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

[colinwalt]

Thanks Jurgis

[Luke 532]

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.

 

+1.  Liquidity is likely the main reason FNMAS is more expensive.  The volume and spreads on the other prefs would make it difficult to adjust a position of any meaningful size if one wanted/needed to do so.  Heck, it's difficult enough to get a decent number of shares on FNMAS without moving the market $0.03+ against you, I can't imagine how tough it would be with the others.

[twacowfca]

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.

 

Sorry for the lack of clarity. The point I was trying to make is that if the U.S. Court of Claims should rule tha holders of the private preferred have a claim as a result of the U.S. taking of all the F&F profits, what might be the amount of just compensation for that claim even if there is a final ruling that the taking should stand.

 

The logical way to go that would be to turn back the clock to see what the consequence would have been if there had never been the sweep of profits and that the status quo before that had been unchanged. That would have been to calculate the amount of the unpaid dividends of 10% per annum that should have been paid but were not. But then there should be an interest rate applied to those unpaid balances that would have accumulated and grown with compounding after they were not paid on time. 

 

Then the question arises: what interest rate should be applied to those missed payments? It's been sometime since I read the documents, but I think there were rather draconian consequences for preferred dividends on the U.S. Gov pref  that were passed. perhaps something like an additional 10% to be assessed on the balances of dividend arrears.

[bmichaud]

twacowfca,

 

I came across an interesting analysis of FNMAS on Twitter the other day that I thought outlined the math of the situation pretty well:

 

Link: http://seventeenmile.com/category/17-mile-investing/investments/special-situations/fnma/fnma-quick-note-october-2014/

 

PDF: https://seventeenmile.files.wordpress.com/2014/10/fnma-analysis-october-20142.pdf

 

The embedded PDF shows a total equity value of approximately $165B by applying a 15X multiple to Pershing Square's normalized earnings power estimate of $11B. The total face value of the Senior and Junior preferreds is just over $136B.

 

So even with no help from the courts...the Junior preferreds could go to par over time + the Government could retain the Sweep proceeds + the Government could retain its Senior preferred position + the Government could retain its 79.9% warrant.

 

I see win-win-win-win-loss (i.e. the common is a goose egg). As the Twitter user that posted this other day said, is it feasible to expect the status quo to continue into perpetuity? The 30y mortgage is not going away; the private sector cannot support the 30y market as-is; legislation is focused on breaking up the status quo; and the Government MUST have some incentive to maximize its 79.9% stake over time if in fact the status quo is broken up, no?

 

I'm actually somewhat surprised at your 'turn' on this situation given how constructive you have been the last several years on the GSE's ability to internally recapitalize ala W.R. Grace or USG Corporation, as you have pointed out previously.

[twacowfca]

twacowfca,

 

I came across an interesting analysis of FNMAS on Twitter the other day that I thought outlined the math of the situation pretty well:

 

Link: http://seventeenmile.com/category/17-mile-investing/investments/special-situations/fnma/fnma-quick-note-october-2014/

 

PDF: https://seventeenmile.files.wordpress.com/2014/10/fnma-analysis-october-20142.pdf

 

The embedded PDF shows a total equity value of approximately $165B by applying a 15X multiple to Pershing Square's normalized earnings power estimate of $11B. The total face value of the Senior and Junior preferreds is just over $136B.

 

So even with no help from the courts...the Junior preferreds could go to par over time + the Government could retain the Sweep proceeds + the Government could retain its Senior preferred position + the Government could retain its 79.9% warrant.

 

I see win-win-win-win-loss (i.e. the common is a goose egg). As the Twitter user that posted this other day said, is it feasible to expect the status quo to continue into perpetuity? The 30y mortgage is not going away; the private sector cannot support the 30y market as-is; legislation is focused on breaking up the status quo; and the Government MUST have some incentive to maximize its 79.9% stake over time if in fact the status quo is broken up, no?

 

I'm actually somewhat surprised at your 'turn' on this situation given how constructive you have been the last several years on the GSE's ability to internally recapitalize ala W.R. Grace or USG Corporation, as you have pointed out previously.

