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

[TwoCitiesCapital]

VIC has a new FNMA write-up today. Any VIC members willing to give a brief summary of the write-up? I'm guessing there's not much there that you can't find on timhoward17 blog, but, of course, I'm curious.

 

 

Thesis summary

 

 

Buy FNMA common at $4.00 because:

 

 

1.  Regan-appointed Judge Lamberth will invalidate the 3rd amendment (3A) via summary judgement in the Perry case soon after his current Blackwater murder trial goes to jury.

2.  He will rule based on facts that are not in dispute (which will expedite the time frame and offer investors a quick catalyst).

3. The 3A will be vacated based on either (a) a finding that Treasury violated HERA by invoking the 3A and creating a new security beyond the 2009 time limit.  (Note:  Even Treasury's own enforcement of tax law deems the 3A a new security), or (b) a finding that the 3A was arbitrary and capricious due to the fact, admitted to by FHFA, that FHFA failed to comply with the APA requirement that they compile an administrative record at the time of the 3A.  (Note:  FHFA did compile an administrative record at the time of the 1A and 2A.)

4.  Vacation of the 3A will put $80bln of excess dividends (above and beyond the 10% as required pre-3A) into question.

5.  Perry will pursue the obvious remedy and successfully have the $80bln used to reduced the $117bln Treasury senior preferred currently outstanding.

6.  The incremental gain of $80bln will be reduced by $12bln (goes to private preferred to bring them to par) and then diluted by 4:1 (80% of common shares goes to Treasury via warrants) leaving $68/ (1.15*5) about $12/share value for the non-US Govt common shareholders, or a 200% gain.

 

 

My only dispute with the thesis is that one could buy the private preferred's today and get a return of over 150% and avoid the risk of steps 4 & 5 entirely.

 

In my opinion, the common thesis of 7x - 10x return rests in the fact that the government is doing the taxpayer an incredible disservice by not exercising its warrants and unlocking that value to the American taxpayer. Any future reform can include the existing common as it stands as opposed to wiping it out and starting over, effectively costing the taxpayer over $150 billion. I think logical heads in the Treasury/FHFA/government will eventually prevail and realize the value the taxpayer would sacrifice.

 

 

The 7x-10x is certainly within the realm of plausible.  But consider all that would need to happen:  Prevailing powers in DC need to agree that the GSEs should be saved and then agreed to act on it, GSEs fees would need to be raised (Ackman suggests 60-100bp), and then the market would need to apply a 15x multiple to GSE earnings.  Whew! How can anyone put a time frame on it?

 

Even if it took 20 years, 7-10x corresponds to 10-12% per annum. I don't think it's the time frame thats going to work against you here.

[valuecfa]

Well you would think that the taxpayer and politicians would be in favor of a > $100 billion dollar windfall to the American taxpayer. It's amazing to me that it is a hard sell. It also seems like a given for the need for fees to change, but that is not a necessity.

[TwoCitiesCapital]

So, I just read every post on timhoward717 and want to make sure I'm summarizing this correctly for myself as I'm looking to make this a significantly bigger position than the current speculative-starter position that I have.

 

1) Conservatorship is intended to restore the health of the company until it can be business as usual. This is supported by the following quotes:

Therefore, in order to tesore the balance between safety and soundeness of mission, FHFA has placed Fannie Mae and Freddie Mac into conservatorship. That is a statutory process designed to stabilize troubled institution with the objective of returning the entities to normal business operations. FHFA will act as the conservator to operate the Enterprises until they are stabilized."

 

"The Court agrees. Discovery will enable plaintiffs to confirm that such evidence exists with regard to the profitability and additionaly answer the question as to when, and how, the conservatorship will end."

Judge Sweeney confirming that the there should be an end envisioned for the conservatorship and that Fairholme may proceed with it's discovery to prevent case dismissal on the grounds that the court doesn't have jurisdiction since the FHFA isn't the government.

 

"I am well aware, and regularly express my belief, that conservatorship should never be viewed as permanent or as a desirable end state and that housing finance reform is necessary."

Current FHFA head agreeing that conservatorship will end eventually...

 

2) The value still resides with the shareholders even though they forfeit other rights during conservatorship

"Q: What happens to a company's stock during conservatorship?"

