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

[merkhet]

I think the preferreds go to $20 or more. But, again, handlebar mustache.

 

I have a view on the intrinsic value. But the market value shortly after invalidation? Tough to tell.

[morningstar]

"immeasurable loss to the rule of law"

 

these kinds of statements irk me a bit because its largely just rhetoric and should have no bearing on the investment decision. will the government actually start trampling over shareholders left and right if they win these lawsuits? of course not. it sets a bad precedent for sure, and yes it justifies indignation and outrage, but cmon, we're all just trying to make a buck here

 

Yes, I sort of agree on rhetoric -- but I think the point is that if the holding ends up being that preferred shareholders can bilaterally, with the agreement of management, decide that they will transform their preferred shares into new common shares that are above the rest of the capital structure, that's going to be bad for the stability of companies in general.

 

Theoretically, the very next day, I would go out and start picking up preferred shares and contacting management to carve up companies 50-50. (Change my preferred dividends to a full sweep, and I will vote to increase your pay by a ton!) A few unscrupulous management teams will probably go for it!

 

I'm not sure this is much different than buying a bunch of debt and contacting management teams to file Chapter 11 with a restructuring agreement that gives me the equity - a pretty well established tactic. Doesn't really matter for the stability of companies in general because almost all companies are solidly solvent and therefore very difficult to this type of attack.

 

I think if the NWS were eliminated by a court the preferreds would go to around $17-18 at the moment. Very little chance I would think of dividends starting again in the next several years even absent the sweep, given that there is no current traction in Congress to reform the system. Clearly, however, they should trade well ahead of the ~$10-11 where FNMAS was trading pre-Lamberth.

[Guest cherzeca]

i dont see how the fnma common gets a 3x bump and the pref gets a 5-6x bump.  while the 5-6x might be right for pref, common should have a greater multiplier. i say that for a number of reasons.

 

first, the common is more leveraged than the pref, and both are non dividend paying for the foreseeable future, so they are really a senior and junior tranche of common.  if the equity gets good news, typically the more leveraged junior tranche does better than the more senior tranche.

 

second, while the effect of any recap is hard to predict, i dont see it being more onerous on the common than pref.  i think new capital will come from retained earnings and new pref senior to the junior, but who knows for sure. and i think recap considerations will not come into play very quickly

 

third, i think berk and perry (pref) will be very weak holders after any litigation win, and sell very quickly, while ack (common) is more likely to hold.  ack might even call the fnma common a platform holding.  i was in mbi when it was litigating against bac, and when that settled, berk blew out about $500MM in four hours.  i think the pref is not as liquid as common, and selling in the pref will have more adverse effect than selling in common.

 

fourth, i think you will start to see people comment that the GSEs are suddenly investable again, and you are going to see much more interest from the buy side, and i think this buying will naturally gravitate to the common.  the preferred will no longer have appeal to someone who believes that the GSEs will live on.

[maverick]

I am not long Fannie or Freddie. Therefore, let me try to challenge the longs (no hard feelings please) and they could perhaps convince me to take a long position. The only reason Fannie and Freddie are still around is due to the government bailout. If not, then the equity and preferreds would have been wiped out. The US Treasury is getting a lot of money from these enterprises now. The longer this has gone on, less is their motivation to spin them back as private enterprises. Further, Fannie and Freddie are shedding most of their risk on newly originated mortgages to the private investors. The government is on hook only for a scenario of catastrophic loss. How will the will to wind them down come if the government is minting money while only exposed to catastrophic losses. To me it appears like a lottery ticket. I am fine to take a position with OPM but will not put my own money into this.

[doughishere]

Think of the prefers like a bond. With an interest component. It should go to par before the common even goes to 1c

[Guest cherzeca]

Think of the prefers like a bond. With an interest component. It should go to par before the common even goes to 1c

 

couldn't disagree more.  non-cumulative pref is like senior common, which is why warren buffett spits on non-cumulative prefs.  if NWS is invalidated, $90B value drops to fnma pref and common.  if pref was cumulative pref and it had a huge accumulated dividend, then pref would go to par. 

[Luke 532]

I put the odds of God having a handlebar mustache at 60%. Don't ask me why.

 

I have a Master's in Theological Studies... the answer is 62% chance of a handlebar mustache.

