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

[investorG]

Ok, I'll take it to the next level.  Let's assume APA claim survives dismissal and gets remanded back.

 

If Collins then loses on APA, aren't we back to a point where the govt has a lookback period to scotch the 4th amendment b/c it was done while FHFA was unconstitutional?  Then all the retained earnings would be owed in cash under the 3rd amendment.

 

I'm trying to sniff out any way for there to be unilateral action here, even if Calabria is willing to stick it out and make exiting cship his primary objective over time, but I just keep coming back to nothing works unless TSY plays ball.

 

If Collins wins on APA, then 3rd amendment becomes void, but then what happens to the 4th amendment?  Does it disappear too?!  Or does it hinge on whether FHFA was kosher, so the courts would assume it's its own independent action and keep it since the president had oversight in the event FHFA is OK, but if FHFA is not OK then the 4th stays around until someone challenges (or ratifies?) it and we go back to the 2nd amendment?

 

I'm trying to sketch out the scenarios forward and they are a total mess.  Even the "wins" leave a pile of problems!

 

cherzeca's 50% chances of winning on constitutional are likely v inflated.  more like 10%.  so most likely is unconstitutional with forward remedy only.    the points you raise are exactly why the SC likely won't give backward relief - I think they even mentioned this during oral arguments.

[Wiggins]

What's really the point of the govt sitting on this now that they can't sweep the profits?

 

The last letter agreement reduced the incentive for the government profiting, but since liquidation preference was and is still in place, one can make the argument they profit, but at a later date. I, personally, am dubious of the idea that the NWS being ended suddenly creates some kind of urgency for a Yellen Admin to settle. There is clear incentive for JPS to settle (and I now think Par is a best-case scenario), but I just don't see it on the Treasury side. If UST was willing to roll the dice on SCOTUS hearing the case, they are not gonna get religion now and settle before ruling. Seems like only thing that could do the trick would be a major adverse ruling from SCOTUS, as others have echoed.

 

So much analysis here was based on the assumption that Mnuchin wanted to end the conservatorship in a manner equitable to legacy shareholders but that was never the case so all this analysis has been faulty. Mnuchin on the way out the door still talks of legislation aimed at restructuring the GSEs while his policies have firmly worked to destroy the interests of legacy shareholders. Mnuchin teed this up for Yellen nicely. She doesn't have to do anything and this is on cruise control until SCOTUS. Yellen has already stated that the GSEs need to be "restructured" and in her opinion the best option is for legislation. But she must wait for the SCOTUS decision before this can be done. (Note, she may or may not do that because the status quo may be preferred for Treasury).

 

Our hope is that SCOTUS (or remand) unwinds the NWS, and a forced settlement occurs with JPS. That's it. Otherwise, in the event of a loss there are any number of options where JPS get nothing: selling core assets to private firms while leaving a worthless shell behind, legislation for new entrants to have an explicit backing, or, status quo.

 

I'm staying in and betting on a SCOTUS win.

[Jcmeg35]

What's really the point of the govt sitting on this now that they can't sweep the profits?

 

The last letter agreement reduced the incentive for the government profiting, but since liquidation preference was and is still in place, one can make the argument they profit, but at a later date. I, personally, am dubious of the idea that the NWS being ended suddenly creates some kind of urgency for a Yellen Admin to settle. There is clear incentive for JPS to settle (and I now think Par is a best-case scenario), but I just don't see it on the Treasury side. If UST was willing to roll the dice on SCOTUS hearing the case, they are not gonna get religion now and settle before ruling. Seems like only thing that could do the trick would be a major adverse ruling from SCOTUS, as others have echoed.

 

So much analysis here was based on the assumption that Mnuchin wanted to end the conservatorship in a manner equitable to legacy shareholders but that was never the case so all this analysis has been faulty. Mnuchin on the way out the door still talks of legislation aimed at restructuring the GSEs while his policies have firmly worked to destroy the interests of legacy shareholders. Mnuchin teed this up for Yellen nicely. She doesn't have to do anything and this is on cruise control until SCOTUS. Yellen has already stated that the GSEs need to be "restructured" and in her opinion the best option is for legislation. But she must wait for the SCOTUS decision before this can be done. (Note, she may or may not do that because the status quo may be preferred for Treasury).

 

Our hope is that SCOTUS (or remand) unwinds the NWS, and a forced settlement occurs with JPS. That's it. Otherwise, in the event of a loss there are any number of options where JPS get nothing: selling core assets to private firms while leaving a worthless shell behind, legislation for new entrants to have an explicit backing, or, status quo.

 

I'm staying in and betting on a SCOTUS win.

