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

[Mephistopheles]

^ They're not required to report OTC securities holdings

[merkhet]

Ackman had some comments on Fannie & Freddie at the Harbor Investment Conference.

 

http://www.valuewalk.com/2015/02/bill-ackman-harbor-conference/

[TwoCitiesCapital]

It's nice to see these things moving. Looks like the markets might agree with Merkhet that this gets resolved before the Obama administration leaves. I wouldn't mind a 10x pay day in amount of time :)

 

Fingers crossed.

[hardincap]

is anyone here going with commons over preferred? i have zero exposure in commons; trying to handicap all the possible scenarios gives me a headache :P. There seems to be numerous scenarios where preferred are restored but commons get wiped or severely diluted. Would love to hear from anyone who agrees with ackman that commons are a better risk adjusted bet.

[Jurgis]

Assuming current price on common ($2.75 for FNMA), it has to get to ~$25 to outperform pref return (assuming ~$6 to $50 return for prefs). Looking at pre-collapse prices of $40-60, $25+ on common is possible only with minimal dilution and no capital injection required. I'd say it's possible for common to outperform prefs, but not very likely.

 

This is back of envelope calculation, possibly with big holes. :)

[Mephistopheles]

Was there any news? Seems like the common outperformed the preferred yet again. :(

 

The common are now higher than they were before the DC case was thrown out, and the preferred are still 40% lower...

 

Either the relative valuation was way off then, or is now. I don't remember the earnings off hand but if I remember correctly, I think an 8x return, which is what you'd get with the prefs, is a bit of a stretch with the common at this price. You would need quite a rosy scenario. On top of that, the regulators will most def require a substantial capital amount if they're ever released from conservatorship.

 

Still this is really frustrating. I used to own Fannie common pre DC case, and then when the preferred fell more I took a tax write off and bought Freddie preferred.

[hardincap]

Was there any news? Seems like the common outperformed the preferred yet again. :(

 

The common are now higher than they were before the DC case was thrown out, and the preferred are still 40% lower...

 

Either the relative valuation was way off then, or is now. I don't remember the earnings off hand but if I remember correctly, I think an 8x return, which is what you'd get with the prefs, is a bit of a stretch with the common at this price. You would need quite a rosy scenario. On top of that, the regulators will most def require a substantial capital amount if they're ever released from conservatorship.

 

Still this is really frustrating. I used to own Fannie common pre DC case, and then when the preferred fell more I took a tax write off and bought Freddie preferred.

 

ackman rally. he specifically recommended commons over preferreds. also, commons are much more liquid than preferreds (30m shares traded today vs .7)

[Pauly]

I think I'd prefer to hold what the 'fat cat' hedge fund guys aren't holding. Seems to me that the gov't would be loath to reward guys like Icahn and Ackman with a 25x-100x payday.  The optics on that would be terrible.

 

 

[hardincap]

I think I'd prefer to hold what the 'fat cat' hedge fund guys aren't holding. Seems to me that the gov't would be loath to reward guys like Icahn and Ackman with a 25x-100x payday.  The optics on that would be terrible.

 

as opposed to rewarding paulson, perry, et al with "only" 8-10x?

[tede02]

I think I'd prefer to hold what the 'fat cat' hedge fund guys aren't holding. Seems to me that the gov't would be loath to reward guys like Icahn and Ackman with a 25x-100x payday.  The optics on that would be terrible.

 

I think this is a very important point which makes this investment idea so difficult.  I totally understand the legal position the hedge fund guys and FAIRX are taking (it seems logical and sound to a lay person).  However, the huge wild card which, in my view, makes the odds impossible to know, is the politicians.  Few would argue the trend toward populism currently underway in the US (especially as income gaps continue to widen and this issue remains in the headlines).  I would absolutely agree that politicians will likely be sensitive to enriching Wall Street, especially as the next presidential election grows closer.  But who knows.  I own FAIRX so I'm hoping for it to work out!

[deadspace]

as one of the original investors in the preferred shares wrote in a letter to the wsj.  The return of my investment with appropriate interest in these shares would not be what Anyone would consider a win fall return.  It's called a normal return on investment

[Pauly]

Right, so a decent (at least) return for the holders of the preferreds could be more palatable to the politicians than a windfall (lottery) payout to the holders of the common...especially if Icahn et al. are major holders of the common.

[Mephistopheles]

I think, legally, it would be really hard to honor the rights of the preferred holders but not the common. It just wouldn't make any sense. If there is a deal like that only rewards preferred holders, than without a doubt Ackman is going to sue both companies under corporate law and I can't imagine him losing in that scenario.

[Jurgis]

I think, legally, it would be really hard to honor the rights of the preferred holders but not the common.

 

I don't agree (but I am not a lawyer :)). One way is to partially nationalize which would dilute the common to the hilt. It's impossible to dilute preferreds. To make prefs worth less than par, you have to go through formal recap in which case they come before common, but might be worth little and common might be worth nothing.

