBO) in 2016, allowing Fannie Mae and Freddie Mac to create a capital cushion simply converts a potential future draw on federal funds into an immediate draw and such an action would effectively increase the size of taxpayer exposure to future losses."

 

anyone want to explain that line? I've read it over 10 times and can't understand it.

 

I think it means that there is no real cushion or bank account at the federal level. 

I think it like Social Security.  The money that is in the social security lockbox is $0.  The gov't borrows from that each year so that they have to issue fewer bonds for that year's deficit.  In something like 8-10 years outflows on Social security will be greater so we as a gov't will have to borrow more to cover that than the official deficit. 

I'd be glad to hear from others.

[Midas79]

http://mba.informz.net/MBA/data/images/GSE%20Reform%20Joint%20letter%20921.pdf

 

"As noted by the Congressional Budget Office (CBO) in 2016, allowing Fannie Mae and Freddie Mac to create a capital cushion simply converts a potential future draw on federal funds into an immediate draw and such an action would effectively increase the size of taxpayer exposure to future losses."

 

anyone want to explain that line? I've read it over 10 times and can't understand it.

 

I believe that withholding part or all of a dividend payment increases Treasury's liquidation preference by the amount withheld. Actually drawing money from Treasury does the same thing.

 

The last part is completely false though. If FnF ever experience losses, the capital cushion they build would be the first thing to go. Sending that money to Treasury and then having to draw it in the case of a loss would not affect the taxpayer situation on a cash basis.

 

Of course, MBA et al are completely missing the point: Watt wants to keep some money to soothe investors, i.e. drawing money from Treasury due to a quarterly loss and zero capital will spook investors, especially those outside the US. Not all "draws" are created equal.

 

If this were such an important point MBA would not have waited so long to make it. It has been months since Watt first mentioned the possibility of building capital. They just seem to be throwing feces at the wall to see what will stick.

[rros]

http://mba.informz.net/MBA/data/images/GSE%20Reform%20Joint%20letter%20921.pdf

 

"As noted by the Congressional Budget Office (CBO) in 2016, allowing Fannie Mae and Freddie Mac to create a capital cushion simply converts a potential future draw on federal funds into an immediate draw and such an action would effectively increase the size of taxpayer exposure to future losses."

 

anyone want to explain that line? I've read it over 10 times and can't understand it.

 

I believe that withholding part or all of a dividend payment increases Treasury's liquidation preference by the amount withheld. Actually drawing money from Treasury does the same thing.

 

The last part is completely false though. If FnF ever experience losses, the capital cushion they build would be the first thing to go. Sending that money to Treasury and then having to draw it in the case of a loss would not affect the taxpayer situation on a cash basis.

 

Of course, MBA et al are completely missing the point: Watt wants to keep some money to soothe investors, i.e. drawing money from Treasury due to a quarterly loss and zero capital will spook investors, especially those outside the US. Not all "draws" are created equal.

 

If this were such an important point MBA would not have waited so long to make it. It has been months since Watt first mentioned the possibility of building capital. They just seem to be throwing feces at the wall to see what will stick.

The only way to increase the liquidation preference is by Fannie and Freddie paying in kind.

 

So I do not think withholding money increases the size of taxpayers exposure in such way.

 

That paragraph resembles what Michael Stegman had been arguing that any recapitalization is at the cost of taxpayers. It's an obfuscated thought. In my view, it means that every time FF pay dividends these funds magically offset, cushion or reduce the size of that exposure because of the inflows in relation to the remaining commitment. It doesn't matter where the money goes once paid or how it is used as Treasury accounts for it in a general fungible account. Once the inflow stops -while the commitment is ongoing- the exposure stops getting smaller ratio-wise. It's an accounting issue.

 

Example, once profit from dividends equal the current remainder of the commitment (approx. 250+/- billion) then one can argue that taxpayers have achieved minimal exposure as the inflows, over a period of decades, have been able to match the rest of the unused commitment. Stop the inflows and taxpayers' exposure freezes at the size of the time of cancelling the dividends. If this makes any sense...

[Sunrider]

Simple. If you’re working from the assumption that you own all of the GSE (or at least all of the profit already), then it’s a left pocket/right pocket argument. Rather than moving some from your right pocket to the left today, you decide to not do that so that tomorrow you don’t have to move it from left to right because you found the right pocket (GSEs) are empty.

 

Of course, if you don’t believe in the premise, then you can see what’s going on.

C.

http://mba.informz.net/MBA/data/images/GSE%20Reform%20Joint%20letter%20921.pdf

 

"As noted by the Congressional Budget Office (CBO) in 2016, allowing Fannie Mae and Freddie Mac to create a capital cushion simply converts a potential future draw on federal funds into an immediate draw and such an action would effectively increase the size of taxpayer exposure to future losses."

 

anyone want to explain that line? I've read it over 10 times and can't understand it.

[rros]

Simple. If you’re working from the assumption that you own all of the GSE (or at least all of the profit already), then it’s a left pocket/right pocket argument. Rather than moving some from your right pocket to the left today, you decide to not do that so that tomorrow you don’t have to move it from left to right because you found the right pocket (GSEs) are empty.

 

Of course, if you don’t believe in the premise, then you can see what’s going on.

