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

[beaufort]

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.

 

I don't disagree with any of these scenarios and at 20% of par, if it works out, that will be great.  My problem is the MOS when looking below.  I have no way of knowing whether this works out and I have proved it to myself.

[WB_fan82]

Calabria only entered the new amendment b/c it was his only option to make progress against the retained earnings caps.  Calabria only agreed to the caps b/c it was his only option to deal with the full cash NWS.

 

So if the full cash NWS falls due to APA, logically (legally?) the subsequent amendments shouldn't stand b/c they are directly traceable back to the bad contract.  I bet Calabria would happily testify to that, too.

 

So depending on the precise APA remedy, we are left with a 10% instrument and an Infinite War / Time Stone trick to unwind everything that came after it.  That means mnuchin's boulders turn to dust on the exit.  Unfortunately, GSEs can't sell new common shares b/c of the way the warrant is written (for 80% of shares instead of a fixed number of shares based on 80% of current), but it's a vastly preferable position. 

[investorG]

@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. 

 

 

 

Tsy doesn't have $125bn laying around.  If they lose (or think they will lose) APA Collins or Schwartz, then they're going to want to deal.  Sending back $125bn in 2023 and hoping to receive cash 10 years later is remote odds, maybe 10%.  that leaves 90% odds for a new PSPA, new deal, in this scenario.    Also yellen isn't a jerk.  Finally this is America as TwoCities wrote and at some point the right thing gets done - after all the current market cap of all public common + pref is currently 6 months of FnF earnings -- there are ways to pay us off if all else fails.

[investorG]

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.

 

This is likely not happening unless calabria is entrenched til 2024.  They can simply wait for their pick in July and give up less.  Mnuchin really screwed calabria by not settling Collins.  who knows though maybe calabria wanted out or maybe there's still 4 days left for settlement.

[Midas79]

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. 

 

I think you are misunderstanding how the SPS dividend works. The SPS don't get a dividend until FnF hit their full with-buffers capital level of 4% of adjusted total assets, even if a future FHFA director makes a new capital rule due to Section 5.15, unless Yellen and the new FHFA director amend that out. Once full capitalization is reached ("Capital Reserve End Date") the SPS get the lesser of any net worth increase from the previous quarter and 10% of the SPS liquidation preference. But dividends to other classes of shareholders subtract from net worth just as earnings add to it. So once dividends are paid out to other preferred and common shareholders, the SPS gets the rest of what FnF earned in that quarter.

 

What that means, paradoxically, is that the SPS are at the back of the line in terms of dividends once full capitalization is achieved, and the SPS get no dividends at all before that. It remains to be seen how easy or possible it will be to sell new common shares who have zero liquidation preference ever but will get normal utility-like dividends.

 

Without a settlement to the lawsuits and private capital raises the SPS will get no money from FnF for decades. Not even a commitment fee, unless a future FHFA director and UST Secretary reinstate it.

 

Altogether this agreement actually gives Treasury an incentive to move quickly on raising private capital: slow accumulation of retained earnings provides less taxpayer protection (in terms of how much capital stands in front of UST's LOC) compared to fast and large capital raises, and those raises accelerate UST's timeline to getting payments on its SPS.

 

The SPS dividend also answers a question I had, which was "what would FnF do with all their earnings once they hit full capitalization?" I couldn't imagine the government would be okay with private shareholders getting enormous dividends, and FnF would have no reason to save any money past full capitalization anyway. Now we know: UST gets all the extra money.

 

Something else to consider is that 4% of adjusted total assets, the threshold at which the SPS divs turn on, was $265B as of last June and grows with FnF's asset base. I use 2.5% per year as a ballpark. FnF's combined core capital, though, was negative $167B at that time. That's a $432B gap! FnF make around $20B in earnings per year, but the 4% target grows at $6.6B per year right now and faster in the future as the 2.5% increases compound. Carrying out the math, that means not only will FnF not be fully capitalized through retained earnings by 2028, it will never happen at all! The smallest the gap between FnF's core capital and the requirement gets is $72B in 2065, then the compounding of the 2.5% becomes greater than $20B per year and the gap starts to widen again.

