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

[constructive]

 

Well, they certainly appear profitable now. But that's only in the context of the Treasury's enormous financial support over the last 5 years, in exchange for the preferred shares. Take the Treasury's support away at any point between 2008 and 2012 and the companies would have immediately imploded.

 

 

The government was issued Government Preferred Shares. Perry Capital and Fairholme Fund own Private Sector Preferred Stock.

 

You and I don't disagree that the government provided aid to the companies in 2008 -- the point is that they were provided with compensation for that aid via the Government Preferred Shares and Government Warrants (amounting to 79.9% of the company's common stock).

 

Yes, sorry if I wasn't clear but I'm aware of the capital structure. I meant that the government poured billions into the companies in exchange for the Senior Preferred Shares.

 

But they did not just provide aid in 2008, they provided $188B over 13 quarters.

 

Of course if you pour enough money into a dead business it will eventually be solvent and profitable. But the fact that it's solvent and profitable now certainly doesn't prove that it was solvent and profitable before pouring money in.

 

 

What do you think public shares were worth in 2012 before the preferred share amendment? I don't think the math ever worked out to a positive value, with the 10% dividend.

 

 

In 2012, Fannie & Freddie were both solvent & had a combined net income of $27 billion -- that amount being more than enough to pay the 10% dividend on the liquidation preference of the Government Preferred Stock. (Correct me if I'm wrong, but I think the liquidation preference is something like $188 billion.) Based on the capital structure, it would seem like the residual would cause the Private Sector Preferred Stock to be worth a positive number that I'm going to say might even approach par.

 

Yes, that's correct. When the senior preferred stock was amended in Q2 2012, FNMA and FMCC had a combined equity of $5.1B, of which $189B was senior preferred (3700%).

 

Together they made $6.9B in Q2 ($27B for the whole year). Now subtract $4.75B quarterly for dividends, shrink the balance sheet by 10% per year (required by the original terms), and subtract the liquidation preference of $189B. How is that a positive number?

 

In order for public preferred and common to have any residual value, income would have to be a lot higher than $6.9B per quarter. More like $13B per quarter.

 

 

I haven't read all the shareholder lawsuits, but here's one that claims placing the companies in conservatorship in 2008 was an unlawful taking.

http://dealbook.nytimes.com/2013/06/17/lawsuit-tries-creative-approach-against-fannie-and-freddie-bailout/?_r=0

 

 

I think that particular lawsuit has very little substance to it -- read the complaints for Perry Capital and Fairholme Fund -- those have to do with the amendment to sweep 100% of profits.

 

I can tell this is not the right investment for me, so I'll leave those complaints to the lawyers.

 

But as a taxpayer, I have to admit I'm rooting for the economic interests of US taxpayers over private shareholders.

[nkp007]

I think what we have here is a case of commonsense perception vs. the technical rule of law.

 

 

Nearly all of America will agree with constructive, no doubt.

[constructive]

I think what we have here is a case of commonsense perception vs. the technical rule of law.

 

 

Nearly all of America will agree with constructive, no doubt.

 

Well, I certainly don't agree with them!  :)

 

Really, I don't think common sense has much to do with this investment at all.

[valuecfa]

Without getting into each of them in any detail, i think that there are several logical legal paths that can and will be taken (some stronger than others). Aside from the very relevant legal aspects of the investment, i think the implied price of certain of these securities is underestimating the probability of success. At a much higher price the asymmetry in risk/reward is not there. At current prices, i like the payoff relative to the implied probabilities.

[merkhet]

 

Of course if you pour enough money into a dead business it will eventually be solvent and profitable. But the fact that it's solvent and profitable now certainly doesn't prove that it was solvent and profitable before pouring money in.

 

 

Don't disagree -- the complaint you referenced is nonsense, and I think the court will probably rule that way. My sense is that the Perry Capital & Fairholme Fund complaints, however, are not nonsense.

 

 

Yes, that's correct. When the senior preferred stock was amended in Q2 2012, FNMA and FMCC had a combined equity of $5.1B, of which $189B was senior preferred (3700%).

 

Together they made $6.9B in Q2 ($27B for the whole year). Now subtract $4.75B quarterly for dividends, shrink the balance sheet by 10% per year (required by the original terms), and subtract the liquidation preference of $189B. How is that a positive number?

