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

[Jurgis]

Over a one year timeframe, assuming current value of equities invested in preferred

 

1. Restructuring with return to par :50%

Value 2.5x

 

2. Status quo or settlement only favoring plaintiffs 25% (cases go on w same or new plaintiffs)

Value 0.5x. Loss 0.5

 

3. Liquidation without just compensation or other black swan scenario:25%

Value 0 , Loss 1

 

Edge

0.50*2.5  + (0.25*-0.5) + (0.25*-1)

1.25 - 0.375

0.875

 

Odds

2.5

 

Edge/Odds = 0.875/2.5 = 0.35

 

Disclosure Newbie

 

Thanks for your thoughts and numbers.

 

I am more skeptical than you (and most of this board).

I realized that I'm getting close to negative Kelly's. Will probably sell (part or all) if we get more runup.

 

Within some model perturbations Kelly's at current prices goes positive/negative at ~0.4 probability of success.

[DocSnowball]

Your skepticism is valid, personally I still have no clue about the the future - "restructuring" is the operative word (see quote from Republican platform 2016 released at time of convention, and well after Mnuchin came onboard the campaign which was April).

 

I'm basing my 50%+ probability of return to par on the historical base rate of Fifth amendment being honored in this country, I still think it is a very conservative estimate, although you can argue about timing of compensation. Also factor in the the admin/ DOJ does talk to Chuck Cooper who knows the facts. The companies are viable and profitable, despite all efforts to wind them down. If the Government wants to restructure them for public good, it has to give just compensation to the current owners. While this may not be a totally legal investment thesis, the legal part still provides the margin of safety.

 

Quote from page 4:

 

"For nine years, Fannie Mae and Freddie Mac have been in conservatorship and the current Administration and Democrats have prevented any effort to reform them. Their corrupt business model lets shareholders and executives reap huge profits while the taxpayers cover all loses. The utility of both agencies should be reconsidered as a Republican administration clears away the jumble of subsidies and controls that complicate and distort home-buying."

 

Link to original:

http://www.housingwire.com/ext/resources/files/Editorial/Files/DRAFT_12_FINAL1-ben_1468872234.pdf

[Cox022]

Over a one year timeframe, assuming current value of equities invested in preferred

 

1. Restructuring with return to par :50%

Value 2.5x

 

2. Status quo or settlement only favoring plaintiffs 25% (cases go on w same or new plaintiffs)

Value 0.5x. Loss 0.5

 

3. Liquidation without just compensation or other black swan scenario:25%

Value 0 , Loss 1

 

Edge

0.50*2.5  + (0.25*-0.5) + (0.25*-1)

1.25 - 0.375

0.875

 

Odds

2.5

 

Edge/Odds = 0.875/2.5 = 0.35

 

Disclosure Newbie

 

Thanks for your thoughts and numbers.

 

I am more skeptical than you (and most of this board).

I realized that I'm getting close to negative Kelly's. Will probably sell (part or all) if we get more runup.

 

Within some model perturbations Kelly's at current prices goes positive/negative at ~0.4 probability of success.

 

Jurgis, Can you share some of the items which you are skeptical about?  I think that would be helpful information for those of us who want to pay attention to downside risk.  Dont feel like you have to write an essay or defend it.  But I think it would be helpful to listen to another view.

 

Thanks

[SnarkyPuppy]

Over a one year timeframe, assuming current value of equities invested in preferred

 

1. Restructuring with return to par :50%

Value 2.5x

 

2. Status quo or settlement only favoring plaintiffs 25% (cases go on w same or new plaintiffs)

Value 0.5x. Loss 0.5

 

3. Liquidation without just compensation or other black swan scenario:25%

Value 0 , Loss 1

 

Edge

0.50*2.5  + (0.25*-0.5) + (0.25*-1)

1.25 - 0.375

0.875

 

Odds

2.5

 

Edge/Odds = 0.875/2.5 = 0.35

 

Disclosure Newbie

 

Thanks for your thoughts and numbers.

 

I am more skeptical than you (and most of this board).

I realized that I'm getting close to negative Kelly's. Will probably sell (part or all) if we get more runup.

 

Within some model perturbations Kelly's at current prices goes positive/negative at ~0.4 probability of success.

 

Jurgis, Can you share some of the items which you are skeptical about?  I think that would be helpful information for those of us who want to pay attention to downside risk.  Dont feel like you have to write an essay or defend it.  But I think it would be helpful to listen to another view.

 

Thanks

 

+1

 

 

[Flynnstone5]

Anyone know the status regarding the docs ordered to be disclosed to P's? Can we assume from the sealed notice to Perry court that in fact has occurred or do we not know that? I'm asking as I'm curious if the gov (although now under Sessions) could file some sort of additional appeal regarding order to release.