 

+1

[WB_fan82]

Today I read the NAR research piece by Wachter about transitioning to a SIFMU utility structure.

 

It's a heavy read, but since she's the leading candidate to replace Calabria, it's worth considering if Supreme Court is a bust.

 

Her proposal has many good points, nearly all of which have been made by Tim Howard.  If she takes over, she would probably find an ally in Yellen.  Basically, the GSEs as SIFMU utilities can pay for TSY backstop, cover expected losses, and still pay profits to shareholders all while lowering G-fees substantially, especially to high risk borrowers.  The trick is that the G-fees need to be regulated with caps and floors, and the stability of the earnings need to attract investors at low ROEs.

 

My takeaway is that since the GSEs have all this in place, it's logical to work with them and just recapitalize.  It would be quite simple to wipe out the commons w/ a sr pfd conversion, though it still has the optical problem of the preferred shares skyrocketing.

 

My other takeaway, and what hasn't been pointed out to her (I might send her a note) is that the ROE models only matter if SIFMU GSEs need to place new capital in the market, which they don't.  Otherwise, market prices take care of it by pricing the existing equity below book such that the P/E equates to the required ROE.  If G-fees are set to earn a 5% return on equity, but equity investors require a 10% return, then the market will price the stock at half of book value.

 

This makes the preferred seem quite compelling here.

 

[orthopa]

Im still unpacking everything and thinking this through but Ill state the obvious in that this wasn't optimal. Alot of this has already been posted but just easier for me to put it on paper.

 

1. The plan no doubt incentivizes raising capital ASAP and the 70B cap no doubt put heavy pressure on this. If not met early with the increasing preference it becomes near impossible especially for Fannie to get out @3%. The door is open only early and and the legal criteria puts plaintiffs in a bind no doubt. Win SCOTUS and the door opens up,  you lose and your waiting for Lamberth and the increased preference bones out of ever getting out on your own with the treasury secretary. What a bastard Mnuchin is. Its clear and I find this interesting that Treasury structures the deal in a way that its easier to exit faster then slower. I thought many things about mnuchin but the closer we got to SCOTUS never that he wanted to settle.

 

2. Apparently Yellen signed off on this too. If we thought we could trust Mnuchin I dont know I could trust Yellen any more then I could throw all 5 feet of her. She doesnt have a track record of any ill to GSEs.

 

3. Incentives will drive this for both sides. Plantifs now have a big incentive to try to get this all over ASAP with the clock ticking and think long and hard about the SCOTUS gamble. Yellen has to contemplate an adverse SCOTUS ruling and sending "billions to greedy hedge funds" if they lose on their watch. Maxine Waters thought this agreement was bad, sheesh, that may damn near kill her.

 

4. Id like everyone's opinion on how binding this is. Lost in these documents after you get shredded is that Treasury will work to restructure their stake in the GSEs. Im done hoping and wishing but does a Yellen treasury even have to do this? This maybe just a carrot but an obvious admission that its current state is unworkable. Again if Yellen is truly on board big win but I not holding my breath thinking about it.

 

5. Question for cherzeca and excuse me if this is obvious but a gov win on the constitutional claim keeps Calabria in his job right? Or is that only if found for acting director? Im not clear on that. What decision keeps Calabria in his job? What the likely hood that happens and we win the APA claim? slim to none?

 

6. At least the gov isnt getting the cash immediately with the increased liquidation preference but its just more of a loan that Treasury admits they may have to restructure anyway in the end so that does give them some incentive to get the warrant money. Biden is already spending like a drunken sailor so that warrant money will be attractive at some point one would think. US could just borrow more $$$ so maybe not.

 

7. Still very surprised at the legal angle of this agreement. This obviously was a huge stumbling block for Mnuchin and in the end maybe the en banc and SCOTUS taking up the case was the final road block on his end as he thought his hands were tied. Not believing his thinking was going to be benevolent otherwise but he was waiting for this to all play out too in a 4 year term.

 

8. Calabria needs a dance partner but he maybe the sacrificial lamb if Yellen want to gamble. What's worse losing a 120B adverse judgement but getting rid of Calabria or saving face before that happens but having to work with a guy you didn't choose from a Trump administration whos goals are opposite your bosses? Maybe I'm over estimating how much Treasury cares about an adverse judgement but there seems to be a real incentive on their part to at least come to the table. An April judgement is nice and soon and Im sure Mnuchin/Yellen/Calabria are aware of this.

 

9. Leaving this to legislation when the Dems control the entire gov is a nightmare. In 22 months maybe that flips and in 4 years we re-elect someone but I'm tired of thinking of this in years. F that. Parrot et al are ready to walk in soon. Serious consideration needs to be given to what those assholes can do with access again.