 

In order for public preferred and common to have any residual value, income would have to be a lot higher than $6.9B per quarter. More like $13B per quarter.

 

 

And, in fact, they have made a good amount of money per quarter in the quarters following.

 

Think of it this way -- let's say you plant some orange trees in a grove. The trees have been planted but have not borne fruit. The government takes your land -- should they pay you the timber value of your trees? or should they pay you for the loss of your yearly crop? I would say that common sense indicates the latter. Same concept here.

 

 

I can tell this is not the right investment for me, so I'll leave those complaints to the lawyers.

 

But as a taxpayer, I have to admit I'm rooting for the economic interests of US taxpayers over private shareholders.

 

 

The legal aspect makes things complicated for sure -- and provides a bit of a competitive advantage for some of us. As a taxpayer and an American, I would root for Fannie & Freddie to pay back the borrowed capital as quickly as possible but without granting the government too much of a right to get away with exercising eminent domain w/o providing just payment.

[valuecfa]

Fairholme holding report out.

 

Fairx :

0.4% in Fannie and freddie common

6.5% in the prefs.

 

FAAFX:

0.7% in Fannie/freddie common

11.6% in the prefs

 

FOCIX:

nada, but it is interesting to see some JCP debt in there along with all that cash.

 

11.6% in FAAFX is quite the show of confidence

[Grenville]

ValueCFA,

 

It looks like he's got them in FOCIX as well, just not at May 31st. See below:

 

Our focused income strategy is proving successful.

Today, 62% of the Fund’s net assets are in cash and cash equivalents. Sears bonds maturing in 2018 are the Fund’s largest non-cash holding, at 23% of net assets, followed by the preferred stock of Fannie Mae and Freddie Mac, at 6% of net assets, and J.C. Penney bonds maturing between 2015 and 2017, at 4% of net assets. MBIA bonds were sold in the period, resulting in an above average return.

[valuecfa]

ValueCFA,

 

It looks like he's got them in FOCIX as well, just not at May 31st. See below:

 

Our focused income strategy is proving successful.

Today, 62% of the Fund’s net assets are in cash and cash equivalents. Sears bonds maturing in 2018 are the Fund’s largest non-cash holding, at 23% of net assets, followed by the preferred stock of Fannie Mae and Freddie Mac, at 6% of net assets, and J.C. Penney bonds maturing between 2015 and 2017, at 4% of net assets. MBIA bonds were sold in the period, resulting in an above average return.

 

Just noticed that... continued:

 

The Fund’s latest investments in the recovery of homeownership are in the preferred stocks of Fannie Mae and Freddie Mac. Your current

mortgage may be backed by Fannie or Freddie – about 60% of new mortgages are. Millions of families depend on them to lower the costs and

increase the availability of homeownership. In times of stress, Fannie and Freddie stand to ensure the continued functioning of our housing

market. Their twelve thousand employees do yeoman’s work helping to preserve a cornerstone of the American dream.

The Fund was able to purchase the preferred stocks of Fannie and Freddie near one-fifth of liquidation values – a significant bargain thanks to

market predictions of U.S. Government agencies expropriating their assets.

w

e see them differently. Fannie and Freddie are successful, publicly

traded, shareholder-owned companies just like AIG and Bank of America. Shifting political winds can change their futures, but not alter their

pasts.

The Fund has filed complaints in the court of Federal claims and the U.S. District court in washington. In our suits, we seek nothing more

than the enforcement of existing contractual rights, which require the payment of dividends to Fannie and Freddie preferred shareholders.

Our arguments are based on fundamental principles. In America, property ownership is a sacrosanct freedom,

guaranteed by our Constitution. In America, we follow the rule of law, not the rule of the crowd. In America, profitable companies honor contracts.

 

Preferred stocks of Fannie and Freddie are a growing opportunity in credit arbitrage. Millions of families depend on Fannie and Freddie to lower

the costs and increase the availability of homeownership. In times of stress, Fannie and Freddie stand to ensure the continued functioning of our

housing market. Their twelve thousand employees do yeoman’s work helping to preserve a cornerstone of the American dream

[rpadebet]

I must admit, I never once thought about the employees and jobs angle here. That is a potential political counterweight to the political argument about the bail out.

