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

[Mephistopheles]

A lottery ticket would not sound as a share/security to invest in at any price?, though I admit it fully depends on the preference of the investor.

 

To add an additional perspective:

 

The cases of Fannie Mae and Freddy Mac are quite complex for us, yet we believe the following three questions summarize them. Taken together, we see the outcome described below as unavoidable:

- Can the conservator FHFA of Fannie Mae and Freddy Mac, change contracts as executed through the August 2012 Third Amendment, effectively sweeping 100% of the profits of both companies towards the government, forever, leaving all other shareholders with nothing despite the fact that they hold title to their shares? Our answer is a firm NO. This would mean the contracts that were signed in 2008 remain in place in the interest of all shareholders and stakeholders.

- Is there a better alternative for Fannie Mae and Freddy Mac and can they be replaced? Our answer is a firm NO. This would mean a solution must be found to keep Fannie and Freddy alive and kicking, in the interest of the United States and the world.

- Are these companies solidly profitable and is it highly likely their position and business models will enable them to continue to earn solid profits in the US financial as well as global financial system? Our answer is a firm YES.

- Therefore, we are happy shareholders in the common and the preferred shares. We are ready to wait many years if needed, but we think the United States will move faster, as the companies are vital for the health of the country.

 

So it's an ideological investment for you?

 

I think it's a value investment for him

[Jurgis]

A lottery ticket would not sound as a share/security to invest in at any price?, though I admit it fully depends on the preference of the investor.

 

To add an additional perspective:

 

The cases of Fannie Mae and Freddy Mac are quite complex for us, yet we believe the following three questions summarize them. Taken together, we see the outcome described below as unavoidable:

- Can the conservator FHFA of Fannie Mae and Freddy Mac, change contracts as executed through the August 2012 Third Amendment, effectively sweeping 100% of the profits of both companies towards the government, forever, leaving all other shareholders with nothing despite the fact that they hold title to their shares? Our answer is a firm NO. This would mean the contracts that were signed in 2008 remain in place in the interest of all shareholders and stakeholders.

- Is there a better alternative for Fannie Mae and Freddy Mac and can they be replaced? Our answer is a firm NO. This would mean a solution must be found to keep Fannie and Freddy alive and kicking, in the interest of the United States and the world.

- Are these companies solidly profitable and is it highly likely their position and business models will enable them to continue to earn solid profits in the US financial as well as global financial system? Our answer is a firm YES.

- Therefore, we are happy shareholders in the common and the preferred shares. We are ready to wait many years if needed, but we think the United States will move faster, as the companies are vital for the health of the country.

 

So it's an ideological investment for you?

 

I think it's a value investment for him

 

Well, none of his claims for me are value claims. They are all ideological claims, in particular suggesting that there is only one resolution - the one that benefits him.

 

I can't say I am expert in this, but I see at least a number of ways to preserve 30 year mortgages with very little return to present shareholders and prefholders.

[merkhet]

Jurgis, I'd be interested to hear the ways you could see preserving a 30-year mortgage with very little return to shareholders and preferred holders.

[Jurgis]

Jurgis, I'd be interested to hear the ways you could see preserving a 30-year mortgage with very little return to shareholders and preferred holders.

 

I kinda knew someone will ask ;), but I'd rather decline because that's ideological arguments again and I'd rather not go there. :)

 

Peace.

[doughishere]

Jurguis.... You tease.

[Mephistopheles]

Shareholders might lose in the court and the 3rd amendment may stay intact, but I personally think there is little to no chance of Fannie and Freddie closing down as profitable businesses.

 

30-year mortgage will never disappear because it's a part of American culture, to own your own home. Now we have two companies with several trillion dollars in assets and thousands of employees that guarantee mortgages for tens of millions of Americans. Why try to disrupt that and create something new and unproven?

 

I can't imagine anybody in government having political will to do that, especially as we move further along from the crisis and anti -financial services sentiment becomes less and less effective. They had a few bills introduced in the last couple of years, none of which have gained traction.

 

It's not going to happen, just like we won't ever get rid of Medicare or Social Security (not saying we should or shouldn't).

 

 

[Menko]

Yes, this is indeed a situation where I see an investment that is complex. And the reason why I share the quote is because I want to share an additional perspective.

 

The ideological element I view as part of the situation.