 

In general though, I think most arguments in this case are emotional or mind-screwing variety from people with ownership agenda (i.e. people holding securities that are possibly worthless will argue anything to prove they are right and other side is wrong). Personally, I am on the government (and Munger/Buffett) side on this: if government would not have backstopped Fannie/Freddie, they'd be BK and worthless now. So IMHO from common sense, government should have nearly 100% ownership in remaining entity. Legal case might have completely different result though - common sense is not what the law is about. ;)

[TwoCitiesCapital]

I think, legally, it would be really hard to honor the rights of the preferred holders but not the common.

 

I don't agree (but I am not a lawyer :)). One way is to partially nationalize which would dilute the common to the hilt. It's impossible to dilute preferreds. To make prefs worth less than par, you have to go through formal recap in which case they come before common, but might be worth little and common might be worth nothing.

 

In general though, I think most arguments in this case are emotional or mind-screwing variety from people with ownership agenda (i.e. people holding securities that are possibly worthless will argue anything to prove they are right and other side is wrong). Personally, I am on the government (and Munger/Buffett) side on this: if government would not have backstopped Fannie/Freddie, they'd be BK and worthless now. So IMHO from common sense, government should have nearly 100% ownership in remaining entity. Legal case might have completely different result though - common sense is not what the law is about. ;)

 

There's an argument against this - most of the losses experienced by Fannie and Freddie were accounting losses - not real cash losses. MTM accounting was discontinued for banks during this period. If Fannie and Freddie had received similar treatment, they wouldn't have been insolvent on paper or in practice. The reversal of these "losses" is why they've been so profitable in recent years.

[Guest wellmont]

I think I'd prefer to hold what the 'fat cat' hedge fund guys aren't holding. Seems to me that the gov't would be loath to reward guys like Icahn and Ackman with a 25x-100x payday.  The optics on that would be terrible.

 

I think this is a very important point which makes this investment idea so difficult.  I totally understand the legal position the hedge fund guys and FAIRX are taking (it seems logical and sound to a lay person).  However, the huge wild card which, in my view, makes the odds impossible to know, is the politicians.  Few would argue the trend toward populism currently underway in the US (especially as income gaps continue to widen and this issue remains in the headlines).  I would absolutely agree that politicians will likely be sensitive to enriching Wall Street, especially as the next presidential election grows closer.  But who knows.  I own FAIRX so I'm hoping for it to work out!

what i think ackman is saying is that politicians have another thing to worry about. and that is what happens when the next recession hits? what happens when fannie and freddie get into trouble, as they surely will in the state they are in. the politicians are going to get the blame from taxpayer for LOSSES that the taxpayer are on the hook for. rather than a private company absorbing the losses because it has the capital to do so.

 

So right now everything is rosy. what happens when rates go up? housing gets hit? people can't get 30y mortgages? And the spigot from fannie and freddie get turned off? what happens when they become a sink hole instead a fountain that shoots money into the treasury? ackman is saying that there are pols in DC that are actually thinking about all this right now. they are getting ahead of the mess.

 

You would think by now they would have started to come up with alternatives to fannie and freddie. but they aren't. there a no new ideas that are viable and that would work. none. going on 6 years after the debacle and the only idea they came up with is to take all the profits and just move them into treasury.

 

The other thing to consider is what happens if us gov can't keep those emails and documents secret any more? the ones that fairholme is trying to get released to public but us gov is fighting tooth and nail to avoid releasing. I suspect they might be a mood to negotiate with the evil hedge funds if the courts force them to reveal what they've been up to. What they rightfully should be revealing anyway.

 

So ackman's bet is that cold hard reality is going to intrude on all of this, and the courts won't matter. the pols in DC will, as they always do, go into self preservation mode. And his bet is that mode involves having a strong housing market and strong fannie and freddie.

[Jurgis]

There's an argument against this - most of the losses experienced by Fannie and Freddie were accounting losses - not real cash losses. MTM accounting was discontinued for banks during this period. If Fannie and Freddie had received similar treatment, they wouldn't have been insolvent on paper or in practice. The reversal of these "losses" is why they've been so profitable in recent years.

 

Does this mean that we should make Bear's and Lehman's and WaMu shareholders whole too? ;)

[hyten1]

Common sense has its place

 

Then there is the rule of law

 

 

I think, legally, it would be really hard to honor the rights of the preferred holders but not the common.

 

I don't agree (but I am not a lawyer :)). One way is to partially nationalize which would dilute the common to the hilt. It's impossible to dilute preferreds. To make prefs worth less than par, you have to go through formal recap in which case they come before common, but might be worth little and common might be worth nothing.