 

the problem is the likely extended time frame in the Court of Claims and the fact that the longer it takes, the more overwhelming the possible compounding as explained above.  I still think a political solution is the most likely outcome, but it may be unrealistic to assume that will be more than a fraction of the value of making the private preferred holders whole.

[merkhet]

twacowcfa,

 

Sorry, I'm still confused.

 

Assuming the court views this as a Takings and engaged in a but for analysis...

 

Why would they miss payments after August 2014? They've been consistently able to cover the 10% amounts and once they received the DTAs again, couldn't they just write those down for the payment?

[bmichaud]

(I'm likely missing something I admit...) Why would the "missed" payments compound if the Government is by definition "sweeping" any possible profits that would go toward paying down the senior preferred?

 

Do you think the Government walks away from its Warrant?

[twacowfca]

twacowcfa,

 

Sorry, I'm still confused.

 

Assuming the court views this as a Takings and engaged in a but for analysis...

 

Why would they miss payments after August 2014? They've been consistently able to cover the 10% amounts and once they received the DTAs again, couldn't they just write those down for the payment?

 

 

Yes, that's one way this could work out, but the US government has always fought tooth and nail for everything it can get in the US court of claims.  If they fight as I expect they will, absent a politically

motivated settlement, I think the most likely outcome after years of litigation will be that  the judge will go back to the documents that governed the original conservatorship and use the terms that applied to the  rate on the government's preferred and the disagreeable consequences that kicked in when  dividends were not paid as scheduled.

 

One might assume that all the profits that were earned in recent years and taken in the USGov's sweep could have been instead paid in dividends, but, in hindsight, that brings up a solvency issue.  A lot of the earnings in recent years had to do with accounting adjustments in things like DTA.  If those non cash earnings had been used to pay dividends, there would have been little cushion on their BS,  and they would have been one slip away from insolvency, as they are now as a result of what has been taken in the sweep.

 

If this case slowly works its way through the court of claims, eventually that's what the government could argue, and judges have not been unsympathetic to the US Gov in that venue.

[merkhet]

So, I suppose what you're saying is the following (please correct me if I'm wrong):

 

Assuming that the plaintiffs win in the Court of Claims, after a possibly lengthy trial, the Government can then argue that despite the GSEs' ability to meet the 10% dividend payment for the last three years (and, presumably in the future as well), the court should instead take an "expected value"-type calculation on their ability to pay that 10% dividend going forward -- and in some model, one could foresee a quarter or two where the 12% PIK option kicks in and the adds a little to the compounding.

 

That's certainly a non-zero possibility, but I think it's improbable. (I find the need again to point out that I also felt the Lamberth opinion was improbable, so maybe take my probability judgements with some grain of salt.) There would certainly be some cognitive dissonance to say that despite what happened in reality, we will go with a model that says something different -- though this might be where the Treasury models indicating that they could see a fairly profitable pair of GSEs comes into play later.

 

As for the solvency issue, even assuming that you paid the last three years' worth of 10% dividends to the Senior Preferred, you'd still have $178 billion in equity or 3.56% equity to the $5 trillion of guarantees which isn't quite 5% but a bit better than the 0.1% we are currently running at with the two entities. It's possible that you'll have some drawdown on the equity in the future if the GSE earnings don't quite cover the payments, but, at the same time, the run down of the FIA business provides a cushion, and in order to bring in new private players, you have to raise the guarantee fee, which increases GSE earnings as well.

 

That's my take anyway.

[doughishere]

Richard Epstein steps back up to the plate.

 

http://www.forbes.com/sites/richardepstein/2015/06/08/the-longstanding-struggle-over-fannie-and-freddie-is-not-over/

 

 

"The Saxton complaint consciously avoids any constitutional challenges to the government’s action, but does state forceful claims that both FHFA (and Ed DeMarco in his official capacity its then Director of FHFA) and Treasury acted beyond the scope of their statutory authority, that these actions were arbitrary and capricious when tested against the normal standards of administrative law, and, finally that their actions were in breach of their contractual and good faith obligations to the private shareholders of both Fannie and Freddie."