A: During the conservatorship, the Company's stock will continue to trade. However, by the statute, the powers of the stockholders are suspended until the conservatorship is terminated. Stockholders will retain all rights in the stock's financial worth; as such worth is determined by the markets."

Common and preferred shareholders are entitled to the value of such shares.

 

So it seems pretty clear to me that conservatorship is a temporary solution and that stock holders retain economic interests. The profit sweep goes against the very purpose of conservatorship which was to stabilize the company back to "business as usual." Any earnings above and beyond the 10% owed on the gov't preferred securities belongs to the other preferred security and common shareholders and were taken. Is there a gov't response to this allegation why this sweep was appropriate or justified?

 

That being said, the Treasury stated in a memo back in 2010 that they were committed to preventing existing shareholders from receiving economic profits - this is an admission that they thought profits were a possibility and the beginning of the formulation of plans to sweep those profits to the Treasury. They then coordinated the 3rd Amendment profit sweep in 2012 to ensure this was the case. This suggests to me that the FHFA was working in tandem/cooperation with the Treasury and it's motives. Does this not make it a government entity for the purposes of this case and validate the current courts jurisdiction and invalidate the government's request for dismissal? How does one define a government agency for the purposes of determining if the court has jurisdiction?

 

It seems like there are a few things that have to happen here for shareholders to receive value:

 

1) Profit sweep is overturned and profits are returned

a) Can be accomplished via a ruling in favor of the Perry injunction or Fairholme's suit. Fairholme's case looks strong. I've    seen less commentary on Perry's.

2) Company's are recapitalized

a) Retained profits

b) Conversion of preferred to common

c) Gov't exercises warrants

3) Company's leave conservatorship and return to BAU.

4) Shareholders profit

 

If anything above is incorrect, please feel free to correct me or provide counterpoints. I intend to read through this thread over the next couple of days but devoted my time to Tim's site this evening.

 

1) It seems like a safe assumption that Fairholme's discovery will lead to continuation of the suit given the documents that have already been leaked. It also seems like it's an open and shut case in regards to the conservator sweeping profits to the Treasury being contrary to the purpose of conservatorship AND unrightfully taking some profits that belonged to others. Does anyone have an opinion to the contrary or why the courts may rule otherwise?

2) Does the government have any incentive to kill these entities, screw shareholders, and forfeit massive profits?

3) What are the ways that preferred and common shareholders could be screwed in the recapitalization?

 

[onyx1]

Is there a gov't response to this allegation why this sweep was appropriate or justified?

 

 

Yes.  The gov't claims that the sweep was intended to calm "fears" in the market that the GSEs would enter into "death spiral" where gov't support capacity would eventually end because up until returning to profitability, the GSEs needed to draw from the Treasury's credit line and then immediately pay that money back to the Treasury in the form of a 10% dividend.  This doesn't pass muster on many levels.  Leaving aside the fact that GSEs debt showed no evidence of this "fear", the gov't preferred had a PIK option at 12% that could have been utilized if credit capacity ever became an issue.  Furthermore, and more significantly for the legal case, this was an after-the-fact justification for the sweep.  The courts afford great deference to federal agencies actions as long as they can show they acted reasonable.  In order to show reasonableness, the agencies are required to compile an administrative record prior to taking action to demonstrate to an outside reviewer that they deliberated and considered alternative actions.  This is a strict requirement of the APA and the initial burden of compilation falls on the agency.  But once complete, an administrative record usually provides a tremendous shield against wronged parties claiming that the agency acted in an arbitrary manner.  Will a court find that the FHFA acted reasonable?  The answer is likely no.  Why?  Because the FHFA failed to compile an administrative record and admits to this failure.  This alone is justification for vacating the sweep. See Perry Injunction for more details 13-1053.

 

 

That being said, the Treasury stated in a memo back in 2010 that they were committed to preventing existing shareholders from receiving economic profits - this is an admission that they thought profits were a possibility and the beginning of the formulation of plans to sweep those profits to the Treasury. They then coordinated the 3rd Amendment profit sweep in 2012 to ensure this was the case. This suggests to me that the FHFA was working in tandem/cooperation with the Treasury and it's motives. Does this not make it a government entity for the purposes of this case and validate the current courts jurisdiction and invalidate the government's request for dismissal?