 

I see the housing sector, the US and the world economy involved. Fannie Mae and Freddie Mac are immensely important in my view. The biggest companies in the world, combined and seen as one, with a very important role. Looking at the different elements, I see the three mentioned elements (see post above) combined leading to an unavoidable outcome.

 

Taken together, I see a logical whole and logical steps. And as an investor, I chose to invest, exactly because of that.

 

 

As an example to stress the importance and the strange situation we are in currently: coming out of the housing crisis, what is I think the first thing we want to do with Fannie Mae and Freddy Mac, the largest companies in the world? We want to make them rock solid. We want to build their equity. No dividends, for years to come. With AIG, that was achieved in my view. With European banks generally, that was not achieved in my view. With Fannie Mae and Freddie Mac, I think all stakeholders really want to achieve that: rock solid institutions.

[Eye4Valu]

I am a lawyer but don't claim to have unique insight into the outcome here. I've read and heard from many intelligent and well versed parties that believe there is no 30 yr. without FNMA and FMCC. I doubt there are several alternatives that can be effectively utilized to preserve it. Capital and liquidity are huge constraints in this regard. I believe any party who is long should own the preferred foremost, and should view the common as an option. My take is that the preferred is a contract and holds a liquidation preference. HERA provides for liquidation in accordance with preference rights through its receivership provisions. The U.S. has a strange hybrid between conservatorship and receivership in effect. What is transpiring is unprecedented. In my opinion, U.S. actions violate HERA. I believe there are several factors that make the preferred an investment, not a speculation. I also believe there are several factors that make the common a speculation, not an investment. That said, upside in the common exceeds that of the preferred. For what its worth, Fairholme is weighted in the preferred (approx. 8%), with a small (approx 1%) stake in the common. Fairholme's preferred stake is not insignificant. Ackman owns more than 10% of the common of both FNMA and FMCC, but this combined stake represents only 3-4% of his portfolio. I heard Ackman state that while he never wants to lose investor's money, that is a possibility here, and thus the stake does not represent a large holding for Pershing. He of course thinks that the common will pay off. He doesn't like the limited upside of the preferred. I don't think this situation will be resolved anytime soon. I would say 2017 at the earliest. As Bruce mentioned, this is an investment for people with patience, persistence and courage of conviction. Having a legal background has supported my conviction, but of course, I cannot predict the outcome.

[muscleman]

I believe there are several factors that make the preferred an investment, not a speculation. I also believe there are several factors that make the common a speculation, not an investment.

 

Can you please elaborate on that?

[Mephistopheles]

He doesn't like the limited upside of the preferred. I don't think this situation will be resolved anytime soon. I would say 2017 at the earliest. As Bruce mentioned, this is an investment for people with patience, persistence and courage of conviction. Having a legal background has supported my conviction, but of course, I cannot predict the outcome.

 

While the ultimate resolution will take 2 years or longer, there will be evidence and catalysts along the way to support one way or another, which is a positive for owning the preferreds rather than not, despite the par ceiling. I think people often miss this fact. For instance, say we have a decision in 2017 overturns the 3rd amendment. Rather than an overnight jump from $5 to $50 for the preferreds, I think it's more likely that we see a gradual rise as more transcripts, documents, briefs, etc. are released. After all, the preferreds were selling for less than $1 a few years ago. But the progress in the Claims Court case, various documents and supporting evidence has led to the rise.

 

The ceiling does take away from the upside, but I personally haven't arrived at a valuation for the common that makes me feel like they are a substantially better bet. I used to own a mix of the two before Lamberth threw out the District Court case, but have switched everything to the preferred given that the common have rebounded substantially whereas the preferreds have remained just about where they were after the drop. I also am not sure about what sort of capital raise (dilution) will be required if and when the companies are released; this poses another risk for the common.

[jawn619]

He doesn't like the limited upside of the preferred. I don't think this situation will be resolved anytime soon. I would say 2017 at the earliest. As Bruce mentioned, this is an investment for people with patience, persistence and courage of conviction. Having a legal background has supported my conviction, but of course, I cannot predict the outcome.