 

In general though, I think most arguments in this case are emotional or mind-screwing variety from people with ownership agenda (i.e. people holding securities that are possibly worthless will argue anything to prove they are right and other side is wrong). Personally, I am on the government (and Munger/Buffett) side on this: if government would not have backstopped Fannie/Freddie, they'd be BK and worthless now. So IMHO from common sense, government should have nearly 100% ownership in remaining entity. Legal case might have completely different result though - common sense is not what the law is about. ;)

[onyx1]

... if government would not have backstopped Fannie/Freddie, they'd be BK and worthless now. So IMHO from common sense, government should have nearly 100% ownership in remaining entity.

 

Maybe we can use this common sense logic toward deficit reduction.  A small business gets hit by lightening, the fire department saves the business, clearly the municipality should have nearly 100% ownership of the business based on the fact that without the fire dept. the business would have gone BK, right?  Or, a policeman saves a hostage that would have been killed, the municipality should have the benefit of all the assets and future earnings of the hostage, right?  Or even better, a terrorist plot is foiled by the FBI that would have ruined an entire town, jackpot!  The government now owns the town! 

 

Who needs property rights when the beneficiary is the taxpayers, right?

 

 

[actuary]

Sunday NYT today:

http://mobile.nytimes.com/2015/02/15/business/after-the-housing-crisis-a-cash-flood-and-silence.html?referrer=&_r=0

 

What a huge swing in public opinion over the past few months. After such a long wait, maybe this will blow open faster than anyone expects.

[merkhet]

Sunday NYT today:

http://mobile.nytimes.com/2015/02/15/business/after-the-housing-crisis-a-cash-flood-and-silence.html?referrer=&_r=0

 

What a huge swing in public opinion over the past few months. After such a long wait, maybe this will blow open faster than anyone expects.

 

This is a big deal. This is the first time that someone with Gretchen Morgensen's clout has jumped on board with this story. Should be interesting moving forward.

[morningstar]

I think, legally, it would be really hard to honor the rights of the preferred holders but not the common.

 

I don't agree (but I am not a lawyer :)). One way is to partially nationalize which would dilute the common to the hilt. It's impossible to dilute preferreds. To make prefs worth less than par, you have to go through formal recap in which case they come before common, but might be worth little and common might be worth nothing.

 

In general though, I think most arguments in this case are emotional or mind-screwing variety from people with ownership agenda (i.e. people holding securities that are possibly worthless will argue anything to prove they are right and other side is wrong). Personally, I am on the government (and Munger/Buffett) side on this: if government would not have backstopped Fannie/Freddie, they'd be BK and worthless now. So IMHO from common sense, government should have nearly 100% ownership in remaining entity. Legal case might have completely different result though - common sense is not what the law is about. ;)

 

On the other hand, the dividend on these prefs is optional ... So it's possible to grow capital for a very long time, building book value for the common while paying nothing to preferred holders.

 

To your other point, I tend to agree and would worry that even in 2012, there was no private market price for the facility the government was providing. I think there's a pretty good case that financially speaking the 2012 amendment was a bargain. That said, a judge could easily come down on either side on that issue.

[Jurgis]

Morningstar - I completely agree.

[Grenville]

Sunday NYT today:

http://mobile.nytimes.com/2015/02/15/business/after-the-housing-crisis-a-cash-flood-and-silence.html?referrer=&_r=0

 

What a huge swing in public opinion over the past few months. After such a long wait, maybe this will blow open faster than anyone expects.

 

Nice article. I like the detail around the privilege logs. Also they point to the document Doughishere found that has the 153.3bln figure.

[Eye4Valu]

"After all, back in 2008, the companies were not put into receivership, the equivalent of bankruptcy. Rather, they were placed under the care of a conservator — the Federal Housing Finance Agency. That conservator was supposed to put the companies “in a sound and solvent condition” and “preserve and conserve the assets and property” of each entity.

 

Siphoning off the entities’ profits is the opposite of conserving their assets and property, the plaintiffs contend. And they point to a 2009 Treasury memo stating that the conservatorship of Fannie and Freddie “preserves the status and claims” of preferred and common shareholders. One of those claims is surely having access to future earnings." -GRETCHEN MORGENSON

 

The illegality involves the Third Amendment, which flies in the face of HERA. Anyone who thinks the Third Amendment was a fair trade should avoid the preferred, the common and this thread because they don't know what they're talking about. Last time I checked, FNMA and FMCC were privately held companies owned by shareholders that were placed into Conservatorship, not Receivership, as Ms. Morgenson points out. The U.S. cannot unilaterally amend the terms of the PSPA and expropriate all assets at the exact time they realized that FNMA and FMCC were returning to profitability, yet this is exactly what they did. If the U.S. truly abides by the rule of law, the Third Amendment cannot stand.

 

“People disagree about what should happen to the G.S.E.’s,” said Matthew D. McGill, a lawyer at Gibson, Dunn & Crutcher in Washington who represents Perry Capital. “But if the plan is to wind them down, Congress provided a means to do that in the 2008 law — it’s called receivership, and it provides a host of procedural protections to claimants. What the Treasury cannot do is abuse its conservatorship powers to nationalize the companies and then, when it deems convenient, wind them down without the protections enacted by Congress.”