 

Now, assuming flat earnings of $20B per year is probably unrealistic. If they also grow at 2.5% per year, which I think is reasonable because FnF's earnings are also roughly proportional to the size of their asset base, the $432B gap closes in a finite amount of time, but not until 2044.

 

Note: only the SPS balance on the balance sheets count (negatively) towards core capital, a total of $193B for FnF combined. Increases to the liquidation preference due to the letter agreements, including the one from Thursday, are not reflected on the balance sheet and thus don't affect core capital at all.

[SnarkyPuppy]

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. 

 

I think you are misunderstanding how the SPS dividend works. The SPS don't get a dividend until FnF hit their full with-buffers capital level of 4% of adjusted total assets, even if a future FHFA director makes a new capital rule due to Section 5.15, unless Yellen and the new FHFA director amend that out. Once full capitalization is reached ("Capital Reserve End Date") the SPS get the lesser of any net worth increase from the previous quarter and 10% of the SPS liquidation preference. But dividends to other classes of shareholders subtract from net worth just as earnings add to it. So once dividends are paid out to other preferred and common shareholders, the SPS gets the rest of what FnF earned in that quarter.

 

What that means, paradoxically, is that the SPS are at the back of the line in terms of dividends once full capitalization is achieved, and the SPS get no dividends at all before that. It remains to be seen how easy or possible it will be to sell new common shares who have zero liquidation preference ever but will get normal utility-like dividends.

 

Without a settlement to the lawsuits and private capital raises the SPS will get no money from FnF for decades. Not even a commitment fee, unless a future FHFA director and UST Secretary reinstate it.

 

Altogether this agreement actually gives Treasury an incentive to move quickly on raising private capital: slow accumulation of retained earnings provides less taxpayer protection (in terms of how much capital stands in front of UST's LOC) compared to fast and large capital raises, and those raises accelerate UST's timeline to getting payments on its SPS.

 

The SPS dividend also answers a question I had, which was "what would FnF do with all their earnings once they hit full capitalization?" I couldn't imagine the government would be okay with private shareholders getting enormous dividends, and FnF would have no reason to save any money past full capitalization anyway. Now we know: UST gets all the extra money.

 

Something else to consider is that 4% of adjusted total assets, the threshold at which the SPS divs turn on, was $265B as of last June and grows with FnF's asset base. I use 2.5% per year as a ballpark. FnF's combined core capital, though, was negative $167B at that time. That's a $432B gap! FnF make around $20B in earnings per year, but the 4% target grows at $6.6B per year right now and faster in the future as the 2.5% increases compound. Carrying out the math, that means not only will FnF not be fully capitalized through retained earnings by 2028, it will never happen at all! The smallest the gap between FnF's core capital and the requirement gets is $72B in 2065, then the compounding of the 2.5% becomes greater than $20B per year and the gap starts to widen again.

 

Now, assuming flat earnings of $20B per year is probably unrealistic. If they also grow at 2.5% per year, which I think is reasonable because FnF's earnings are also roughly proportional to the size of their asset base, the $432B gap closes in a finite amount of time, but not until 2044.

 

Note: only the SPS balance on the balance sheets count (negatively) towards core capital, a total of $193B for FnF combined. Increases to the liquidation preference due to the letter agreements, including the one from Thursday, are not reflected on the balance sheet and thus don't affect core capital at all.

 

"unless Yellen and the new FHFA director amend that out"

 

Absent SCOTUS - this whole thing is moot due to the possibility of future amendments

[investorG]

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. 