 

While the ultimate resolution will take 2 years or longer, there will be evidence and catalysts along the way to support one way or another, which is a positive for owning the preferreds rather than not, despite the par ceiling. I think people often miss this fact. For instance, say we have a decision in 2017 overturns the 3rd amendment. Rather than an overnight jump from $5 to $50 for the preferreds, I think it's more likely that we see a gradual rise as more transcripts, documents, briefs, etc. are released. After all, the preferreds were selling for less than $1 a few years ago. But the progress in the Claims Court case, various documents and supporting evidence has led to the rise.

 

The ceiling does take away from the upside, but I personally haven't arrived at a valuation for the common that makes me feel like they are a substantially better bet. I used to own a mix of the two before Lamberth threw out the District Court case, but have switched everything to the preferred given that the common have rebounded substantially whereas the preferreds have remained just about where they were after the drop. I also am not sure about what sort of capital raise (dilution) will be required if and when the companies are released; this poses another risk for the common.

 

Can you talk about what upside you see for the preferreds and the specifics you used to calculate that? TIA

[Mephistopheles]

He doesn't like the limited upside of the preferred. I don't think this situation will be resolved anytime soon. I would say 2017 at the earliest. As Bruce mentioned, this is an investment for people with patience, persistence and courage of conviction. Having a legal background has supported my conviction, but of course, I cannot predict the outcome.

 

While the ultimate resolution will take 2 years or longer, there will be evidence and catalysts along the way to support one way or another, which is a positive for owning the preferreds rather than not, despite the par ceiling. I think people often miss this fact. For instance, say we have a decision in 2017 overturns the 3rd amendment. Rather than an overnight jump from $5 to $50 for the preferreds, I think it's more likely that we see a gradual rise as more transcripts, documents, briefs, etc. are released. After all, the preferreds were selling for less than $1 a few years ago. But the progress in the Claims Court case, various documents and supporting evidence has led to the rise.

 

The ceiling does take away from the upside, but I personally haven't arrived at a valuation for the common that makes me feel like they are a substantially better bet. I used to own a mix of the two before Lamberth threw out the District Court case, but have switched everything to the preferred given that the common have rebounded substantially whereas the preferreds have remained just about where they were after the drop. I also am not sure about what sort of capital raise (dilution) will be required if and when the companies are released; this poses another risk for the common.

 

Can you talk about what upside you see for the preferreds and the specifics you used to calculate that? TIA

 

They're selling for about 11-12 cents on the dollar. I'm not a lawyer but I've read many of the court filings and opinions on both sides of the issue. I think if the rule of law is upheld, it's fairly obvious that the sweep is illegal. Certainly confident enough at 8 to 1 odds. If it gets to 2 to 1 or even, I will probably sell depending on the facts at that time.

[jawn619]

He doesn't like the limited upside of the preferred. I don't think this situation will be resolved anytime soon. I would say 2017 at the earliest. As Bruce mentioned, this is an investment for people with patience, persistence and courage of conviction. Having a legal background has supported my conviction, but of course, I cannot predict the outcome.

 

While the ultimate resolution will take 2 years or longer, there will be evidence and catalysts along the way to support one way or another, which is a positive for owning the preferreds rather than not, despite the par ceiling. I think people often miss this fact. For instance, say we have a decision in 2017 overturns the 3rd amendment. Rather than an overnight jump from $5 to $50 for the preferreds, I think it's more likely that we see a gradual rise as more transcripts, documents, briefs, etc. are released. After all, the preferreds were selling for less than $1 a few years ago. But the progress in the Claims Court case, various documents and supporting evidence has led to the rise.

 

The ceiling does take away from the upside, but I personally haven't arrived at a valuation for the common that makes me feel like they are a substantially better bet. I used to own a mix of the two before Lamberth threw out the District Court case, but have switched everything to the preferred given that the common have rebounded substantially whereas the preferreds have remained just about where they were after the drop. I also am not sure about what sort of capital raise (dilution) will be required if and when the companies are released; this poses another risk for the common.

 

Can you talk about what upside you see for the preferreds and the specifics you used to calculate that? TIA

 

They're selling for about 11-12 cents on the dollar. I'm not a lawyer but I've read many of the court filings and opinions on both sides of the issue. I think if the rule of law is upheld, it's fairly obvious that the sweep is illegal. Certainly confident enough at 8 to 1 odds. If it gets to 2 to 1 or even, I will probably sell depending on the facts at that time.

 

FNMAS trades for $3.94, with a par of $25. An upside of a little over 6 to 1.