 

Have to think on this more but its what we have and it seems at a minimum the agreement incentives action sooner then later and recognizes both parties and "stuff" at stake.

[COBFInfinity]

So much analysis here was based on the assumption that Mnuchin wanted to end the conservatorship in a manner equitable to legacy shareholders but that was never the case so all this analysis has been faulty.

I never thought that. I have always and only owned preferreds based on the assumption that as long as receivership is avoided, you can't dilute the par value. I never had a clue what might happen to common or assumed it would be treated fairly.

 

I did, however, buy into the assumption that Mnuchin wanted to end the conservatorship, because, you know, he told us that over and over for 4 years. Why he punted, I have no clue. He could have created this blueprint, but not have been so punitive.

[Guest cherzeca]

Today I read the NAR research piece by Wachter about transitioning to a SIFMU utility structure.

 

It's a heavy read, but since she's the leading candidate to replace Calabria, it's worth considering if Supreme Court is a bust.

 

Her proposal has many good points, nearly all of which have been made by Tim Howard.  If she takes over, she would probably find an ally in Yellen.  Basically, the GSEs as SIFMU utilities can pay for TSY backstop, cover expected losses, and still pay profits to shareholders all while lowering G-fees substantially, especially to high risk borrowers.  The trick is that the G-fees need to be regulated with caps and floors, and the stability of the earnings need to attract investors at low ROEs.

 

My takeaway is that since the GSEs have all this in place, it's logical to work with them and just recapitalize.  It would be quite simple to wipe out the commons w/ a sr pfd conversion, though it still has the optical problem of the preferred shares skyrocketing.

 

My other takeaway, and what hasn't been pointed out to her (I might send her a note) is that the ROE models only matter if SIFMU GSEs need to place new capital in the market, which they don't.  Otherwise, market prices take care of it by pricing the existing equity below book such that the P/E equates to the required ROE.  If G-fees are set to earn a 5% return on equity, but equity investors require a 10% return, then the market will price the stock at half of book value.

 

This makes the preferred seem quite compelling here.

 

the article was informative, and if you posted it on TH, then thanks.  pure speculation, of course, but I suspect SM had a conversation with Biden transition and got feedback that they wanted a review period (which they got until 9/2021 in the LA) and their inclination was to arrive at some sort of recap eventually, using a utility model.  Wachter is not some Parrott lunatic, and if she gets in after collins nukes the for cause in HERA, then maybe we can read some tea leaves.  right now, I distrust Ds on GSEs, but collins may have an effect on accelerating things

[Guest cherzeca]

@orthopa

 

I dont see scotus saying that fhfa is different from cfpb, so Calabria will be able to be removed at will.  the whole acting d issue seems to be BS to me but I will acknowledge that some justices wanted to see what was down that rabbit hole

[WB_fan82]

Cherzeca,

 

If FHFA is unconst. won't the justices have to address and opine on the acting director issue?

 

If so, it seems like they have to take one of three paths on it:

 

1.  Acting directors are always removeable unless statute specifies otherwise, or

 

2.  Acting directors have the same removal restrictions as regular director when statute states the agency shall be independent (as HERA does for FHFA), or

 

3.  Acting directors always have the same removal restrictions as regular directors unless statute specifies otherwise

 

 

Which do you think they do with and why?  I think I can make a reasonable case for all, which means it's hard to handicap.  Collins could be a loser if SC goes with door #1.

 

 

[Guest cherzeca]

@82

 

yes and 2.  the hallmark of an independent agency is director insulation from removal. plus HERA states that the term of AD shall last until replacement is confirmed. so given agency is independent and AD term is specified without mentioning removal, I am hard pressed to see how scotus finds the AD removable at will. 

[investorG]

The deal was rough for Tsy bc it lifted the caps to a level that blocks cash payments to govt for 10+ years without settlement. 

 

The rising liq pref sucks for us but it caps the common stock price which makes it easier to sell new stock.

 

If we lose Collins, common gets plugged, jr pref is mostly a price taker during negotiations, and Tsy eventually monetizes most of its ~ $250bn liq pref.

 

If we get a Collins remand, it could take 2+ years after appeals to finalize.  'If' the Tsy wants to see cash any time soon, they need to get going on a restructuring.

 

For visible catalysts, 2021 should be defined by a) collins verdict b) Sep30 congress report and c) broad debate on housing finance reform with new FHFA head shaping the path forward.    If the economy holds, 2022 could be implementation, equity raises, etc.