[doughishere]

Think of the prefers like a bond. With an interest component. It should go to par before the common even goes to 1c

 

couldn't disagree more.  non-cumulative pref is like senior common, which is why warren buffett spits on non-cumulative prefs.  if NWS is invalidated, $90B value drops to fnma pref and common.  if pref was cumulative pref and it had a huge accumulated dividend, then pref would go to par.

 

Class a shares and class b shares. I can see that. Class a still gets a "par" dividend before class b's get anything

[Picasso]

I am not long Fannie or Freddie. Therefore, let me try to challenge the longs (no hard feelings please) and they could perhaps convince me to take a long position. The only reason Fannie and Freddie are still around is due to the government bailout. If not, then the equity and preferreds would have been wiped out. The US Treasury is getting a lot of money from these enterprises now. The longer this has gone on, less is their motivation to spin them back as private enterprises. Further, Fannie and Freddie are shedding most of their risk on newly originated mortgages to the private investors. The government is on hook only for a scenario of catastrophic loss. How will the will to wind them down come if the government is minting money while only exposed to catastrophic losses. To me it appears like a lottery ticket. I am fine to take a position with OPM but will not put my own money into this.

 

This is where I stand as well, minus putting OPM in it.  But I take it a step further with this logic:

 

If FNMA/FMCC are such great businesses, then why would the government have any incentive to give them back to private investors?  We as public investors took on the risk (FNMA/FMCC may not have worked out and we'll see how legal the NWS is) and now that things look better, the private investors wants the upside again?  Where were these private investors back in 2009?

 

And if FNMA/FMCC are that vulnerable and need to be recapitalized without a NWS, why does the government want to give them back to private investors when no one is big enough to cover the losses when something catastrophic happens? 

 

Just seems like a tough sell to me.  The government (and by extension, the public) deserves to reap all the upside given how much risk they were taking on.  They might have changed the rules a bit mid-game but 2009 was extraordinary and they can pretty much call all the shots after what they had to do to fix the mess, albeit one they helped create. 

 

Anyway I know it's a touchy subject but that's where I put the FNMA/FMCC complex in my too hard bucket.

[deadspace]

Lots of music information here

1) even the notion that GSEs were in need of a bail out is questionable  This depends on what you assume their losses would be.  Most of these "losses" were accounting losses that never occurred

2) if they did need a bail out the rules in play were that a sliver of equity remained.  Government statements at the time made it clear that this ownership was intact. That if the GSEs returned to profitability the equity would be worth something

3) 10% was charged to the GSE vs 5% for the banks

4) when it became clear that all the accounting losses were to be reversed in 2012 the net worth sweep was put into action so it would flow to treasury

By this mechanism you could bankrupt almost any company.  So be careful when you defend this move

There could be many other companies the government may want to own in the future.

[Picasso]

Got it, so the question is, if there was no bailout how exactly was FNMA supposed to fund themselves and at what rates?  I recall them having to shove preferred stock at 8% down the throats of poor retail investors in late 2008.  Isn't it more reflexive than just accounting losses when FNMA had access to a cheaper cost of capital from the not-100%-implicit government backstop?  So 5% versus 10% or NWS versus no-NWS ignores the hidden costs to the government from having the prior arrangement? 

 

In some sense, decades of private investors benefited from the arrangement until 2009.  Those unlucky investors in FNMA/FMCC got shafted but it was going to happen at some point, no? 

 

As far as the questionable nature of the bailout, it happened and no one fought against it then?  Where was all the private capital that could have bid a higher price, etc?  The losses ended up being a lot of the "accounting" type only because of what the government had to do to step in.  In some sense it was like taking risk across a whole portfolio (banks, AIG, FNMA, etc) and there were certain parts that were harder to leave untouched.  The overall result has been fantastic (maybe not for the zerohedge guys) but that wasn't a guaranteed outcome.  Despite all the injections, there was still risk that was taken on.

 

Anyway just trying to understand this a bit better and maybe my thought process is all off.