 

The common on the other hand is a little harder for calculate the upside but i'll try (please correct me if you see any mistakes).

 

In 2013 they had about $19B in earnings before taxes and 2014 had about $12B. The most recent quarter they had about $2.7B in earnings which comes out to be about $11/12B if projected out on a yearly basis. There's 5.9B shares outstanding so at $12B it amounts to about $2/share in "earnings". Doing a DCF assuming no growth, 15% hurdle i get a value of $15.5. Shares trade at $2.5 now so that's also about a 6 to 1 upside from here.

 

The preferred's are probably safer in that they get paid first but they don't seem like an extremely good deal in relation to the common, especially since the common gets to participate in the upside Fannie ever gets released. If anything, my calculations for the common are too conservative because Fannies cost of capital is probably lower than 15% and because earnings are currently understated because of the interest hedges.

[Mephistopheles]

FNMAS trades for $3.94, with a par of $25. An upside of a little over 6 to 1.

 

The common on the other hand is a little harder for calculate the upside but i'll try (please correct me if you see any mistakes).

 

In 2013 they had about $19B in earnings before taxes and 2014 had about $12B. The most recent quarter they had about $2.7B in earnings which comes out to be about $11/12B if projected out on a yearly basis. There's 5.9B shares outstanding so at $12B it amounts to about $2/share in "earnings". Doing a DCF assuming no growth, 15% hurdle i get a value of $15.5. Shares trade at $2.5 now so that's also about a 6 to 1 upside from here.

 

The preferred's are probably safer in that they get paid first but they don't seem like an extremely good deal in relation to the common, especially since the common gets to participate in the upside Fannie ever gets released. If anything, my calculations for the common are too conservative because Fannies cost of capital is probably lower than 15% and because earnings are currently understated because of the interest hedges.

 

I haven't looked at the income statement in a while so I can't comment too much on that for now. But I know that the companies will need to raise quite a bit of capital, even assuming that sweep is used towards principle payments. So you need to account for dilution.

 

FNMAS is one of the more expensive ones. I own FREJN, FMCCG, and FMCCN; which are $6.55, $5.51, and $5.26 as of the last tick, on a par value of $50.

[jawn619]

FNMAS trades for $3.94, with a par of $25. An upside of a little over 6 to 1.

 

The common on the other hand is a little harder for calculate the upside but i'll try (please correct me if you see any mistakes).

 

In 2013 they had about $19B in earnings before taxes and 2014 had about $12B. The most recent quarter they had about $2.7B in earnings which comes out to be about $11/12B if projected out on a yearly basis. There's 5.9B shares outstanding so at $12B it amounts to about $2/share in "earnings". Doing a DCF assuming no growth, 15% hurdle i get a value of $15.5. Shares trade at $2.5 now so that's also about a 6 to 1 upside from here.

 

The preferred's are probably safer in that they get paid first but they don't seem like an extremely good deal in relation to the common, especially since the common gets to participate in the upside Fannie ever gets released. If anything, my calculations for the common are too conservative because Fannies cost of capital is probably lower than 15% and because earnings are currently understated because of the interest hedges.

 

I haven't looked at the income statement in a while so I can't comment too much on that for now. But I know that the companies will need to raise quite a bit of capital, even assuming that sweep is used towards principle payments. So you need to account for dilution.

 

FNMAS is one of the more expensive ones. I own FREJN, FMCCG, and FMCCN; which are $6.55, $5.51, and $5.26 as of the last tick, on a par value of $50.

 

Those all have different coupon rates right? It looks like FNMAS has the highest of all the preferred which would explain the premium in relation to the others.

Either way I can sum up this investment up. It's a speculative bet where there is a real chance of permanent capital loss though the chance is unclear. The upside seems to be asymmetric compared to the downside.

[merkhet]

One of the things I see a lot of people forgetting on the calculation of par for the preferred -- there's likely to be interest @ around 9% per annum if it's ruled as a taking.

 

[Edited because I realized that the reason for the interest was unclear.]

[Jurgis]

Jurguis.... You tease.

 

Right. I prefer that people talk about numbers - which is what they are talking about now.  ;)

 

So... here's the number tease for you:

 

Let's do backward and forward Graham arbitrage analysis. I'm taking the

 

I own FREJN, FMCCG, and FMCCN; which are $6.55, $5.51, and $5.26 as of the last tick, on a par value of $50.