 

I think you are misunderstanding how the SPS dividend works. The SPS don't get a dividend until FnF hit their full with-buffers capital level of 4% of adjusted total assets, even if a future FHFA director makes a new capital rule due to Section 5.15, unless Yellen and the new FHFA director amend that out. Once full capitalization is reached ("Capital Reserve End Date") the SPS get the lesser of any net worth increase from the previous quarter and 10% of the SPS liquidation preference. But dividends to other classes of shareholders subtract from net worth just as earnings add to it. So once dividends are paid out to other preferred and common shareholders, the SPS gets the rest of what FnF earned in that quarter.

 

What that means, paradoxically, is that the SPS are at the back of the line in terms of dividends once full capitalization is achieved, and the SPS get no dividends at all before that. It remains to be seen how easy or possible it will be to sell new common shares who have zero liquidation preference ever but will get normal utility-like dividends.

 

Without a settlement to the lawsuits and private capital raises the SPS will get no money from FnF for decades. Not even a commitment fee, unless a future FHFA director and UST Secretary reinstate it.

 

Altogether this agreement actually gives Treasury an incentive to move quickly on raising private capital: slow accumulation of retained earnings provides less taxpayer protection (in terms of how much capital stands in front of UST's LOC) compared to fast and large capital raises, and those raises accelerate UST's timeline to getting payments on its SPS.

 

The SPS dividend also answers a question I had, which was "what would FnF do with all their earnings once they hit full capitalization?" I couldn't imagine the government would be okay with private shareholders getting enormous dividends, and FnF would have no reason to save any money past full capitalization anyway. Now we know: UST gets all the extra money.

 

Something else to consider is that 4% of adjusted total assets, the threshold at which the SPS divs turn on, was $265B as of last June and grows with FnF's asset base. I use 2.5% per year as a ballpark. FnF's combined core capital, though, was negative $167B at that time. That's a $432B gap! FnF make around $20B in earnings per year, but the 4% target grows at $6.6B per year right now and faster in the future as the 2.5% increases compound. Carrying out the math, that means not only will FnF not be fully capitalized through retained earnings by 2028, it will never happen at all! The smallest the gap between FnF's core capital and the requirement gets is $72B in 2065, then the compounding of the 2.5% becomes greater than $20B per year and the gap starts to widen again.

 

Now, assuming flat earnings of $20B per year is probably unrealistic. If they also grow at 2.5% per year, which I think is reasonable because FnF's earnings are also roughly proportional to the size of their asset base, the $432B gap closes in a finite amount of time, but not until 2044.

 

Note: only the SPS balance on the balance sheets count (negatively) towards core capital, a total of $193B for FnF combined. Increases to the liquidation preference due to the letter agreements, including the one from Thursday, are not reflected on the balance sheet and thus don't affect core capital at all.

 

"unless Yellen and the new FHFA director amend that out"

 

Absent SCOTUS - this whole thing is moot due to the possibility of future amendments

 

This stuff cracks me up.  Let's go all in at 50% of par while message board sentiment is drunkenly high but at 20% of par let's focus on all the negatives. 

 

As you know the 2012 NWS happened when the pref shares were sub $1 with little attention being paid outside of a handful of vulture investors.  Now we're featured in major media outlets with many high profile (and stubborn) investors involved -- its going to be very hard for a new FHFA head to pull a 2012 repeat that caters strictly to Tsy.  That said, yes if we lose major pending court cases, we become price takers in a potential negotiation.

[undervalued]

With all the negativity around Mnuchin not delivering what we expected, I still think there is something positive that happened that maybe we overlooked. Is Mnuchin not doing anything be a better alternative? Hopefully, MC will give clarification next week in his interview.

[beaufort]

@midas

 

You are correct that I did not interpret the SPS getting their dividends at the end after subtracting from net worth.  Assuming you are right, and I accept that you are, dividends get paid at some point in the future if nothing changes again due to another letter agreement, for example, while in conservatorship. 

 

I have assumed that Treasury doesn't care about making money here.  As long as the companies are well capitalized, that will be good enough.  You have my other assumptions.