[nkp007]

Check out the attached snapshot of repayments.

 

If Freddie reverses the writedown of tax assets, things will get very interesting very quickly.

[indythinker85]

 

 

Bruce Berkowitz, a mutual-fund manager with a history of bold bets, is doubling down on a risky wager that the U.S. government ultimately will sell mortgage giants Fannie Mae FNMA +7.32% and Freddie Mac FMCC +9.65% back to private investors.

 

Mr. Berkowitz is reopening his $8 billion Fairholme Fund to look for new investment opportunities, including potentially increasing his stake in Fannie and Freddie, Mr. Berkowitz said in an interview with The Wall Street Journal.

 

Mr. Berkowitz said he continues to believe Fannie and Freddie are a "very important element of the U.S. economy" and undervalued. "We haven't found a way to disprove our thesis about Fannie and Freddie," he said.

http://online.wsj.com/article/SB10001424127887324139404579015032274244954.html

[fareastwarriors]

 

 

Bruce Berkowitz, a mutual-fund manager with a history of bold bets, is doubling down on a risky wager that the U.S. government ultimately will sell mortgage giants Fannie Mae FNMA +7.32% and Freddie Mac FMCC +9.65% back to private investors.

 

Mr. Berkowitz is reopening his $8 billion Fairholme Fund to look for new investment opportunities, including potentially increasing his stake in Fannie and Freddie, Mr. Berkowitz said in an interview with The Wall Street Journal.

 

Mr. Berkowitz said he continues to believe Fannie and Freddie are a "very important element of the U.S. economy" and undervalued. "We haven't found a way to disprove our thesis about Fannie and Freddie," he said.

http://online.wsj.com/article/SB10001424127887324139404579015032274244954.html

 

classic Bruce

[nkp007]

BB normally uses some of the best attorneys on the planet. I bet he's getting some good advice.

[BargainValueHunter]

http://online.wsj.com/article/SB10001424127887324139404579015032274244954.html

 

Under mutual-fund regulations, Mr. Berkowitz could invest up to 25% of Fairholme's portfolio each in Fannie and Freddie, although he has no plans to reach that maximum amount as it would require him to reduce his other positions, he said. A more realistic scenario would see him increasing his position to about 5% each of the portfolio, or a total of $800 million based on the value of the shares today, he said.

[nkp007]

http://online.wsj.com/article/SB10001424127887324823804579015100418242862.html#articleTabs%3Darticle

 

Fannie Mae's New Fans:

 

President Obama said last week that he wants Congress to close down Fannie Mae FNMA +0.74% and Freddie Mac FMCC -0.79% . But that doesn't faze Bruce Berkowitz, the manager of the $8 billion Fairholme mutual fund, who says he's bullish on the government-run mortgage bailout twins and wants to increase his investment.

 

Our Journal colleagues report that Mr. Berkowitz thinks the mortgage giants are "a very important element of the U.S. economy" and that Congress will choose not to shut them down and will eventually spin them off to private investors.

 

This is not good news, but it is predictable. As the housing market recovers, Fan and Fred are making money again, and private investors smell an easy political mark. Like Mr. Berkowitz, they figure Congress will find it impossible to resist the attraction of some kind of Fan and Fred cashout, which would give the politicians more money to spend. These private investors, in turn, will become another political force against winding down the toxic twins.

 

This is one reason among many that we urged Hank Paulson, the Treasury Secretary in 2008, to put the companies in receivership. He chose conservatorship instead, which means the companies can return from the dead to haunt the capital markets again. The combination of private profit and public risk is what made Fan and Fred so politically powerful, and so economically destructive, and here we go again.

 

A version of this article appeared August 16, 2013, on page A12 in the U.S. edition of The Wall Street Journal, with the headline: Fannie Mae's New Fans.

 

And an interesting comment on the WSJ online comment board for the article by "Fred Fraenkel"

 

Fred Fraenkel Wrote:

 

 

Analysis weak on two counts:

 

1. This editor is wiling to "throw away" a system that has over a 70 year period of time created more housing units per capita, larger housing units per capita, and higher quality housing units than any on the face of the earth. One of the few government private collaborations with this type of track record. Contrary to the partisan hype this HAS NOT COST TAXPAYERS ONE PENNY. The loan from taxpayers has already been repaid 75% and will be fully 100% repaid by next year. Pretty darn impressive for a once every 70 year bailout of institutions that the GOVERNMENT MANDATED to become the lender of last resort during the emergency of 2008 and 2009. A depression would have been locked if Fannie and Freddie didn't continue to provide liquidity to the housing market through the great recession. Even the most ardent F&F opponents acknowledge that government loses one of its major abilities to fight recession without the GSE's.