 

$6.55 price, $50 par. Don't count 9% interest - sorry Merkhet - you guys can adjust yourselves if you want. ;)

Assume January 2017 resolution: 1.5 years remaining time.

Assume zero on negative outcome.

Assume you want 20% expected annualized return.

Then you can calculate the implied chance of success: 17% and implied chance of failure: 83%.

 

If you go with 2.5 years to resolve, the conditions imply about 20% chance of success and 80% chance of failure. The length of time to resolve does not influence return or probabilities much right now unless you start talking about 5 years+ to resolve.

 

Clearly, you can go in the other direction as the calculation is usually used. Feed in probabilities of success and failure that you believe in, and you'll get expected annualized return. It is somewhat clear though that with probability above 20% you get a large annualized return. So the question becomes: is the probability of success higher than 20%? (and I won't get into that as promised  :P )

 

Now if prefs run up to $20 on $50 par as they have done in the past, you are suddenly looking at implied probability of over 60% success. Whether it's worth holding at that time, is your call... ;)

 

I completely agree with Mephistopheles that common will be likely diluted (a lot?), so calculations on common are IMHO much harder.

 

Caveats: I used straight Graham merger arbitrage formula, you can use something more complicated to account for compounding, etc.

 

Have fun.

[merkhet]

The filings keep getting more comical:

 

It is true that the Government produced to Fairholme its “final” FHFA privilege log. It did so, however, without any prior notice at 3:38 p.m. on June 1. Less than 20 minutes later, at 3:56, it filed its motion for leave to file the Sur-Reply, attaching the proposed sur-reply in which it, among other things, criticized Fair- holme for not withdrawing its motion in light of the final FHFA privilege log it had just received minutes earlier.

 

The whole thing is a pretty good read.

 

The Government does not note in its Sur-reply that although it had previously rep- resented, on multiple occasions, that it expected to produce all of its final privi- lege logs by the end of May, it informed Fairholme on May 28 that it now ex- pected to complete its final privilege log (presumably one relating to its Treasury document productions) no earlier than the end of June.

 

I'm starting to wonder what's in the Treasury privilege log that's so important. I mean, it's a privilege log. What's the point in fighting so much over what is, presumably, a non-important document?

 

http://gselinks.com/Court_Filings/Fairholme/13-465-0159.pdf

[Eye4Valu]

I believe there are several factors that make the preferred an investment, not a speculation. I also believe there are several factors that make the common a speculation, not an investment.

 

Can you please elaborate on that?

 

In brief, the factors involve contractual rights and rights in liquidation, irrespective of future government sponsorship. Make no mistake, I believe the common shareholders have the right to any residual interest, not the Treasury. However, common shares are not contractual in nature, and are bottom of the barrel in priority.

[twacowfca]

The filings keep getting more comical:

 

It is true that the Government produced to Fairholme its “final” FHFA privilege log. It did so, however, without any prior notice at 3:38 p.m. on June 1. Less than 20 minutes later, at 3:56, it filed its motion for leave to file the Sur-Reply, attaching the proposed sur-reply in which it, among other things, criticized Fair- holme for not withdrawing its motion in light of the final FHFA privilege log it had just received minutes earlier.

 

The whole thing is a pretty good read.

 

The Government does not note in its Sur-reply that although it had previously rep- resented, on multiple occasions, that it expected to produce all of its final privi- lege logs by the end of May, it informed Fairholme on May 28 that it now ex- pected to complete its final privilege log (presumably one relating to its Treasury document productions) no earlier than the end of June.

 

I'm starting to wonder what's in the Treasury privilege log that's so important. I mean, it's a privilege log. What's the point in fighting so much over what is, presumably, a non-important document?

 

http://gselinks.com/Court_Filings/Fairholme/13-465-0159.pdf

 

Thanks for your posts, Merkhet. They are the best on this thread.

 

 

Realize the game now is delay, this way, then that way, beginning wih technicalities before addressing substantive issues.  The time frame for these maneuvers is not merely months but years.

 

Liquidation analysis will likely produce a zero for common shareholders and very little if anything for preferred holders because a complete victory that would overturn the taking would likely mean a return to the status quo ante. 