 

I can't think of any new money coming in as things stand.  But who knows, it's possible.

 

Edit: 

 

One more point that I made previously, but really shook me up.  My thesis is this letter agreement was made for litigation.  It is a blueprint alright, for how to marshal facts that will defeat the claims.   

 

"Something else to consider is that 4% of adjusted total assets, the threshold at which the SPS divs turn on, was $265B as of last June and grows with FnF's asset base. I use 2.5% per year as a ballpark. FnF's combined core capital, though, was negative $167B at that time. That's a $432B gap! FnF make around $20B in earnings per year, but the 4% target grows at $6.6B per year right now and faster in the future as the 2.5% increases compound. Carrying out the math, that means not only will FnF not be fully capitalized through retained earnings by 2028, it will never happen at all! The smallest the gap between FnF's core capital and the requirement gets is $72B in 2065, then the compounding of the 2.5% becomes greater than $20B per year and the gap starts to widen again.

 

Now, assuming flat earnings of $20B per year is probably unrealistic. If they also grow at 2.5% per year, which I think is reasonable because FnF's earnings are also roughly proportional to the size of their asset base, the $432B gap closes in a finite amount of time, but not until 2044.

 

Note: only the SPS balance on the balance sheets count (negatively) towards core capital, a total of $193B for FnF combined. Increases to the liquidation preference due to the letter agreements, including the one from Thursday, are not reflected on the balance sheet and thus don't affect core capital at all."

 

I accept all of these points.  My thesis is they never leave conservatorship, until a court forces them out (if at all), long into the future, at a time I can't predict.  I recall a statement by a judge that conservatorship is not an end state.  More potential lawsuits.

 

@IG

 

I acknowledge that I might be wrong.  I didn't base my decision on sentiment on a message board.  New facts came to light on Thursday and I changed my mind on the investment on the downside v. the upside with current prices.  Other people are free to have a different view. 

 

[investorG]

@midas

 

You are correct that I did not interpret the SPS getting their dividends at the end after subtracting from net worth.  Assuming you are right, and I accept that you are, dividends get paid at some point in the future if nothing changes again due to another letter agreement, for example, while in conservatorship. 

 

I have assumed that Treasury doesn't care about making money here.  As long as the companies are well capitalized, that will be good enough.  You have my other assumptions.

 

I can't think of any new money coming in as things stand.  But who knows, it's possible.

 

@IG

 

I acknowledge that I might be wrong.  I didn't base my decision on sentiment on a message board.  New facts came to light on Thursday and I changed my mind on the investment on the downside v. the upside with current prices.  Other people are free to have a different view.

 

of course. wasn't responding to you.  don't remember many all-in posts at high levels from you.  good luck.  maybe the shares will halve again to 10% of par during the next few months quiet period and you'll be back again. 

[beaufort]

@IG.

At the right price, I would consider it.  But I am beat up right now, so hard to get to that price. 

 

Edit:

 

"Tsy doesn't have $125bn laying around.  If they lose (or think they will lose) APA Collins or Schwartz, then they're going to want to deal.  Sending back $125bn in 2023 and hoping to receive cash 10 years later is remote odds, maybe 10%.  that leaves 90% odds for a new PSPA, new deal, in this scenario.    Also yellen isn't a jerk.  Finally this is America as TwoCities wrote and at some point the right thing gets done - after all the current market cap of all public common + pref is currently 6 months of FnF earnings -- there are ways to pay us off if all else fails."

 

Plaintiffs have asked for accounting entry as remedy.  Not sure how much Treasury has, but I don't have confidence that this is a sufficient impediment. 

 

I see your points.  But they are soft points as far as I am concerned and not an investible thesis. 

[investorG]

The current warrants are 'magic' and so they already needed to be exercised before any capital raise -- nothing new here.