 

Also, why wouldn't Fairholme immediately file whatever possible to go after all of the other remaining 11K?

[Jurgis]

IMO, it's somewhat hard to evaluate probabilities in this case.

 

Let me try to enumerate possible "not-par" scenarios:

 

1. Plaintiffs lose at court level, government does not withdraw the case. This is probably 5-10% chance right now. Although I am probably biased by the echo chamber of this thread which doesn't even contemplate such case. Possibly the chance is higher.

 

2. Govt cancels NWS, does not reinstitute pref divvies until GSEs have sufficient capital (in 5-10??? years). I think this is quite likely. Possibly 40% or higher. What is the pref valuation in such case? I guess plaintiffs continue suing for return of all NWS money since it was instituted... but then IMHO case 1 has much higher probability. I don't see how govt can afford to return all NWS money since it was instituted without a big fight.

 

3. Recession with house price drop and GSEs are insolvent again unless government backstops them. Yeah, new govt backstop would not negate previous legal case, but it still would complicate things enormously. How can govt backstop GSEs if they don't know their standing from previous court cases? I'd say this is something like 15% chance within next couple years. Note that this is independent of scenarios 1 and 2 somewhat.

 

4. Congress decides to close GSEs, nationalize them, or redo them into new-GSEs. These probably does not invalidate the legal cases, since they have past priority, so perhaps this is not worth inclusion into probabilities.

 

5. Govt removes GSE govt backstop. Where would prefs/common trade without govt backstop? Even assuming reversal of NWS and return all that money to GSEs (which I think is unlikely)? I'd say this is unlikely (5%?).

 

There's likely some convoluted legal/political scenarios that I am missing.

 

Now for the "par" scenarios:

 

1P. Settlement that does not invalidate NWS. I see how this is reachable for prefs (just return par value). I am not sure how common shareholders would agree to this. So IMO this is something that govt would like, but I am not sure if it is reachable now that the plaintiffs smell profits. Plaintiffs probably would have agreed on this with Dem administration, but not sure they would agree now.

2P. Invalidate NWS. I don't see how govt can deal with this, but perhaps people here assume this is workable.

 

Anyway, I think that market is valuing prefs pretty efficiently right now with ~40% chance of par return.

[no_free_lunch]

Does anyone know what happened in Feb 2014 that pref's traded higher than they do today?

[Desert_Rat]

I believe it was around that time when they had fully repaid treasury. Stakeholders were expecting release.

[orthopa]

IMO, it's somewhat hard to evaluate probabilities in this case.

 

Let me try to enumerate possible "not-par" scenarios:

 

1. Plaintiffs lose at court level, government does not withdraw the case. This is probably 5-10% chance right now. Although I am probably biased by the echo chamber of this thread which doesn't even contemplate such case. Possibly the chance is higher.

 

2. Govt cancels NWS, does not reinstitute pref divvies until GSEs have sufficient capital (in 5-10??? years). I think this is quite likely. Possibly 40% or higher. What is the pref valuation in such case? I guess plaintiffs continue suing for return of all NWS money since it was instituted... but then IMHO case 1 has much higher probability. I don't see how govt can afford to return all NWS money since it was instituted without a big fight.

 

3. Recession with house price drop and GSEs are insolvent again unless government backstops them. Yeah, new govt backstop would not negate previous legal case, but it still would complicate things enormously. How can govt backstop GSEs if they don't know their standing from previous court cases? I'd say this is something like 15% chance within next couple years. Note that this is independent of scenarios 1 and 2 somewhat.

 

4. Congress decides to close GSEs, nationalize them, or redo them into new-GSEs. These probably does not invalidate the legal cases, since they have past priority, so perhaps this is not worth inclusion into probabilities.

 

5. Govt removes GSE govt backstop. Where would prefs/common trade without govt backstop? Even assuming reversal of NWS and return all that money to GSEs (which I think is unlikely)? I'd say this is unlikely (5%?).

 

There's likely some convoluted legal/political scenarios that I am missing.

 

Now for the "par" scenarios:

 

1P. Settlement that does not invalidate NWS. I see how this is reachable for prefs (just return par value). I am not sure how common shareholders would agree to this. So IMO this is something that govt would like, but I am not sure if it is reachable now that the plaintiffs smell profits. Plaintiffs probably would have agreed on this with Dem administration, but not sure they would agree now.

2P. Invalidate NWS. I don't see how govt can deal with this, but perhaps people here assume this is workable.

 

Anyway, I think that market is valuing prefs pretty efficiently right now with ~40% chance of par return.