 

Run the numbers realizing that compounding the government's 10% dividend on their preferred will overtake the accretion of normalized earnings going forward in a time frame measured in years. Normalized earnings in the future will be a lot less than the extraordinary earnings produced in the rebound from the financial crisis.

[merkhet]

Thanks twacowcfa.

 

I think that we have to think of two (maybe three) different possible end games here.

 

(1) Court of Federal Claims:

 

In Sweeney's Court, no one is contesting the Net Worth Sweep ("NWS") -- they are just assuming that the Government has the authority to take the property. Instead, they are merely asserting that they should be paid for the fact that the sweep has essentially expropriated their dividend rights and their liquidation preference. In other words, "but for" the NWS, the windfall over the past few years would have dropped down to the Private Preferred.

 

Think of it this way, can you add up to $222 billion in a liquidation? ($187B Senior Preferred + $35B Private Preferred.) Well, F&F have paid out $228 billion over the last few years, so it sure looks like it's possible. Even if you tack on the $56 billion for the 10% dividend, you've got Pershing Square saying that the Fixed Income Arbitrage department can produce $24 billion over the next two years or so. Add that to the $6 billion of equity remaining in the companies, and you're looking for $20 billion from the companies' earning power -- I suspect that they could do that in a little over a year or so.

 

I have no idea what happens to the common here.

 

(2) Reversing the NWS:

 

Similar to the above, you'd net out $56 billion from the $228 billion (for the 10% dividend on the Government Preferred) so you're left with $172B + $6B equity left in the companies or $178B in equity on the books. Can the combined net income from the two companies support the $18.7B in 10% dividends paid out to the Government Preferred? (You'd have to run your own numbers on this one, but my personal calculations indicate that they probably could.) And then you've got $178B "stuck" in the two companies unless there's either a release or a receivership -- either way, the Private Preferred is well covered.

 

(3) Let's Make a Deal:

 

In a deal, it's likely that the deal struck for Private Preferred will take into consideration that they're pretty well covered in (1) and (2).

 

That's the way that I'm looking at this, anyway.

[twacowfca]

Thanks twacowcfa.

 

I think that we have to think of two (maybe three) different possible end games here.

 

(1) Court of Federal Claims:

 

In Sweeney's Court, no one is contesting the Net Worth Sweep ("NWS") -- they are just assuming that the Government has the authority to take the property. Instead, they are merely asserting that they should be paid for the fact that the sweep has essentially expropriated their dividend rights and their liquidation preference. In other words, "but for" the NWS, the windfall over the past few years would have dropped down to the Private Preferred.

 

Think of it this way, can you add up to $222 billion in a liquidation? ($187B Senior Preferred + $35B Private Preferred.) Well, F&F have paid out $228 billion over the last few years, so it sure looks like it's possible. Even if you tack on the $56 billion for the 10% dividend, you've got Pershing Square saying that the Fixed Income Arbitrage department can produce $24 billion over the next two years or so. Add that to the $6 billion of equity remaining in the companies, and you're looking for $20 billion from the companies' earning power -- I suspect that they could do that in a little over a year or so.

 

I have no idea what happens to the common here.

 

(2) Reversing the NWS:

 

Similar to the above, you'd net out $56 billion from the $228 billion (for the 10% dividend on the Government Preferred) so you're left with $172B + $6B equity left in the companies or $178B in equity on the books. Can the combined net income from the two companies support the $18.7B in 10% dividends paid out to the Government Preferred? (You'd have to run your own numbers on this one, but my personal calculations indicate that they probably could.) And then you've got $178B "stuck" in the two companies unless there's either a release or a receivership -- either way, the Private Preferred is well covered.

 

(3) Let's Make a Deal:

 

In a deal, it's likely that the deal struck for Private Preferred will take into consideration that they're pretty well covered in (1) and (2).

 

That's the way that I'm looking at this, anyway.

 

 

Oops. I should have said, "will overcome the monetary loss of the taking."

 

It's possible to imagine what Bruce describes, but turning F&F into a fixed income arbitrage focused company goes against the public purpose for their creation.  Doing that in an opaque way on a small scale is what got them in trouble.  Will that happen before pigs fly? 

[merkhet]

I'm confused.

 

Fannie & Freddie already have a Fixed Income Arbitrage ("FIA") business that's distinct from their Guarantee business -- as you let that FIA business wind down, it will generated $24 million over the next two and a half years or so. You're not starting up a new FIA business -- you're letting the Guarantee business live on. (But maybe I'm missing something here...)