[Guest cherzeca]

there seems to be posters who believe that if Collins is a win for Ps and remedy is to void SP, then this last letter agreement somehow revives the SP.  a collins win will result in the retirement of the SP so that, imo, this letter agt will relate to a security that no longer exists.  all of this language will become as void as the security that it relates to will have become

[investorG]

there seems to be posters who believe that if Collins is a win for Ps and remedy is to void SP, then this last letter agreement somehow revives the SP.  a collins win will result in the retirement of the SP so that, imo, this letter agt will relate to a security that no longer exists.  all of this language will become as void as the security that it relates to will have become

 

wouldn't Tsy have the option to send $125bn and keep the sr pref?  This was in original PSPAs before 3rd amend NWS.  I do think though they would rather cancel the SPS than send the $125bn and then hopefully your statement would be accurate.

[Guest cherzeca]

I agree with this, as expressed on TH's blog:

 

Tim

 

there is some question in my mind as to the enforceability of many of these letter agreement provisions if SCOTUS gives Ps a win…which can lead to a T obligation owed to the GSEs in an amount in excess of the senior preference amount both FHFA and T presume to be outstanding. put another way, if the 3rdA is found to be invalid which gives rise to a massive T obligation (in an amount in excess of the preference amount which was presumed to be outstanding), are these letter agreement provisions what FHFA as conservator would have negotiated? when there is a massive misunderstanding of fact between the parties, agreement provisions based upon this massive misunderstanding of fact often are subject to attack. Yes, more litigation if these provisions are not revised in a post-SCOTUS win negotiation.

 

rolg

[WB_fan82]

The remedy is tricky here for a Collins win.  If we go back to the original (10% cash, 12% in-kind), it should be noted that there are ZERO provisions for paying down the balance of this instrument.  It seems like the court would not pencil in such a material provision to the preferred that simply isn't there.

 

So Treasury would need to agree to the remedy to consider it paid down....  But would they?!  The alternative would be to send all the cash back to the entities, then figure out if the dividends since the amendment should have been paid 10% in cash or 12% in kind and settle up through a combination of cash back to the entities and/or higher liq. pref. 

 

And then we have to look at the amendment which put the caps to $25B and increased liquidation value, and then the most recent amendment... just rip those up and reduce the liquidation preference accordingly and have FHFA decide how much to pay in cash and how much to pay in kind under the fixed dividends?  It's tricky.

 

And another question for Cherzeca, or anyone.... who determines what legal position the FHFA takes in these cases?  Now that Calabria has no earnings caps and isn't beholden to TSY with a looming cash sweep, can he come out and say that the original cash sweep was outside the power of the conservator and he agrees w/ the plaintiffs that it should be killed?  We know he feels that way in his heart of hearts :)  In-kind sweep does preserve/conserve and that is what he agreed to w/ Mnuchin, so it would be totally consistent for him to do that.  Anyone have a take on that?

[orthopa]

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. 

 

I think you are misunderstanding how the SPS dividend works. The SPS don't get a dividend until FnF hit their full with-buffers capital level of 4% of adjusted total assets, even if a future FHFA director makes a new capital rule due to Section 5.15, unless Yellen and the new FHFA director amend that out. Once full capitalization is reached ("Capital Reserve End Date") the SPS get the lesser of any net worth increase from the previous quarter and 10% of the SPS liquidation preference. But dividends to other classes of shareholders subtract from net worth just as earnings add to it. So once dividends are paid out to other preferred and common shareholders, the SPS gets the rest of what FnF earned in that quarter.

 

What that means, paradoxically, is that the SPS are at the back of the line in terms of dividends once full capitalization is achieved, and the SPS get no dividends at all before that. It remains to be seen how easy or possible it will be to sell new common shares who have zero liquidation preference ever but will get normal utility-like dividends.

 

Without a settlement to the lawsuits and private capital raises the SPS will get no money from FnF for decades. Not even a commitment fee, unless a future FHFA director and UST Secretary reinstate it.