 

 

[SnarkyPuppy]

There's really no reason for the UST to settle or equitize the senior preferreds.  You need to win SCOTUS APA or lamberth.  The govt can let the liquidation preference rise to the 3% threshold and then continue to effectively receive the net worth sweep (10% of a large liquidation preference).  Although the government isn't receiving cash, there is a benefit to taxpayers having less risk as the GSEs retain capital - and once they hit it the government gets to keep its dividend.  It's ironically the opposite of the "private gains, public losses" - they've quite literally flipped this.  The GSE entities fund the losses - the govt reaps the gains. 

 

Why would they give this up?  Mnuchin seemed to be an outsider, seemed to have the appropriate incentives/relationships, and pseudo-communicated that this would be resolved.  He didn't do it.  There previously was margin of safety in this investment in that, if we were wrong about Mnuchin, the preferreds would not decline to $0 as there remained a legal case with some reasonable % of success. 

 

There is no longer multiple pillars of margin of safety - you need a legal victory.  Hoping a future UST will somehow be favorable to you is too optimistic. 

 

My view is that you cannot assign any reasonable probability of success on the admin front anymore - I'm stunned that some of you are continuing to read into "yellen was briefed on the plan" tea leaves.  And I think most are in over their heads trying to underwrite SCOTUS.  cherz, while informed, has been consistently wrong in his legal predictions.  It's an incredibly complicated area and I suspect there's an element of luck involved.

 

Forward returns are quite attractive on a long-term basis.  IRR to par value through 2030 is higher than you can reasonably achieve on most investments.  The longer you're in a position - the more commitment and consistency bias you suffer from.  I've learned over time that thesis creep can be even worse than being brutally honest about being wrong.  I've materially reduced my position.

[investorG]

There's really no reason for the UST to settle or equitize the senior preferreds.  You need to win SCOTUS APA or lamberth.  The govt can let the liquidation preference rise to the 3% threshold and then continue to effectively receive the net worth sweep (10% of a large liquidation preference).  Although the government isn't receiving cash, there is a benefit to taxpayers having less risk as the GSEs retain capital - and once they hit it the government gets to keep its dividend.  It's ironically the opposite of the "private gains, public losses" - they've quite literally flipped this.  The GSE entities fund the losses - the govt reaps the gains. 

 

Why would they give this up?  Mnuchin seemed to be an outsider, seemed to have the appropriate incentives/relationships, and pseudo-communicated that this would be resolved.  He didn't do it.  There previously was margin of safety in this investment in that, if we were wrong about Mnuchin, the preferreds would not decline to $0 as there remained a legal case with some reasonable % of success. 

 

There is no longer multiple pillars of margin of safety - you need a legal victory.  Hoping a future UST will somehow be favorable to you is too optimistic. 

 

My view is that you cannot assign any reasonable probability of success on the admin front anymore - I'm stunned that some of you are continuing to read into "yellen was briefed on the plan" tea leaves.  And I think most are in over their heads trying to underwrite SCOTUS.  cherz, while informed, has been consistently wrong in his legal predictions.  It's an incredibly complicated area and I suspect there's an element of luck involved.

 

Forward returns are quite attractive on a long-term basis.  IRR to par value through 2030 is higher than you can reasonably achieve on most investments.  The longer you're in a position - the more commitment and consistency bias you suffer from.  I've learned over time that thesis creep can be even worse than being brutally honest about being wrong.  I've materially reduced my position.

 

We are guessing at Tsy's intentions and the risk you point out is real.  It's all about probabilities though. 

 

-- Biden and the housing advocates probably could use the hard cash during this 4 years rather than wait for a decade-plus.

 

-- If they chose the wait 10-15 years route for the NWS to restart, what's to stop a new admin who believes in privatization from changing its mind in 4 or 8 years from now - current Tsy officials can't be sure a plan hatched now to wait would fully endure.

 

-- Tsy has a track record of selling investments from prior bailouts rather than holding.  This is a unique situation but generally holding pref in publicly traded companies for 25 years (12 already plus 10-15 more) isn't their bag.

 

IMO there's some chance Mnuchin would have acted differently if the SC hearing went south.  He was 'contemplating' consent order on Dec 2 hearing and by Dec 15 he chose no.  After hearing Breyer talk nationalization Dec9 he perhaps thought he could still achieve his objective -- delayed by a year -- by hatching this plan that is rough on both us and Tsy while avoiding the spotlight of writing down a large govt asset.    And so he screwed us but also chose to increase the caps by way more than expected to motivate Tsy to act in 2h2021+.