 

Also, I'm not sure why you're compounding the 10% dividend on the Government Preferred. It's simple interest -- not compound interest. The Government Preferred gets paid $18.7 billion a year. It doesn't get paid $18.7 billion the first year and then $20.57 billion the next year... the only compounding that would happen is if the Companies take the 12% PIK route.

[colinwalt]

FNMAS trades for $3.94, with a par of $25. An upside of a little over 6 to 1.

 

The common on the other hand is a little harder for calculate the upside but i'll try (please correct me if you see any mistakes).

 

In 2013 they had about $19B in earnings before taxes and 2014 had about $12B. The most recent quarter they had about $2.7B in earnings which comes out to be about $11/12B if projected out on a yearly basis. There's 5.9B shares outstanding so at $12B it amounts to about $2/share in "earnings". Doing a DCF assuming no growth, 15% hurdle i get a value of $15.5. Shares trade at $2.5 now so that's also about a 6 to 1 upside from here.

 

The preferred's are probably safer in that they get paid first but they don't seem like an extremely good deal in relation to the common, especially since the common gets to participate in the upside Fannie ever gets released. If anything, my calculations for the common are too conservative because Fannies cost of capital is probably lower than 15% and because earnings are currently understated because of the interest hedges.

 

I haven't looked at the income statement in a while so I can't comment too much on that for now. But I know that the companies will need to raise quite a bit of capital, even assuming that sweep is used towards principle payments. So you need to account for dilution.

 

FNMAS is one of the more expensive ones. I own FREJN, FMCCG, and FMCCN; which are $6.55, $5.51, and $5.26 as of the last tick, on a par value of $50.

 

How are folks thinking about the preferreds?  For example, here’s a few I’ve been looking at:

 

FNMAS

 

• Price as of Jun 4: 3.9

• Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series S, stated value $25 per share

• Dividend: greater of 7.75 or LIBOR + 4.23%

• Potential upside: 6.4 (25/3.9)  - (ignoring spread for simplicity)

 

FNMAH

 

• Price as of Jun 4: 3.55

• Variable Rate Non-Cumulative Preferred Stock, Series P, stated value $25 per share

• Dividend: greater of 4.5% or LIBOR + .75%

• Potential upside: 7.04 (25/3.55)

 

FMCCN

 

• Price as of Jun 4: 5.26

• Variable-Rate Preferred Stock Offering, $50 per share

• Dividend: 12 month LIBOR -.2% (Max 11%)

• Potential upside: 9.5 (50/5.26)

 

So FNMAS is currently about 10% more than FNMAH, which is presumably due to the large difference in dividend.  However, the difference in price is just 35 cents which seems cheap if you assume you’ll start to get dividends again within a couple of years, as the difference in the potential dividend is far greater:

 

• 25 * 7.75 = 1.9375

• 25 * 4.5 = 1.125

o Difference: .8125

 

• So is the market assuming that the chances of ever getting dividends are very low? For example, if the Government wins, of even if they don’t win, the Prefs will be called, so you’ll just get the $25 back without years of dividends?

• Also, given that the dividend on FNMAS is so much higher than on FNMAH, I suppose there’s a much higher chance (if the Gov doesn’t win) that it will be called, also limiting the advantage of the higher dividend.

 

• As for FMCCN, times 9.5 is a huge discount to the $50 value, I suppose because the market doesn’t see interest rates increasing any time in the near future in addition to the risk of the government winning.

• But it does seem to be a big discount versus the other two given the uncertainty of ever getting the dividend.

 

So those are my thoughts as I begin to think about this… but maybe trying to figure out which prefs will work out the best is just too uncertain and the best thing to do is hold a mix.

 

TIA

[Jurgis]

AFAIK, prefs trade mostly based on liquidity: more liquid ones have less upside, less liquid ones have more. Some of the less liquid ones trade at huge spreads and on appointment, so you can have big variations on upside that are hard to arbitrage away. I think that most people don't look at exact divvies since the upside to par dominates.

 

Also FIDO does not allow online purchase for common and a lot of prefs: probably because they are afraid that widows-and-orphans will buy them and then blame Fido for purchasing "bankrupt" securities. They do allow online purchase of some prefs that they probably missed when they put on limitations...