 

Altogether this agreement actually gives Treasury an incentive to move quickly on raising private capital: slow accumulation of retained earnings provides less taxpayer protection (in terms of how much capital stands in front of UST's LOC) compared to fast and large capital raises, and those raises accelerate UST's timeline to getting payments on its SPS.

 

The SPS dividend also answers a question I had, which was "what would FnF do with all their earnings once they hit full capitalization?" I couldn't imagine the government would be okay with private shareholders getting enormous dividends, and FnF would have no reason to save any money past full capitalization anyway. Now we know: UST gets all the extra money.

 

Something else to consider is that 4% of adjusted total assets, the threshold at which the SPS divs turn on, was $265B as of last June and grows with FnF's asset base. I use 2.5% per year as a ballpark. FnF's combined core capital, though, was negative $167B at that time. That's a $432B gap! FnF make around $20B in earnings per year, but the 4% target grows at $6.6B per year right now and faster in the future as the 2.5% increases compound. Carrying out the math, that means not only will FnF not be fully capitalized through retained earnings by 2028, it will never happen at all! The smallest the gap between FnF's core capital and the requirement gets is $72B in 2065, then the compounding of the 2.5% becomes greater than $20B per year and the gap starts to widen again.

 

Now, assuming flat earnings of $20B per year is probably unrealistic. If they also grow at 2.5% per year, which I think is reasonable because FnF's earnings are also roughly proportional to the size of their asset base, the $432B gap closes in a finite amount of time, but not until 2044.

 

Note: only the SPS balance on the balance sheets count (negatively) towards core capital, a total of $193B for FnF combined. Increases to the liquidation preference due to the letter agreements, including the one from Thursday, are not reflected on the balance sheet and thus don't affect core capital at all.

 

Very nice analysis Midas. So on paper in the end, it is the private gain/public losses that could occur.

 

Calabria has stated time and time again the time to fix the roof is when its shining.  With NWS ended as Midas points out Treasury is never in line for an endless stream of dividends but with FnF still leveraged where they are first in line to have to bailout the GSEs again. Im not sure what the excuse would be framed as if the Gov had to bailout FnF again but with a capital rule in place, an eager (for now) FHFA director, FA advisors, etc my assumption would be a stubborn Treasury would be at fault. In the aftermath this may note even matter but it is what it is. 

 

A couple points that come to mind as I continue to think this through.

 

1. The litigation must have either really bothered Mnuchin or he wanted it to be an impetus to something happening. When looking at the conditions for raising capital and leaving conservatorship there are blocks set up. 2 for selling stock. Treasury exercising warrants AND litigation settled. Treasury already had the upper hand in that they have to exercise the warrants. They have till 2028 to do that so could stall all they want but they want the litigation gone too. Same with leaving conservatorship. Have to meet cap levels but with the SPS in place that is a big impediment to raising capital, esp common stock, while in conservatorship. But again Tsy wants the litigation gone too.  My read is that Tsy had blocks on both both explicitly with the warrants and implicitly with selling common in conservatorship without adding anything else. The litigation no matter how much it seems to us does not matter, must inside Tsy. They want it gone.

 

2. The more I think about what options Mnuchin had writing down the Sr Preferred from his seat would have been very tough. Calabria with his objectives its a no brainer.  If optics matter much easier to have SCOTUS throw down the hammer then cave. Does treasury in the end feel like they will have to retire SPS either now or in April after consultation with the DOJ? The answer in believe is in their requests in the letter agreement. I also think the decision to discuss restructuring of the SPS in the late summer/fall time frame per the LA will be quite obvious if SCOTUS rules for plaintiffs and there is a 120B decision coming.

 

3. Not sure how much to actually take from the Treasury blueprint or end of the LA but it does make you feel warm and fuzzy. Not sure how binding this is at all and if not ignore this but Treasury admits in the end the SPS have to go away, third party capital will be raised, and that distributions will be made as appropriate. I could be wrong but if both FHFA and Tsy signed the LA they cant just pick and choose what parts are agreed upon and enforceable. If its in the text that the LA is tied to Calabrias Capital rule can either just ignore that? The word endeavor here isnt great.