[WB_fan82]

Cherzeca,

 

I re-read HERA last night, while reading the majority and dissenting opinions on the statutory claims in Collins.  I had to read the majority twice to follow along, but I think they make a pretty good case about how to read HERA.  I feel better that the "in FHFA's interests" relates more to letting them take a subset of actions that are consistent with the "preserve and conserve" without worrying about fiduciary duties than it does as some massive grant of permission to do anything it wants like sell a commemorative conservatorship coin for $5 billion.  I used to be worried that clause just kind of allowed anything, but the majority convinced me that's not the case.  Of course my brain is working overtime to confirm why I still own the prefs, so I don't really trust myself!

 

But on the Const. claims, I do wonder if the FHFA is far more of a regulatory agency than it is an executive agency.  It doesn't bring claims or make rules on private individuals as far as I can tell.  Everything it touches -- FHFA, Home loan banks, GSEs -- are other agencies of the government with public interests.  It doesn't look much like the CFPB at all, which has vast power on private entities.  When amicus pointed out that HERA is really an instruction manual and the FHFA doesn't wield much executive power, that strikes me as accurate.  Therefore, I'm wondering why the FHFA is unconst. even with a single director.  There are lots of purely regulatory agencies that have single directors, and FHFA seems to resemble them a lot more than it does the CFPB.  Seila also referenced  "significant executive power", which makes me wonder if it's actually more consistent with Seila that FHFA is deemed const.

 

Do you think the first threshold matter in Collins is whether FHFA is an executive agency with "significant executive power" (quoting Seila here)?  If so, why would it be?

 

I am coming around to your view on the acting director (at least I've moved from "it's dead" to "coin flip"!), but now I worry about the executive aspect.

 

Hope you don't mind getting wonky on this stuff with me.  I'm not a lawyer, but I've read more legal docs and cases than I care to admit.  Const. law is a new one for me, though!

[investorG]

Cherzeca,

 

I re-read HERA last night, while reading the majority and dissenting opinions on the statutory claims in Collins.  I had to read the majority twice to follow along, but I think they make a pretty good case about how to read HERA.  I feel better that the "in FHFA's interests" relates more to letting them take a subset of actions that are consistent with the "preserve and conserve" without worrying about fiduciary duties than it does as some massive grant of permission to do anything it wants like sell a commemorative conservatorship coin for $5 billion.  I used to be worried that clause just kind of allowed anything, but the majority convinced me that's not the case.  Of course my brain is working overtime to confirm why I still own the prefs, so I don't really trust myself!

 

But on the Const. claims, I do wonder if the FHFA is far more of a regulatory agency than it is an executive agency.  It doesn't bring claims or make rules on private individuals as far as I can tell.  Everything it touches -- FHFA, Home loan banks, GSEs -- are other agencies of the government with public interests.  It doesn't look much like the CFPB at all, which has vast power on private entities.  When amicus pointed out that HERA is really an instruction manual and the FHFA doesn't wield much executive power, that strikes me as accurate.  Therefore, I'm wondering why the FHFA is unconst. even with a single director.  There are lots of purely regulatory agencies that have single directors, and FHFA seems to resemble them a lot more than it does the CFPB.  Seila also referenced  "significant executive power", which makes me wonder if it's actually more consistent with Seila that FHFA is deemed const.

 

Do you think the first threshold matter in Collins is whether FHFA is an executive agency with "significant executive power" (quoting Seila here)?  If so, why would it be?

 

I am coming around to your view on the acting director (at least I've moved from "it's dead" to "coin flip"!), but now I worry about the executive aspect.

 

Hope you don't mind getting wonky on this stuff with me.  I'm not a lawyer, but I've read more legal docs and cases than I care to admit.  Const. law is a new one for me, though!

 

wb82 what should we be rooting for in terms of calabria getting replaced?

 

if he stays then we have someone who believes in privatization and we could avoid a timing delay while a new director gets their feet wet.  but he might not see eye to eye with Biden Tsy and a stalemate could ensue, plus his capital rule is tough.

[beaufort]

There's really no reason for the UST to settle or equitize the senior preferreds.  You need to win SCOTUS APA or lamberth.  The govt can let the liquidation preference rise to the 3% threshold and then continue to effectively receive the net worth sweep (10% of a large liquidation preference).  Although the government isn't receiving cash, there is a benefit to taxpayers having less risk as the GSEs retain capital - and once they hit it the government gets to keep its dividend.  It's ironically the opposite of the "private gains, public losses" - they've quite literally flipped this.  The GSE entities fund the losses - the govt reaps the gains. 

 

Why would they give this up?  Mnuchin seemed to be an outsider, seemed to have the appropriate incentives/relationships, and pseudo-communicated that this would be resolved.  He didn't do it.  There previously was margin of safety in this investment in that, if we were wrong about Mnuchin, the preferreds would not decline to $0 as there remained a legal case with some reasonable % of success. 