 

2. Fiscal conservatives get up on their high horse about government involvement in the housing market but jump over the confiscation of private property that the government unilaterally imposed in August of 2012 when Treasury simply decided, with no explanation or legal rationale, to take 100% of the profits forever of companies that were and are privately owned with publicly traded securities.

 

There is nothing wrong with reforming GSE's back to their original insurance purpose. But throwing away the baby with the bathwater would be a mistake of epic proportions.

 

Most likely this Fred Fraenkel: http://en.wikipedia.org/wiki/Fred_Fraenkel

[muscleman]

Has anyone initiated a long position?

I am wondering if Obama closes these two twins, he will wipe out the common and repaid the preferred, or will he wipe out the preferred as well?

[merkhet]

We should be seeing a response in the litigation within the next two weeks or so. I've been waiting with baited breath...

[Grenville]

We should be seeing a response in the litigation within the next two weeks or so. I've been waiting with baited breath...

 

Hi merkhet,

 

Where can I follow this? Is there a court website that I can tack the progress of the case?

 

Thanks!

[thecynic]

Where can I follow this? Is there a court website that I can tack the progress of the case?

 

Not a lawyer, but you can track the case Perry Capital filed online at http://www.pacer.gov/. The case number is 1:13-cv-01025-RLW. The site requires a credit card to register but it won't charge you unless the charges exceed $15 per quarter.

[Grenville]

Where can I follow this? Is there a court website that I can tack the progress of the case?

 

Not a lawyer, but you can track the case Perry Capital filed online at http://www.pacer.gov/. The case number is 1:13-cv-01025-RLW. The site requires a credit card to register but it won't charge you unless the charges exceed $15 per quarter.

 

Awesome! Thank you.

 

I see the respond by date for the government. I'm still looking for any scheduled date for responses. Is there a good way to know when new items have been posted or will be posted?

 

I appreciate the heads up on the cost info.

[Grenville]

www.pacer.gov --> A very useful site! Thanks again for the info!

 

Some information I found:

 

1) Fairholme has two complaints in the courts: Fairholme vs USA (US Court of Federal Claims) & Fairholme vs FHFA (District Court of DC, Similar to Perry)

 

2) There are three cases moving in parallel in the District Court of DC

--> Allege violations of Administrative Procedure Act

a. Perry vs Lew

b. Fairholme v FHFA

c. Liao v Lew (consolidation of 4 plaintiffs)

 

3) There are five cases moving through the US Court of Federal Claims against the US including Fairholme

--> These allege an uncompensated taking under the Fifth Amendment

---

I've found the both complaints for Fairholme and Perry Capital online. I have attached the initial complaint of Liao (not the consolidation). I haven't read the complaint from Liao or Fairholme, but I've read the Perry Capital one and it reads well.  Let me know if we aren't allowed to post these complaints.

 

I'm no legal expert so I might have my description of things off, I used the motion to stay in the Fairholme v USA case to summarize the two different courts.

Liao_v_Lew_Complaint.pdf

[nkp007]

Great article in the FT about F+F.

 

http://www.ft.com/intl/cms/s/2/b6f87b18-0f14-11e3-8e58-00144feabdc0.html#axzz2dvYgLRDA

[fareastwarriors]

http://video.cnbc.com/gallery/?play=1&video=3000196230

 

Bruce Berkowitz on CNBC.

[Grenville]

Great article in the FT about F+F.

 

http://www.ft.com/intl/cms/s/2/b6f87b18-0f14-11e3-8e58-00144feabdc0.html#axzz2dvYgLRDA

 

Agreed. Enjoyed the comments from the politicians.

[fareastwarriors]

Life Without Fannie Mae and Freddie Mac

 

http://www.nytimes.com/2013/09/08/realestate/life-without-fannie-mae-and-freddie-mac.html