 

A couple of your not par scenarios do fit with Mnunchins tone to get fannie and freddie out of govt control and priority to get things done quickly. Would also argue this is a new govt with polar opposites in regards to president/cabinet/treasury sec/advisors etc. The govt tone your scenarios seem more consistent with an Obama admin vs a Trump administration.

 

I could be too trusting, we will see I guess.

[Jurgis]

The govt tone your scenarios seem more consistent with an Obama admin vs a Trump administration.

 

Do you think that govt can afford the return of full NWS to GSEs without a big budgetary issue? If you think the return of full NWS to GSEs is easy/affordable/won't crash into congress/debt ceiling/etc., then yeah, "par" scenarios are more likely.

[Flynnstone5]

The govt tone your scenarios seem more consistent with an Obama admin vs a Trump administration.

 

Do you think that govt can afford the return of full NWS to GSEs without a big budgetary issue? If you think the return of full NWS to GSEs is easy/affordable/won't crash into congress/debt ceiling/etc., then yeah, "par" scenarios are more likely.

 

They're never going to return the NWS, but there is a high probability that the overage against original 10% div. gets applied to the outstanding senior prf'd effectively zeroing it out. I think the point you raise regarding a court loss is absolutely a valid concern, but that likely reduces leverage in a settlement as opposed to gov continuing the fight. Do you really think knowing the players involved that Trump is going to go out of his way to screw some of his closest and most loyal supporters - this does not fit at all with his character.

 

As far as not re-instituting divs on prf'd for 5-10 years to recap solely through retained earnings, it's way too long IMO. They're going to want to recap in 3-4 years max.

 

Recession risk and congress winding down are non-issues as far as I can see. A reformed utility model is ultra safe and Mnuchin has already clearly stated that the GSE's are necessary and serve a vital purpose. I do think you're viewing the investment as though the prior admin or HRC were in office. That said, my opinion on what is a probable outcome doesn't amount to anything right now so I appreciate your views and any others that present alternative views.

[Guest cherzeca]

@jurgis  you say "Do you think that govt can afford the return of full NWS to GSEs without a big budgetary issue?"

 

have you thought that the NWS would be retroactively voided through a 4th amendment, converting all excess dividends into principal repayments?

 

you say "Settlement that does not invalidate NWS. I see how this is reachable for prefs (just return par value)",

 

you seem to think that if the NWS was just "stopped", junior prefs would go to par...but in fnma case, senior pref would be $117B bearing 10% and junior pref would be worthless.

 

there will be no P settlement without retroactive invalidation of NWS.

 

if you own junior prefs expecting the NWS will simply be stopped, i suggest you sharpen your pencil

 

[SnarkyPuppy]

Mnuchin confirmed.

[Desert_Rat]

@jurgis  you say "Do you think that govt can afford the return of full NWS to GSEs without a big budgetary issue?"

 

have you thought that the NWS would be retroactively voided through a 4th amendment, converting all excess dividends into principal repayments?

 

you say "Settlement that does not invalidate NWS. I see how this is reachable for prefs (just return par value)",

 

you seem to think that if the NWS was just "stopped", junior prefs would go to par...but in fnma case, senior pref would be $117B bearing 10% and junior pref would be worthless.

 

there will be no P settlement without retroactive invalidation of NWS.

 

if you own junior prefs expecting the NWS will simply be stopped, i suggest you sharpen your pencil

 

I don't understand. Since the NWS (3rd amendment) didn't call for anything other than a sweep of all net earnings, if it is simply 'stopped' it is null and void. And, similarly, if the usurious 10% dividends are amended to something reasonable, these preferreds will still appreciate. It won't be the home run I'd like to see but they will appreciate.

 

Munchkin, yeh!

[Luke 532]

Mnuchin just got sworn in, it's official.

[DocSnowball]

For what its worth, my take two on Kelly equation, this time on a 4 year timeframe, analysis of the disconfirming opinions, confirmation of Mnuchin, use of the words "corrupt business model" and "utility" in the Republican agenda, and the current political administration.

 

Assuming current value of equities invested in preferred: 

 

1. Restructuring into low risk public utility with Preferreds return to par, NWS retroactively voided to pay down Sr preferred :60%

Value 2.5x

 

2. Status quo or partial solution for political or legal or economic reasons 25% (cases go on w same or new plaintiffs)

Value 0.5x. Loss 0.5

 

3. Liquidation without just compensation or other black swan scenario:15%

Value 0 , Loss 1

 

Edge

0.60*2.5  + (0.25*-0.5) + (0.15*-1)

1.5 - 0.275

1.225

 

Odds

2.5

 

Edge/Odds = 1.225/2.5 = 0.49

[merkhet]

Mnuchin just got sworn in, it's official.