 

There is no longer multiple pillars of margin of safety - you need a legal victory.  Hoping a future UST will somehow be favorable to you is too optimistic. 

 

My view is that you cannot assign any reasonable probability of success on the admin front anymore - I'm stunned that some of you are continuing to read into "yellen was briefed on the plan" tea leaves.  And I think most are in over their heads trying to underwrite SCOTUS.  cherz, while informed, has been consistently wrong in his legal predictions.  It's an incredibly complicated area and I suspect there's an element of luck involved.

 

Forward returns are quite attractive on a long-term basis.  IRR to par value through 2030 is higher than you can reasonably achieve on most investments.  The longer you're in a position - the more commitment and consistency bias you suffer from.  I've learned over time that thesis creep can be even worse than being brutally honest about being wrong.  I've materially reduced my position.

 

+1 regrettably.  But I am less optimistic.  The newest letter agreement destroys the margin of safety from the lawsuits, including rendering the Collins case moot, but from a different angle.  Even if the accounting adjustment entry is done and UST sends back the money, FnF still can't get out because of the warrants until 2028.

In addition,  the letter agreement drafters learned from the ongoing litigation.  They are using the Hindes precedent as a method to get all of the money by cutting out the other classes out of the capital structure and sending the money to UST eventually, but not completely, at least on paper.  After FnF retain 3% of assets and a commitment fee is negotiated, 10% goes to UST or lift in net worth for the quarter.  That leaves almost nothing for preferred shareholders.  Commons are a 0. 

 

The APA claim moving forward is done.  Calabria will now be conserving and preserving assets - for FnF benefit.  The fact that the shareholders don't get anything doesn't matter.  Calabria will be doing his job. 

 

After FnF are capitalized, in 10 years, UST gets all of the money because of the agreement that Calabria signed, which he can do.

 

That leaves the expropriation claim.  Maybe.  The problem is UST/FHFA are now creating the necessary facts to defeat that lawsuit by not completing cutting out shareholders, but almost. 

 

I acknowledge the various points re potential admin action moving forward, but I can't handicap that, and I have demonstrated that with Mnuchin.

 

We were sold out.  The beneficiaries are, amongst others, buyers of MBS.  They will have a mountain of money in front of them, and the LOC.  They will be taking no risk for their investment, printing risk free money.  Treasury also gets to keep this money making machine to itself moving forward, or until special interests manage to buy it for a song later.   

 

This letter agreement is deviously brilliant.  This was a chess game and we lost.  I didn't even realize the adversary was Blackrock, Pimco etc until Thursday. 

 

My thesis changed on Thursday night.  My margin of safety was eviscerated by this new letter agreement.  There may very well be new lawsuits arising from this letter agreement - but I have no way of handicapping this.  I was wrong on Admin action.  I therefore sold out of my positions yesterday. 

 

As InvestorG is fond of saying, good luck everybody.

 

 

[investorG]

There's really no reason for the UST to settle or equitize the senior preferreds.  You need to win SCOTUS APA or lamberth.  The govt can let the liquidation preference rise to the 3% threshold and then continue to effectively receive the net worth sweep (10% of a large liquidation preference).  Although the government isn't receiving cash, there is a benefit to taxpayers having less risk as the GSEs retain capital - and once they hit it the government gets to keep its dividend.  It's ironically the opposite of the "private gains, public losses" - they've quite literally flipped this.  The GSE entities fund the losses - the govt reaps the gains. 

 

Why would they give this up?  Mnuchin seemed to be an outsider, seemed to have the appropriate incentives/relationships, and pseudo-communicated that this would be resolved.  He didn't do it.  There previously was margin of safety in this investment in that, if we were wrong about Mnuchin, the preferreds would not decline to $0 as there remained a legal case with some reasonable % of success. 

 

There is no longer multiple pillars of margin of safety - you need a legal victory.  Hoping a future UST will somehow be favorable to you is too optimistic. 

 

My view is that you cannot assign any reasonable probability of success on the admin front anymore - I'm stunned that some of you are continuing to read into "yellen was briefed on the plan" tea leaves.  And I think most are in over their heads trying to underwrite SCOTUS.  cherz, while informed, has been consistently wrong in his legal predictions.  It's an incredibly complicated area and I suspect there's an element of luck involved.

 

Forward returns are quite attractive on a long-term basis.  IRR to par value through 2030 is higher than you can reasonably achieve on most investments.  The longer you're in a position - the more commitment and consistency bias you suffer from.  I've learned over time that thesis creep can be even worse than being brutally honest about being wrong.  I've materially reduced my position.