C.

http://mba.informz.net/MBA/data/images/GSE%20Reform%20Joint%20letter%20921.pdf

 

"As noted by the Congressional Budget Office (CBO) in 2016, allowing Fannie Mae and Freddie Mac to create a capital cushion simply converts a potential future draw on federal funds into an immediate draw and such an action would effectively increase the size of taxpayer exposure to future losses."

 

anyone want to explain that line? I've read it over 10 times and can't understand it.

Yes. Your explanation is simpler. It's the basic premise that confuses us. Stegman believes these companies have been nationalized with no need to protect taxpayers because of the incoming dividends and starts his analysis from there. We believe they are still private companies in need of capital for taxpayers' protection.

[racemize]

Simple. If you’re working from the assumption that you own all of the GSE (or at least all of the profit already), then it’s a left pocket/right pocket argument. Rather than moving some from your right pocket to the left today, you decide to not do that so that tomorrow you don’t have to move it from left to right because you found the right pocket (GSEs) are empty.

 

Of course, if you don’t believe in the premise, then you can see what’s going on.

C.

http://mba.informz.net/MBA/data/images/GSE%20Reform%20Joint%20letter%20921.pdf

 

"As noted by the Congressional Budget Office (CBO) in 2016, allowing Fannie Mae and Freddie Mac to create a capital cushion simply converts a potential future draw on federal funds into an immediate draw and such an action would effectively increase the size of taxpayer exposure to future losses."

 

anyone want to explain that line? I've read it over 10 times and can't understand it.

Yes. Your explanation is simpler. It's the basic premise that confuses us. Stegman believes these companies have been nationalized, have no need to protect taxpayers because of the incoming dividends and starts his analysis from there. We believe they are still private companies in need of capital for taxpayers' protection.

 

Yeah, they are just skipping the part where they can transfer a ton of risk to the private market and make a ton of money. Which is really odd.

[Midas79]

The only way to increase the liquidation preference is by Fannie and Freddie paying in kind.

 

So I do not think withholding money increases the size of taxpayers exposure in such way.

 

That paragraph resembles what Michael Stegman had been arguing that any recapitalization is at the cost of taxpayers. It's an obfuscated thought. In my view, it means that every time FF pay dividends these funds magically offset, cushion or reduce the size of that exposure because of the inflows in relation to the remaining commitment. It doesn't matter where the money goes once paid or how it is used as Treasury accounts for it in a general fungible account. Once the inflow stops -while the commitment is ongoing- the exposure stops getting smaller ratio-wise. It's an accounting issue.

 

Example, once profit from dividends equal the current remainder of the commitment (approx. 250+/- billion) then one can argue that taxpayers have achieved minimal exposure as the inflows, over a period of decades, have been able to match the rest of the unused commitment. Stop the inflows and taxpayers' exposure freezes at the size of the time of cancelling the dividends. If this makes any sense...

 

I see another way to prove the MBA's statement false: let's say there is a quarter where Fannie and Freddie both have exactly zero net income (break even). Does that increase the amount that taxpayers are on the hook for? Of course not.

[Luke 532]

Might see tax reform plan on Monday...

 

This tweet is from 9 days ago:

Chad Pergram‏Verified account @ChadPergram

Ryan says Brady told GOPers principles of tax reform to be released Sept 25. Consensus of what the Big 6 envisions

 

[Luke 532]

Freddie CEO on capital buffers...

http://www.politico.com/story/2017/09/22/politico-pro-q-a-freddie-mac-ceo-don-layton-243022

[rros]

Freddie CEO on capital buffers...

http://www.politico.com/story/2017/09/22/politico-pro-q-a-freddie-mac-ceo-don-layton-243022

Paying in kind would have been good. Or paying annually. These 2 options appear to be gone as Layton sounds very confident that only a buffer has some real chance. A buffer means obviously the nws continues, just at a different pace. And given the overall tone of the interview he basically admits under new terms (buffer) the c-ship can continue -not forever- but may be another decade or two. Amazing how easy it is for some of these guys to simply embrace nationalization only because some companies cannot function without government support. His views are in stark contrast to the RNC document. But then, he is the one running Freddie and in close contact with Watt. So he has the inside view.

 

Layton is clearly happy with Treasury's (taxpayers) capital and has no desire for private markets to interfere in how Freddie Mac is funded.

 

It is always better for some to become civil servants and bow down to Uncle Sam who would rarely fire you than to respond to the discipline of free markets and board of directors who may make your life difficult. After all, if taxpayers are the ones giving you the money to run your business... do they really have any say?  Layton is just another bureaucrat.

[Guest cherzeca]

Hope this makes it to every court, senators, congressman

 

http://gselinks.com/pdf/OPEN_LETTER_TO_THE_US_COURTS_REGARDING_GSE_NATIONALIZATION.pdf

 

Nice job

[rros]

Hope this makes it to every court, senators, congressman

 

http://gselinks.com/pdf/OPEN_LETTER_TO_THE_US_COURTS_REGARDING_GSE_NATIONALIZATION.pdf

 

Nice job

Yes. To the point and awesome.

[TonyG]

http://www.tennessean.com/story/news/politics/2017/09/26/sen-bob-corker-not-seek-re-election-next-year/678088001/

 

don't let the door hit you on the way out

[Guest cherzeca]

http://www.tennessean.com/story/news/politics/2017/09/26/sen-bob-corker-not-seek-re-election-next-year/678088001/

 

don't let the door hit you on the way out

 

I'll bet dollars to donuts sob goes on wfc board