 

 

This is what side ive tried to take. Its not "ideological" arguments that Jurgis argues for. I try to stay away from "ideological arguments," they serve me no purpose. What i have a problem with is what is contractually obligated by the government when it decided to enter into an agreement with shareholders.

 

The Govt thought they had a win all battle plan but when the tides turned against them they changed the rules.

 

 

Episten enven says it out right, "There is a morality play at stake in this history." What i think guys like Jurgis and certainly Carney want is the ideological argument  aginst TBTF. They dont want these companies to continue...they want heads. They want someone to punish.

 

I dont care about that Ideological argument...punish them or not. Just dont change the rules when you dont get what you want. Shit even Epistein admits hes a huge libertarian but still argues that the government must contractually hold their end of the original agreement.

 

 

[Jurgis]

This is what side ive tried to take. Its not "ideological" arguments that Jurgis argues for. I try to stay away from "ideological arguments," they serve me no purpose. What i have a problem with is what is contractually obligated by the government when it decided to enter into an agreement with shareholders.

 

Of course this is ideological argument. You are arguing that government is wrong based on one sided articles.

 

Edit: to clarify: there can be a legal argument that government is wrong - this requires legal expertise. Legal arguments will be resolved in the court eventually (or settled and we'll never know the legal outcome). I have no expertise in legal arguments and I don't take sides in legal argument. IMHO people who don't have legal expertise and who say that government is wrong (based on writeups/articles) are making ideological argument. I have my opinion about ideological argument, but I would rather not discuss it, since it serves very little purpose. People can feel morally right about their position, but that's pretty much it. :) I think that it might be hazardous to invest based on ideological position, but I'm not gonna try to change anyone's mind.

 

Episten enven says it out right, "There is a morality play at stake in this history." What i think guys like Jurgis and certainly Carney want is the ideological argument  aginst TBTF. They dont want these companies to continue...they want heads. They want someone to punish.

 

That's completely misrepresenting my position.

 

Good luck.

[merkhet]

The Government has moved to dismiss the case because Fairholme didn't own the shares at the time of the Net Worth Sweep.

 

https://timhoward717.files.wordpress.com/2015/06/6815-defendant_s-supplemental-motion-to-dismiss.pdf

 

Does anyone have access to the following opinion?

 

Maniere v. United States, 31 Fed. Cl. 410 (1994)

[stevevri]

Is anyone familiar with Slattery v the US at all? There's some interesting elements that are tangent to this case. Namingly, it tackles the who should be compensated current shareholders or former shareholders.

 

In Summary: The government made a deal with Meritor Bank to hold certain types of goodwill as capital, and then later on seized the bank saying it was inadequately capitalized and went back on its agreement.  They eventually won and held the government to its original word even though it took many years. Later on shareholders at the time of the seizure that had sued saying they should be the ones compensated and the court found that it was "current shareholders" that were proper recipients of receivership surplus.

 

http://law.justia.com/cases/federal/appellate-courts/cafc/12-5041/12-5041-2013-03-21.html

 

Disclaimer: I have no special legal knowledge or anything and may be messing some details up.

[muscleman]

The Government has moved to dismiss the case because Fairholme didn't own the shares at the time of the Net Worth Sweep.

 

https://timhoward717.files.wordpress.com/2015/06/6815-defendant_s-supplemental-motion-to-dismiss.pdf

 

Does anyone have access to the following opinion?

 

Maniere v. United States, 31 Fed. Cl. 410 (1994)

 

I am not a lawyer so I could be completely wrong, but I felt like it should be common sense for the current shareholder to receive the recovery. I read a story about a guy buying default credit card notes at 1-2 cents on the dollar during 2008-2010 and then try to collect 20 cents. He made a killing. Of course when he buys those papers and recover the money, he is the one to receive the money, not the previous bank who sold him the notes 1-2 cents on the dollar, right?