 

+1 regrettably.  But I am less optimistic.  The newest letter agreement destroys the margin of safety from the lawsuits, including rendering the Collins case moot, but from a different angle.  Even if the accounting adjustment entry is done and UST sends back the money, FnF still can't get out because of the warrants until 2028.

In addition,  the letter agreement drafters learned from the ongoing litigation.  They are using the Hindes precedent as a method to get all of the money by cutting out the other classes out of the capital structure and sending the money to UST eventually, but not completely, at least on paper.  After FnF retain 3% of assets and a commitment fee is negotiated, 10% goes to UST or lift in net worth for the quarter.  That leaves almost nothing for preferred shareholders.  Commons are a 0. 

 

The APA claim moving forward is done.  Calabria will now be conserving and preserving assets - for FnF benefit.  The fact that the shareholders don't get anything doesn't matter.  Calabria will be doing his job. 

 

After FnF are capitalized, in 10 years, UST gets all of the money because of the agreement that Calabria signed, which he can do.

 

That leaves the expropriation claim.  Maybe.  The problem is UST/FHFA are now creating the necessary facts to defeat that lawsuit by not completing cutting out shareholders, but almost. 

 

I acknowledge the various points re potential admin action moving forward, but I can't handicap that, and I have demonstrated that with Mnuchin.

 

We were sold out.  The beneficiaries are, amongst others, buyers of MBS.  They will have a mountain of money in front of them, and the LOC.  They will be taking no risk for their investment, printing risk free money.  Treasury also gets to keep this money making machine to itself moving forward, or until special interests manage to buy it for a song later.   

 

This letter agreement is deviously brilliant.  This was a chess game and we lost.  I didn't even realize the adversary was Blackrock, Pimco etc until Thursday. 

 

My thesis changed on Thursday night.  My margin of safety was eviscerated by this new letter agreement.  There may very well be new lawsuits arising from this letter agreement - but I have no way of handicapping this.  I was wrong on Admin action.  I therefore sold out of my positions yesterday. 

 

As InvestorG is fond of saying, good luck everybody.

 

I've read your post multiple times and still don't fully get it.  I assume you think Tsy will want to never do anything and will simply take the sweep in 10-15 years.    If that's correct then yes we should all sell out unless you want to wait years for lamberth.

[beaufort]

Yes you are interpreting my view correctly InvestorG - no settlement by UST - there is no reason to. 

 

Edit:

 

FnF will be operating soundly.  They will be very well capitalized.  The 30 year mortgage will be fine. 

 

Calabria doesn't care about shareholders and he thinks that shareholders should have been wiped out in 2008.  He has made that clear.  He will be adhering to HERA. 

 

Shareholder lawsuits have taught UST over the years the necessary facts they need to marshal to defeat the various claims.  This letter agreement smoked us and is proof of that.     

 

If I am wrong, it will sting, but I am still rooting for those in this.  This is because I disagree with the way shareholders were treated after 2008 until today.  But that is no investment thesis. 

[investorG]

Yes you are interpreting my view correctly InvestorG - no settlement by UST.

 

Ok.  I outlined above on this page why I disagree and am more worried about losing Collins or the econ rolling over than a decade of Tsy inaction -- but it's a subjective view and you and Snarky may be correct.  Good luck to you and come back with your solid posts if you change your mind at a later date.

[WB_fan82]

Beau,

 

Yea, it's gloomy but the prefs are down 50%.  I think/thought Calabria was the GSEs best friend despite the capital rule b/c he was so ardent about getting them out of chip.  Mnuchin was a brick wall, but Calabria had his hands tied b/c he had to give the store away to secure getting rid of the earnings caps.  Now that he has those, he has far more leverage to negotiate something with the Dems.  I say leverage b/c Calabria has at least two things the Dems want:  the ability to unilaterally set GSE affordable lending goals under HERA, and the ability to regulate the G-fees (especially for affordable housing).

 

He has things to give, and they are also consistent with the statute so Calabria's "by the book" nature will be warm to the idea.  What must he want for it?  We know he pushed hard to get them out of cship, and it involved some capital restructuring ideas (WSJ).  It might be a bridge too far to get the Dems to budge on the sr pfd (he will surely try), but just getting them to exercise the warrant would be a win and I think he could get substantially more.  That would clear the way for an APA win.