[deadspace]

I'm not sure this was an offer that could be refused

As an example tell me why Wells Fargo didn't refuse their bailout? They clearly didn't need it

 

Why does Bernake testify to congress that the GSEs are well capitalized weeks before

 

In 2012 there was no reason to activate a net worth sweep. They were about to turn profitable. And the treasury had the option of taking "in kind" rather than cash dividends. No independent conservator would have approved this deal seeing that the market was turning and that there were other options to pay dividends

 

Here's the truth.  They chose the wrong dividend rate.  To kill them they should have chose 20%. But they chose 10%.  They screwed up.  And in 2012 by the time they realized it they needed to get creative. 

 

 

Got it, so the question is, if there was no bailout how exactly was FNMA supposed to fund themselves and at what rates?  I recall them having to shove preferred stock at 8% down the throats of poor retail investors in late 2008.  Isn't it more reflexive than just accounting losses when FNMA had access to a cheaper cost of capital from the not-100%-implicit government backstop?  So 5% versus 10% or NWS versus no-NWS ignores the hidden costs to the government from having the prior arrangement? 

 

In some sense, decades of private investors benefited from the arrangement until 2009.  Those unlucky investors in FNMA/FMCC got shafted but it was going to happen at some point, no? 

 

As far as the questionable nature of the bailout, it happened and no one fought against it then?  Where was all the private capital that could have bid a higher price, etc?  The losses ended up being a lot of the "accounting" type only because of what the government had to do to step in.  In some sense it was like taking risk across a whole portfolio (banks, AIG, FNMA, etc) and there were certain parts that were harder to leave untouched.  The overall result has been fantastic (maybe not for the zerohedge guys) but that wasn't a guaranteed outcome.  Despite all the injections, there was still risk that was taken on.

 

Anyway just trying to understand this a bit better and maybe my thought process is all off.

[doughishere]

Think of the prefers like a bond. With an interest component. It should go to par before the common even goes to 1c

 

couldn't disagree more.  non-cumulative pref is like senior common, which is why warren buffett spits on non-cumulative prefs.  if NWS is invalidated, $90B value drops to fnma pref and common.  if pref was cumulative pref and it had a huge accumulated dividend, then pref would go to par.

 

I'm going to take that back I'm pretty sure that contractually in a bankruptcy that the prefereds have to be made whole before the common gets their "thin sliver of hope"

 

Class a shares generally equate to a higher voting rights than class b. So BrKa get something like 70 vote to every 1 the class b.

[doughishere]

Prefereds shares get the seniority, par value and contractual coupon rate. Common shares get the right to vote plus the non capped upside

[merkhet]

"immeasurable loss to the rule of law"

 

these kinds of statements irk me a bit because its largely just rhetoric and should have no bearing on the investment decision. will the government actually start trampling over shareholders left and right if they win these lawsuits? of course not. it sets a bad precedent for sure, and yes it justifies indignation and outrage, but cmon, we're all just trying to make a buck here

 

Yes, I sort of agree on rhetoric -- but I think the point is that if the holding ends up being that preferred shareholders can bilaterally, with the agreement of management, decide that they will transform their preferred shares into new common shares that are above the rest of the capital structure, that's going to be bad for the stability of companies in general.

 

Theoretically, the very next day, I would go out and start picking up preferred shares and contacting management to carve up companies 50-50. (Change my preferred dividends to a full sweep, and I will vote to increase your pay by a ton!) A few unscrupulous management teams will probably go for it!

 

I'm not sure this is much different than buying a bunch of debt and contacting management teams to file Chapter 11 with a restructuring agreement that gives me the equity - a pretty well established tactic. Doesn't really matter for the stability of companies in general because almost all companies are solidly solvent and therefore very difficult to this type of attack.

 

I think if the NWS were eliminated by a court the preferreds would go to around $17-18 at the moment. Very little chance I would think of dividends starting again in the next several years even absent the sweep, given that there is no current traction in Congress to reform the system. Clearly, however, they should trade well ahead of the ~$10-11 where FNMAS was trading pre-Lamberth.

 

Main difference here is that in a bankruptcy proceeding everyone in the capital stack has various protections via bankruptcy laws...

 

Also, FNMA was very solvent in 2012.

[morningstar]

Got it, so the question is, if there was no bailout how exactly was FNMA supposed to fund themselves and at what rates?  I recall them having to shove preferred stock at 8% down the throats of poor retail investors in late 2008.  Isn't it more reflexive than just accounting losses when FNMA had access to a cheaper cost of capital from the not-100%-implicit government backstop?  So 5% versus 10% or NWS versus no-NWS ignores the hidden costs to the government from having the prior arrangement? 