 

When Fairholme buys the preferred shares at the market price, that price already discounted the potential recovery benefits, so if recovery does occur, fairholme is entitled to it, right?

[muscleman]

Is anyone familiar with Slattery v the US at all? There's some interesting elements that are tangent to this case. Namingly, it tackles the who should be compensated current shareholders or former shareholders.

 

In Summary: The government made a deal with Meritor Bank to hold certain types of goodwill as capital, and then later on seized the bank saying it was inadequately capitalized and went back on its agreement.  They eventually won and held the government to its original word even though it took many years. Later on shareholders at the time of the seizure that had sued saying they should be the ones compensated and the court found that it was "current shareholders" that were proper recipients of receivership surplus.

 

http://law.justia.com/cases/federal/appellate-courts/cafc/12-5041/12-5041-2013-03-21.html

 

Disclaimer: I have no special legal knowledge or anything and may be messing some details up.

 

Just finished reading this ruling that you provided here. Thanks a lot! How did you find this one? That's an interesting case.

[merkhet]

The Government has moved to dismiss the case because Fairholme didn't own the shares at the time of the Net Worth Sweep.

 

https://timhoward717.files.wordpress.com/2015/06/6815-defendant_s-supplemental-motion-to-dismiss.pdf

 

Does anyone have access to the following opinion?

 

Maniere v. United States, 31 Fed. Cl. 410 (1994)

 

I am not a lawyer so I could be completely wrong, but I felt like it should be common sense for the current shareholder to receive the recovery. I read a story about a guy buying default credit card notes at 1-2 cents on the dollar during 2008-2010 and then try to collect 20 cents. He made a killing. Of course when he buys those papers and recover the money, he is the one to receive the money, not the previous bank who sold him the notes 1-2 cents on the dollar, right?

 

When Fairholme buys the preferred shares at the market price, that price already discounted the potential recovery benefits, so if recovery does occur, fairholme is entitled to it, right?

 

The difference is that there are results based on common sense and results based on legal reasoning. Sometimes they come out to the same conclusion. Sometimes they do not -- here, the question is whether there is a legal technicality in terms of whether the "right to sue for a Takings" passes on beyond those shareholders holding as of August 17, 2012.

 

While the Slattery ruling is rather persuasive, it talks about distributing a restructuring surplus rather than distributing the proceeds from a finding of Takings. (I've only quickly skimmed it, so it's possible I'm missing something.) This could be persuasive to a judge, but the question here is best framed the following way:

 

"In the case law for Takings Clause claims, is there a direct precedence stating that the individual(s) suing the government for a violation of the Takings Clause must have been the owner of that property/claim at the time of the Taking?"

 

The government's motion indicates that Maniere says this. Until I get a copy of it in my hands, I can't say one way or the other whether the legal technicality that the government is trying to put forth is correct.

 

The best I can say is that many of the cases citing Maniere that I've found mention something about third-party beneficiaries, in which case, it wouldn't necessarily apply. I've taken a look at the Textainer case that was cited as well, and it seems like that could be distinguished by the fact that when buying shipping containers, you have the opportunity to negotiate for exactly what you are buying (i.e. which assets and which liabilities you are expressly taking on) and the plaintiff in that case didn't specifically negotiate for the assignment of the right to sue for a Takings Clause violation.

[muscleman]

 

The difference is that there are results based on common sense and results based on legal reasoning. Sometimes they come out to the same conclusion. Sometimes they do not -- here, the question is whether there is a legal technicality in terms of whether the "right to sue for a Takings" passes on beyond those shareholders holding as of August 17, 2012.

 

While the Slattery ruling is rather persuasive, it talks about distributing a restructuring surplus rather than distributing the proceeds from a finding of Takings. (I've only quickly skimmed it, so it's possible I'm missing something.) This could be persuasive to a judge, but the question here is best framed the following way:

 

"In the case law for Takings Clause claims, is there a direct precedence stating that the individual(s) suing the government for a violation of the Takings Clause must have been the owner of that property/claim at the time of the Taking?"