 

It will be interesting to see Calabria's response to a utility idea.  He was willing to move forward without additional guarantors, and he knows that's a non-starter now, so the duopoly was always the baseline.  So.. why not?  The only reason the G-fees are absurdly high today (55 bps including tcca today vs. 20 bps historical) is b/c they are priced based on aggressive private capital return assumptions.  Those are things he should be able to work with the democrats on.  Check out the Wachter paper on utility in front of NAR (She's the leading Calabria replacement, btw).

 

There is a clear deal to be made here, and a clear win for Democrats, GSE investors (at least the prefs), homeowners, and Calabria.  LOWER G-fees.  Higher capital.  Private ownership.  Out of cship.  He should be in a position to do it all, and now on the other side of the table he has someone that has worked at the Fed since the 70s instead of a right-place right-time movie producer, and an administration with a more cooperative attitude vs. the schoolyard playground of the last 4 years.

 

 

[Guest cherzeca]

"cherz, while informed, has been consistently wrong in his legal predictions."

 

right on Collins in 5th C en banc.  you need only one

[Guest cherzeca]

@beaufort

 

"The newest letter agreement destroys the margin of safety from the lawsuits..."

 

dont understand, explain.

[Guest cherzeca]

I expect a utility regulator like Wachter after Collins permits MC to be removed without cause. I also expect a victory on at least the APA claim from scotus. this puts SP at risk.

 

so I dont see the doomsday...after a night of gin exorcising my intense dislike of SM

[COBFInfinity]

"cherz, while informed, has been consistently wrong in his legal predictions."

 

right on Collins in 5th C en banc.  you need only one

 

I thought "you need only one", too. So when preferred price started to soften a week or so after that, I bought more preferred for the first time since early 2015. Those shares are down about 60% right now.

 

My plan with this investment has always been "par or bust", so I plan to ride this out even if it's another decade. But I will never again get involved in an investment dependent on litigation.

[beaufort]

@beaufort

 

"The newest letter agreement destroys the margin of safety from the lawsuits..."

 

dont understand, explain.

 

Assumptions:

1.  No settlements because they don't need to.

2.  No obligations to shareholders by anybody leaving only judicial remedy.

3.  No exercising of warrants.  Expiry in 2028.

 

New litigation:  can shareholders get remedy if UST doesn't exercise warrants.  I don't know, but we are relatively confident that much litigation will be pursued to that end, which makes exit impossible for yet another roadblock that Mnuchin put in. 

 

1.  Expropriation.  Shareholders will not have been expropriated completely.  In 2028, FnF are recapped through retained earnings and/or Collins APA win.  GSEs pays out dividends to Treasury according to cap structure and the new deal:  10% of SPS liquidation preference at time of dividend payment, which will have been increasing 8 years straight.  FnF won't make enough money to ever pay much to JPS holders.  Common are 0.  Low yielding JPS are basically a 0. 

 

But neither JPS or common holders are not expropriated completely.  They just have really crappy economic interests.  Nobody promised us a good deal and no remedy for crappy economic interests. 

 

I have had problems with expropriation claim for some time in assessing damages, even though I think they are likely there.  If the facts are that FnF were in trouble at time relevant time, arguably the original position was already low, so low damages.  If the facts are that they were valuable at relevant time and have not been expropriated by the crafty new letter agreement, up to SCOTUS for review, and then back down. 

 

2.  APA claim. 

Assumption shareholders will win with SPS writedown.  The new letter agreement requires all earning to raise the liquidation preference again - NWS by another name - more litigation - starting from scratch, because of the new cause of action.  Success means FnF only have their retained earnings to pay out on in 2028.  This still leaves little money to pay out to shareholders.  45B now in net worth.  20B a year moving forward x 8 = 160 plus 45B now 205.  10% on that is 20B.  How much is left for shareholders? 

 

Assumption shareholders will win lawsuit and remand to lower court.  More litigation for many years down the road until remedy.  But we still come back to the 10% dividend in a number of years.

 

3.  Constitutional claim.  Even with win, same problem as #2 - arising from the new letter agreement.  Any increase in GSE net worth increases liquidation preference of SPS and further raises their dividend entitlements.

 

4.  Lamberth claims.  Direct.  Fact driven.  Possible win - toss up, with good upside given remand to lower court.  But, will be appealed all the way to SCOTUS.  Years before shareholders see any money.

 

5.  Hindes litigation.  UST learned.  Clearly everybody will in fact be cut out of capital structure except SPS, but this has now been decided.  Res judicata.  In addition, defendants have better facts now.  There will potentially be something left for other classes of shareholders, just not much.  The original deal was a bad deal and here we are.

 

MOS for shareholders from lawsuits:

 

Other than Lamberth, there isn't one.  In its current form, I can't get an approximation of the odds for Lamberth claims.  At current 20% of par, too rich for me.