 

In some sense, decades of private investors benefited from the arrangement until 2009.  Those unlucky investors in FNMA/FMCC got shafted but it was going to happen at some point, no? 

 

As far as the questionable nature of the bailout, it happened and no one fought against it then?  Where was all the private capital that could have bid a higher price, etc?  The losses ended up being a lot of the "accounting" type only because of what the government had to do to step in.  In some sense it was like taking risk across a whole portfolio (banks, AIG, FNMA, etc) and there were certain parts that were harder to leave untouched.  The overall result has been fantastic (maybe not for the zerohedge guys) but that wasn't a guaranteed outcome.  Despite all the injections, there was still risk that was taken on.

 

Anyway just trying to understand this a bit better and maybe my thought process is all off.

 

Having been bearish on this thread for awhile, I tend to agree with this. The GSEs incontrovertibly required a bailout, in my view; in fact they had been bailed out from day 1. The question is whether the US implicitly guaranteeing the debt was a  sufficient bailout. I do think there's plenty of room to dispute this from a market perspective, but the fact (which equity holders knew all along) is that the companies exist and function at the sufferance of the Government. They still do. So when the government says hop, the GSEs hop and the FHFA in assuming the powers of their boards has slid comfortably into that role. Ultimately that's why I'm skeptical a court would say, for instance, that the Sweep was a failure of fiduciary duty - it's hard to negotiate with someone who is at once your controlling shareholder, your only creditor, and your only customer.

[Luke 532]

It is an extremely difficult argument to make that the 2012 NWS was legal, given that one has read the filings from all the court cases.

 

I only own prefs (no common) for the simple fact that the possibility exists that common gets heavily diluted.  Win in court and not win on share price... not a risk I'm willing to take when prefs are trading at 9%-13% of par.

[Jurgis]

Since people are asking, I pretty much agree with maverick's, morningstar's, and Picasso's positions.

 

I also find the propaganda of some longs that government's actions destroyed US, capitalism and apple pie to be distasteful. It's pretty much mind f*cking for your monetary and ideological positions. Edit: I think that government probably should have nationalized GSEs from the very beginning instead of current semi limbo state and 2012 (?) NWS - not that this would have made longs happier.

 

That said, I have a not-16% position because I believe the expected probable return is somewhat attractive. And I will abide with whatever judicial outcome we get. ;)

 

 

It reminds me, that it's not so bad,

It's not so bad

[Guest cherzeca]

"Since people are asking, I pretty much agree with maverick's, morningstar's, and Picasso's positions."

 

actually i asked for pref and common price predictions in event of NWS invalidation, not polemical diatribes and unsubstantiated thought pieces.  and i received responsive $ estimates only from merkhet and hardincap.  which leads me to believe that they are the only two who have given the names any real analysis beyond the twitter/social media level of inquiry 

[Jurgis]

"Since people are asking, I pretty much agree with maverick's, morningstar's, and Picasso's positions."

 

actually i asked for pref and common price predictions in event of NWS invalidation, not polemical diatribes and unsubstantiated thought pieces.  and i received responsive $ estimates only from merkhet and hardincap.  which leads me to believe that they are the only two who have given the names any real analysis beyond the twitter/social media level of inquiry

 

And I was not answering to you. Have a good one.

[hardincap]

@chris all valid points and i think you're probably right re: commons having higher upside at least in the short term after nws invalidation ruling. also if you compare the charts for fnma and fnmas from 1/1/13 to lamberth decision, commons climbed much higher - for a while it was holding double the returns of preferreds.

 

and yeah, its too bad theres no ignore button on here

[Picasso]

I'm not sure this was an offer that could be refused

As an example tell me why Wells Fargo didn't refuse their bailout? They clearly didn't need it

 

Why does Bernake testify to congress that the GSEs are well capitalized weeks before

 

In 2012 there was no reason to activate a net worth sweep. They were about to turn profitable. And the treasury had the option of taking "in kind" rather than cash dividends. No independent conservator would have approved this deal seeing that the market was turning and that there were other options to pay dividends

 

Here's the truth.  They chose the wrong dividend rate.  To kill them they should have chose 20%. But they chose 10%.  They screwed up.  And in 2012 by the time they realized it they needed to get creative. 