 

4. In regards to investorGs pointing out Mnuchins flip flop on CD I never for one believed that Treasury was ever up for negotiations. Is the Tsy who do they negotiate with????? There have been a couple rumors of this with Berkowitz a while back in an annual letter and others but Treasuries request in the LA has me thinking otherwise. Since when does Tsy ask for lawsuits to go away? SCOTUS surely is a gamble for plaintiffs but if negotiations did truly take place at some level they told Mnuchin to go kick rocks. All speculation of course and probably worthless to think about but whatever.

 

5.This LA no doubt is complex but as Midas points out Tsy really has nothing to gain now by waiting. No commitment fee, an escrow account of liquidation preference they may never get their hands on, requests for ending exposure to material lawsuits at the SCOTUS, and exposure as the largest shareholders of severely undercapitalized entities that underpin the US housing market.

 

6. Bidens team has been reported as not in a rush to do anything on housing but if Yellen really was looped in on this (she is not my new savior by any means) and the new Tsy understands where the incentives are hopefully someone lets the Biden team know what the GSEs really represent now to Tsy. If SCOTUS goes for plantiffs 3 months from now they could hold an escrow account with an up to 120B liability attached to it and be responsible as the unreimbursed back stop if the economy takes a shit. What gets them out is making $$$ via warrants and getting paid for what they are doing now anyway in a commitment fee.

[investorG]

I don't know how to reconcile the dozens of signs we received for 4+ years including up to the Dec 1-2 congressional testimony with Thursday's letter agreement except to believe that during negotiations in the first 2 weeks of December there was too large of a bid - ask between mnuchin/DOJ and plaintiffs on how much sr pref to forgive without the SC verdict cover.  I can easily imagine Berkowitz demanding a full deal given his wealth and patience and that was perhaps a bridge too far for the govt.

 

Bye Mnuchin.  You failed and your inaction likely cost Trump re-election bc a partially capitalized and free-wheeling FnF would have likely boosted the economy enough to deliver the 40k total votes Trump needed in the swing states.  But it could have been worse, at least you raised the caps to $280bn instead of $80bn, so thank you for that. 

 

Yellen speaks @ 10am tmrw.

 

[muscleman]

The administrative resolution hope is gone. Only counting on legal battles. But the US is no longer the US in the old days and the separation of power is quickly eroding. I am seeing the US quickly turning into China where the government has unlimited power of both modifying laws and explaining laws, which is exactly what happened in the November election. I am sure Chris agrees with this.

 

[undervalued]

I am holding and pretty much agreed with Michael here https://twitter.com/urbankaoboy/status/1351185902207426563?s=21

 

Like COBFInifinity said, if going to 0 is unlikely all we need to do is wait. Which series do you like COBF?

[typicalvalue]

I am holding and pretty much agreed with Michael here https://twitter.com/urbankaoboy/status/1351185902207426563?s=21

 

Like COBFInifinity said, if going to 0 is unlikely all we need to do is wait. Which series do you like COBF?

 

+1 was just going to post this. Michael is smart guy and like most of his thoughts on JPS.

[investorG]

I am holding and pretty much agreed with Michael here https://twitter.com/urbankaoboy/status/1351185902207426563?s=21

 

Like COBFInifinity said, if going to 0 is unlikely all we need to do is wait. Which series do you like COBF?

 

+1 was just going to post this. Michael is smart guy and like most of his thoughts on JPS.

 

I don't see anything happening until after the Collins SC ruling.  The Sep30 date aligns with this view.

[COBFInfinity]

I am holding and pretty much agreed with Michael here https://twitter.com/urbankaoboy/status/1351185902207426563?s=21

 

Like COBFInifinity said, if going to 0 is unlikely all we need to do is wait. Which series do you like COBF?