 

The government's motion indicates that Maniere says this. Until I get a copy of it in my hands, I can't say one way or the other whether the legal technicality that the government is trying to put forth is correct.

 

The best I can say is that many of the cases citing Maniere that I've found mention something about third-party beneficiaries, in which case, it wouldn't necessarily apply. I've taken a look at the Textainer case that was cited as well, and it seems like that could be distinguished by the fact that when buying shipping containers, you have the opportunity to negotiate for exactly what you are buying (i.e. which assets and which liabilities you are expressly taking on) and the plaintiff in that case didn't specifically negotiate for the assignment of the right to sue for a Takings Clause violation.

 

I goolged really hard but can't find the original ruling for Maniere. The fact that so many case are citing it implies the document should be available in a lot of places, but we can't find it.  ::)

 

merket, do you have access to some legal library?

 

I find it perplexing and anti-common sense if shareholders bought after the taking cannot sue. I remember someone said that Fairholme or maybe Perry case has 3 original preferred shareholders who held from 2008? In that case, the suit should still be valid even if Maniere case applies right?

[merkhet]

 

The difference is that there are results based on common sense and results based on legal reasoning. Sometimes they come out to the same conclusion. Sometimes they do not -- here, the question is whether there is a legal technicality in terms of whether the "right to sue for a Takings" passes on beyond those shareholders holding as of August 17, 2012.

 

While the Slattery ruling is rather persuasive, it talks about distributing a restructuring surplus rather than distributing the proceeds from a finding of Takings. (I've only quickly skimmed it, so it's possible I'm missing something.) This could be persuasive to a judge, but the question here is best framed the following way:

 

"In the case law for Takings Clause claims, is there a direct precedence stating that the individual(s) suing the government for a violation of the Takings Clause must have been the owner of that property/claim at the time of the Taking?"

 

The government's motion indicates that Maniere says this. Until I get a copy of it in my hands, I can't say one way or the other whether the legal technicality that the government is trying to put forth is correct.

 

The best I can say is that many of the cases citing Maniere that I've found mention something about third-party beneficiaries, in which case, it wouldn't necessarily apply. I've taken a look at the Textainer case that was cited as well, and it seems like that could be distinguished by the fact that when buying shipping containers, you have the opportunity to negotiate for exactly what you are buying (i.e. which assets and which liabilities you are expressly taking on) and the plaintiff in that case didn't specifically negotiate for the assignment of the right to sue for a Takings Clause violation.

 

I goolged really hard but can't find the original ruling for Maniere. The fact that so many case are citing it implies the document should be available in a lot of places, but we can't find it.  ::)

 

merket, do you have access to some legal library?

 

I find it perplexing and anti-common sense if shareholders bought after the taking cannot sue. I remember someone said that Fairholme or maybe Perry case has 3 original preferred shareholders who held from 2008? In that case, the suit should still be valid even if Maniere case applies right?

 

Well, yes, but it's of no use to us. If it's the case that only shareholders at the time of the Net Worth Sweep have standing to sue, then only those shareholders will be able to recover any money from the Takings. The rest of us would receive nothing.

[merkhet]

In all the commotion around the Fairholme Motion to Dismiss, it seems this filing went unnoticed

 

http://gselinks.com/Court_Filings/Cacciapalle/13-466-0053.pdf

 

We have now completed our document production of FHFA and Treasury documents, with the exception of a small number of documents that may be produced in whole or in part as a part of our final privilege review. Over 600,000 pages have been produced, and several provisional privilege logs have been served. We expect to serve our final privilege log by the end of this month. In addition, plaintiffs in Fairholme have deposed two FHFA officials (one present, one former), and the parties are negotiating deposition dates for current and former Treasury officials, former Fannie Mae and Freddie Mac chief financial officers, and an accountant formerly employed by Grant Thornton LLP, a Treasury consultant.

 

In reliance upon the agreements reached by the parties following those lengthy discussions, the Government has completed its production to the Fairholme plaintiffs of over 600,000 pages of documents. Moreover, the Fairholme plaintiffs have already conducted two depositions, and five more are expected to be completed by the end of July.