 

 

Got it, so the question is, if there was no bailout how exactly was FNMA supposed to fund themselves and at what rates?  I recall them having to shove preferred stock at 8% down the throats of poor retail investors in late 2008.  Isn't it more reflexive than just accounting losses when FNMA had access to a cheaper cost of capital from the not-100%-implicit government backstop?  So 5% versus 10% or NWS versus no-NWS ignores the hidden costs to the government from having the prior arrangement? 

 

In some sense, decades of private investors benefited from the arrangement until 2009.  Those unlucky investors in FNMA/FMCC got shafted but it was going to happen at some point, no? 

 

As far as the questionable nature of the bailout, it happened and no one fought against it then?  Where was all the private capital that could have bid a higher price, etc?  The losses ended up being a lot of the "accounting" type only because of what the government had to do to step in.  In some sense it was like taking risk across a whole portfolio (banks, AIG, FNMA, etc) and there were certain parts that were harder to leave untouched.  The overall result has been fantastic (maybe not for the zerohedge guys) but that wasn't a guaranteed outcome.  Despite all the injections, there was still risk that was taken on.

 

Anyway just trying to understand this a bit better and maybe my thought process is all off.

 

I guess what I'm struggling with (because I get your points to a certain extent) is that this is all being done with the benefit of hindsight.  I think that once the bailout deal was made before the NWS, pretty much anything could be put on the table.  We might live in the United States of America, but there are hundreds of thousands of people in jail or whatever who can tell you that the system isn't always fair, for various reasons.  We shouldn't be waterboarding or torturing people but it happens anyway because the pain of a few is seen as better than pain for millions.  A very, very large amount of people are benefiting from the fact that FNMA guys got "screwed" (hey at least there's still *some* value left for the equity/preferred) but the price had to be paid somewhere.  IMO, I feel terrible for the investors who gobbled up all these preferred ahead of the bailout.  I remember working at a large sell-side firm that was stuffing tons of retail accounts because they were getting paid 3% to do it and rates were so low that it was an easy sell.  As soon as they started trading, they dropped 5 points.  It was a sucker deal. 

[hardincap]

"immeasurable loss to the rule of law"

 

these kinds of statements irk me a bit because its largely just rhetoric and should have no bearing on the investment decision. will the government actually start trampling over shareholders left and right if they win these lawsuits? of course not. it sets a bad precedent for sure, and yes it justifies indignation and outrage, but cmon, we're all just trying to make a buck here

 

Yes, I sort of agree on rhetoric -- but I think the point is that if the holding ends up being that preferred shareholders can bilaterally, with the agreement of management, decide that they will transform their preferred shares into new common shares that are above the rest of the capital structure, that's going to be bad for the stability of companies in general.

 

Theoretically, the very next day, I would go out and start picking up preferred shares and contacting management to carve up companies 50-50. (Change my preferred dividends to a full sweep, and I will vote to increase your pay by a ton!) A few unscrupulous management teams will probably go for it!

 

except its not exactly like that, bc there would be no anti injunction provision that shields management from legal challenges on grounds that they neglected their fiduciary duty to common shareholders

[Sunrider]

Chris H

 

What's your view (and that of those having offered numbers) on the prefs being held as a dividend investment. On some of them, albeit only once full payments start (a few years out?), you'd be getting a 30 - 40% yield on current purchase price. This may be attractive even to Berkowitz?

 

Of course against that we have to hold the fact that management would likely try to refinance those prefs asap--- but I see that the ones Berkowitz holds most of can only be repaid at certain points in time (e.g. Next in 2020). So perhaps on balance it will depend on how close to par they trade upon legal resolution?

 

Thanks.

 

[maverick]

My 2cents on preferreds (since I haven't looked at FN/FH preferreds in detail) - if it's a cumulative preferreds, then they can trade much higher than par as all the missed dividend can get added to the par. Since these are not cumulative preferreds, all they can do it is get close to par and trade at whatever the market yield on preferreds for similar risk profile is. If equity has any residual value then the preferreds will go to par. The beauty of preferreds is that the common can't get any dividend till the preferreds get their dividend. I love preferreds, in general, as a high dividend play.