 

Now it's just a matter of playing the GOP Congress against Mel Watt & vice versa. Fat lady hasn't sung yet, but she's warming up.

[Flynnstone5]

Favorable court ruling would be so sweet right now. For all the delay, the timing would be absolutely perfect.

 

Lets hope that additional docs reinforce what should already be devastating to the govs claims/case.

 

Wallison: One question: Do the dividend payments amortize principal, and if so how? For example, if the 10% dividend rate were

in effect, a payment of more than 10% would amortize principal, but from the press release it sounds as though the

profits that are swept into Treasury are replacing the 10% dividend.

 

Parrott: No principal is written down no matter what the quartely payment is. Dividend is variable, set at whatever profit for

quarter is, eliminating ability to pay down principal (so they can"t repay their debt and escape as it were).

 

Wallison: That could be a problem. From the perspective of the budget, if Congress were to eliminate them it would be

eliminating a revenue source. If principal were amortized that problem would eventually go away.

 

[Cox022]

Mnuchin just got sworn in, it's official.

 

Now it's just a matter of playing the GOP Congress against Mel Watt & vice versa. Fat lady hasn't sung yet, but she's warming up.

 

I always thought these comments from Watt in January of 2015 were very telling, but I dont recall it being reported on or discussed.

 

Watch the 2 minutes beginning on 1:44:00, ending 1:45:29

https://www.c-span.org/video/?324024-1/hearing-sustainable-housing-finance&start=11007

 

He basically says, 'when i got to FHFA, the organization had many visions to lead to the wind down of the companies but I stopped that since that isnt our job.  Our statutory mission is to ensure safety and soundness in the market in the present '

 

So I'm tempted to think that Watt wont put himself out of a job, he did leave congress for it, and I further think he is a fan of the GSE's.  He doesnt seem like a fighter to me, I think he wants to be told what to do, either by congress or by the Tsy.  However, the extent to which D's want to use him to fight anything coming out of the Trump admin is unknown.

 

 

 

 

[investorG]

Mnuchin just got sworn in, it's official.

 

Now it's just a matter of playing the GOP Congress against Mel Watt & vice versa. Fat lady hasn't sung yet, but she's warming up.

 

I always thought these comments from Watt in January of 2015 were very telling, but I dont recall it being reported on or discussed.

 

Watch the 2 minutes beginning on 1:44:00, ending 1:45:29

https://www.c-span.org/video/?324024-1/hearing-sustainable-housing-finance&start=11007

 

He basically says, 'when i got to FHFA, the organization had many visions to lead to the wind down of the companies but I stopped that since that isnt our job.  Our statutory mission is to ensure safety and soundness in the market in the present '

 

So I'm tempted to think that Watt wont put himself out of a job, he did leave congress for it, and I further think he is a fan of the GSE's.  He doesnt seem like a fighter to me, I think he wants to be told what to do, either by congress or by the Tsy.  However, the extent to which D's want to use him to fight anything coming out of the Trump admin is unknown.

 

it's all about the deal, imo. 

 

admin wants gse reform, congress wants dodd frank adjusted, and watt wants some unknown ask that should be accommodated.

 

 

[Guest cherzeca]

Mnuchin just got sworn in, it's official.

 

Now it's just a matter of playing the GOP Congress against Mel Watt & vice versa. Fat lady hasn't sung yet, but she's warming up.

 

i think GOP congress is plenty distracted with everything on its plate as it is, and watt reminds me of the kid with a glove at the park who asks if anyone wants to play ball with him

[Flynnstone5]

Listening to Yellen testimony in background. Crapo just mentioned FnF and how bipartisan reform is needed - could she please comment on her views.

[investorG]

imo mnuchin is under serious heat to make things happen, in general.  cohn has impressed Trump, likely creating an internal rivalry for attention.  last night, when trump spoke before mnuchin's swearing in (can find via trump's twitter feed to facebook link), he said something like 'a lot of people wanted this job' implying mnuchin better deliver.  he also mentioned mnuchin works 24 (28 even) hrs per day, which may simply be the President's expectation for him.

 

 

[investorG]

Listening to Yellen testimony in background. Crapo just mentioned FnF and how bipartisan reform is needed - could she please comment on her views.

 

whether it happens this week or sometime in march, it will be disappointing if the 4q profits are swept.

 

simply say we're stopping the sweep and we hope this serves as a jump start for bipartisan reform discussions --- this should not be controversial.

 

[Luke 532]

 

whether it happens this week or sometime in march, it will be disappointing if the 4q profits are swept.

 

simply say we're stopping the sweep and we hope this serves as a jump start for bipartisan reform discussions --- this should not be controversial.

 

Agreed.