[colinwalt]

http://blogs.wsj.com/moneybeat/2015/06/08/uncle-sam-sours-on-frannie-suit/

 

Hmmm... the case this article links to (CRV ENTERPRISES, INC. AND C. RYAN VOORHEES, v US) only seems to be partly relevant (not that I'm a lawyer) - not really a takings issue (although ownership at the time of the "taking" is an issue here too) - but overall it does seem quite different.

[muscleman]

http://blogs.wsj.com/moneybeat/2015/06/08/uncle-sam-sours-on-frannie-suit/

 

Hmmm... the case this article links to (CRV ENTERPRISES, INC. AND C. RYAN VOORHEES, v US) only seems to be partly relevant (not that I'm a lawyer) - not really a takings issue (although ownership at the time of the "taking" is an issue here too) - but overall it does seem quite different.

 

My guess is that this case's relevance is weak. Otherwise the government lawyer should have placed this onto the table in May last year instead of now. It just doesn't make sense, unless either:

1. This is just a desperate struggle.

2. This is indeed relevant but government lawyer is so crappy that they didn't know this case until now.

 

I think #1 has a much higher probability than #2, but who knows..........

[colinwalt]

http://blogs.wsj.com/moneybeat/2015/06/08/uncle-sam-sours-on-frannie-suit/

 

Hmmm... the case this article links to (CRV ENTERPRISES, INC. AND C. RYAN VOORHEES, v US) only seems to be partly relevant (not that I'm a lawyer) - not really a takings issue (although ownership at the time of the "taking" is an issue here too) - but overall it does seem quite different.

 

My guess is that this case's relevance is weak. Otherwise the government lawyer should have placed this onto the table in May last year instead of now. It just doesn't make sense, unless either:

1. This is just a desperate struggle.

2. This is indeed relevant but government lawyer is so crappy that they didn't know this case until now.

 

I think #1 has a much higher probability than #2, but who knows..........

 

I wouldn't attach much weight to this case, I was hoping it was a link to the "Maniere" case... No idea why the blog article linked this case (lazy I guess)

[merkhet]

Carney linked it because that's the case that is directly cited for the idea that you have to own the property at the time the taking occurred.

[doughishere]

Peter Chapman update on motion:

“Our Government has filed a Supplemental Motion to Dismiss in Fairholme v. U.S. this afternoon. Our Government wants all claims by all shareholders who acquired Fannie or Freddie shares after Aug. 17, 2012 — the date of the Third Amendment — to be dismissed as a matter of law because, our Government argues, they lost nothing.

 

The argument is nonsense. In America, the bundle of rights that attach to a security do not change based on the identity of the holder. Here are some legal citations for that proposition:

 

— In re Lorraine Castle Apartments Bldg. Corp., 149 F.2d 55, 57-58 (7th Cir.), cert. denied, 326 U.S. 728 (1945) (“[T]he prices which security holders pay for their securities in no wise affects the measure of their participation in reorganization or their voting power.”);

 

— Standard Gas & Elec. Co. v. Deep Rock Oil Corp., 117 F.2d 615, 619 (10th Cir.), cert. denied, 313 U.S. 564 (1941); and

 

— Security-First Nat’l Bank v. Rindge Land & Navigation Co., 85 F.2d 557, 561 (9th Cir.), reh’g denied, 86 F.2d 3 (9th Cir.), cert. denied, 299 U.S. 613 (1936), reh’g denied, 300 U.S. 686 (1937) (“The legal value or property right in an obligation is the right to recover from the maker to the entire extent of his promise to pay. The consideration given for a security by the holder thereof is immaterial.”).

 

Via todd sullivan http://www.valueplays.net/2015/06/08/the-government-makes-a-bizarre-argument-in-gse-case/

[colinwalt]

Carney linked it because that's the case that is directly cited for the idea that you have to own the property at the time the taking occurred.

 

Ooops, guess that makes me the lazy one  :-\