 

I don't think I said that. I did say that the few preferreds that have low floating rate coupons (some of which would actually be 0% right now) are bad bets.

 

I think everything with a fixed coupon of 4.5-6.0% is where the best values are. It is possible, but I don't think certain, that the even higher coupon issues will get better terms down the line, but you have to pay up for it, which I choose not to do.

 

The interesting question now is should we actually have a preference for Freddie preferreds over Fannie? Based on the $70 billion capital raise limit before SPS paydown is required, Fannie is constrained from exiting conservatorship a lot longer than Freddie. But if the preferreds get exchanged as part of a settlement at the same time, then it may not matter that much as to the actual end date of the conservatorship. Mr. Market didn't make any distinction between the two on Friday, but that was just one day. Does anyone think there will be some price separation favoring Freddie in the near term?

[investorG]

I am holding and pretty much agreed with Michael here https://twitter.com/urbankaoboy/status/1351185902207426563?s=21

 

Like COBFInifinity said, if going to 0 is unlikely all we need to do is wait. Which series do you like COBF?

 

I don't think I said that. I did say that the few preferreds that have low floating rate coupons (some of which would actually be 0% right now) are bad bets.

 

I think everything with a fixed coupon of 4.5-6.0% is where the best values are. It is possible, but I don't think certain, that the even higher coupon issues will get better terms down the line, but you have to pay up for it, which I choose not to do.

 

The interesting question now is should we actually have a preference for Freddie preferreds over Fannie? Based on the $70 billion capital raise limit before SPS paydown is required, Fannie is constrained from exiting conservatorship a lot longer than Freddie. But if the preferreds get exchanged as part of a settlement at the same time, then it may not matter that much as to the actual end date of the conservatorship. Mr. Market didn't make any distinction between the two on Friday, but that was just one day. Does anyone think there will be some price separation favoring Freddie in the near term?

 

Yes this is possible.  But Freddie doesn't even have a permanent CEO currently.  Given the last bullet in the Treasury Department Blueprint, there is some real chance that the Biden admin's tentative plans are a merged utility and Yellen asked the prior admin to give that concept an initial nudge.

 

edit: Mel Watt formally pushed utility in Jan 2018.

[Midas79]

there seems to be posters who believe that if Collins is a win for Ps and remedy is to void SP, then this last letter agreement somehow revives the SP.  a collins win will result in the retirement of the SP so that, imo, this letter agt will relate to a security that no longer exists.  all of this language will become as void as the security that it relates to will have become

 

That's now how I understood it.

 

[*]FnF never had (and currently does not have) the ability to pay down the seniors voluntarily because the funding commitment still exists: this is in Section 4(a) of the original contract that is not being contested. More technically, they can't pay down liquidation preference increases due to draws, which have been the source of all such increases. Thus the proposed remedy that pays down the seniors violates the original contract, while the other remedy (UST keeps the seniors but sends back $125B) respects it. Why would the Fifth Circuit choose the former over the latter in that light?

[*]The funding commitment, whose removal could very well collapse the housing market, is tied to the existence of the seniors. Extinguishing the seniors entirely would alter large parts of the original contract, and I would imagine even the plaintiffs don't want this. Writing the liquidation preference down to its original value of $1B helps, but then the 1:1 increases in last week's letter agreement as FnF retain capital would stay in force.

[*]My interpretation of the questions before SCOTUS is that they won't be determining the form of backward relief on the constitutional claim anyway, only if it should be available; the form would be remanded back down to the Fifth Circuit. Is this correct?

[*]The same reasoning applies to the APA claims. On that front SCOTUS is only being asked if the APA claims should be dismissed due to either 4617(f) or the succession clause. A victory for the plaintiffs there merely means upholding the Fifth Circuit's ruling on that front, remanding the case back down the Judge Atlas, right?