 

HERA prohibits the FHFA from taking direction from any other agency.  The 2010 Treasury memo is a smoking gun in many respects.  The Ackman suit just filed (14-1404) shows a timeline of statements by FHFA officials from the beginning of the conservatorship in 2008 to present.  For years,  FHFA officials asserted its duty to conserving the assets of the GSEs.  But in 2012, out of nowhere, FHFA asserted their duty was now to protect taxpayers and wind down the GSEs.  Enter the sweep.  This is wholly inconsistent with the purpose of a conservatorship, and is strong circumstantial evidence (now subject to a discovery action in the Fairholme suit 13-465) that Treasury was calling the shots at the FHFA.    Evidence that Treasury directed the sweep and benefited itself by taking all the GSE capital is game over for the gov't and a win for shareholders since the 5th Amendment to the US Constitution demands compensation for  those whose property was taken.  More details can be found in Fairholme 13-465.

 

 

I intend to read through this thread over the next couple of days but devoted my time to Tim's site this evening.

 

 

Although this tread is interesting as the thesis has morphed over the years from a capital structure arbitrage to a levered bet on a small housing recover to a legal case with many dimensions, your time is best spent on the court cases and the replies.  Keep in mind that there are two claims:  The Federal Court of Claims cases deal with seeking compensation for taking of property under the 5th Amendment.  The Fairholme case here is in the discovery phase and will take a long time to come to a conclusion.  The District Courts cases deal with the the violations of the well established Administrative Proceedures Act (APA) that if successful would allow an immediate vacation of the sweep and send the excess sweep money back to the GSEs.  This is the Perry Injunction suit. 

 

[merkhet]

^ +1

[PullTheTrigger]

Thanks for the summary onyx1!

[nkp007]

Having read Onyx1/valuecfa's great commentary as a refresher, it sure looks like there are a lot of ways to get to a positive outcome.

 

 

[Mephistopheles]

VIC has a new FNMA write-up today. Any VIC members willing to give a brief summary of the write-up? I'm guessing there's not much there that you can't find on timhoward17 blog, but, of course, I'm curious.

 

 

Thesis summary

 

 

Buy FNMA common at $4.00 because:

 

 

1.  Regan-appointed Judge Lamberth will invalidate the 3rd amendment (3A) via summary judgement in the Perry case soon after his current Blackwater murder trial goes to jury.

2.  He will rule based on facts that are not in dispute (which will expedite the time frame and offer investors a quick catalyst).

3. The 3A will be vacated based on either (a) a finding that Treasury violated HERA by invoking the 3A and creating a new security beyond the 2009 time limit.  (Note:  Even Treasury's own enforcement of tax law deems the 3A a new security), or (b) a finding that the 3A was arbitrary and capricious due to the fact, admitted to by FHFA, that FHFA failed to comply with the APA requirement that they compile an administrative record at the time of the 3A.  (Note:  FHFA did compile an administrative record at the time of the 1A and 2A.)

4.  Vacation of the 3A will put $80bln of excess dividends (above and beyond the 10% as required pre-3A) into question.

5.  Perry will pursue the obvious remedy and successfully have the $80bln used to reduced the $117bln Treasury senior preferred currently outstanding.

6.  The incremental gain of $80bln will be reduced by $12bln (goes to private preferred to bring them to par) and then diluted by 4:1 (80% of common shares goes to Treasury via warrants) leaving $68/ (1.15*5) about $12/share value for the non-US Govt common shareholders, or a 200% gain.

 

 

My only dispute with the thesis is that one could buy the private preferred's today and get a return of over 150% and avoid the risk of steps 4 & 5 entirely.

 

But wouldn't steps 4 and 5 be a given if the sweep is vacated? Why would the judge rule that it's illegal but not compensate the shareholders for $80 billion in excess dividends.

 

Also, correct me if I'm wrong, but step 6 only seems to value the shares based on the returned $68 billion, but not on any future earnings power. My back of the envelope calculation indicates that the common would be worth 4x, or 300% more if the 3A was revoked, and the Jr. Pfds were paid off at par. I based it by annualizing 2Q profits:

 

1) Net income of $3.7 billion x 4 = $14.7 billion.

2) Back out the $81 billion in excess dividends, arrive at a Sr. liquidation preference of $36 billion. 10% dividend on this is $3.6 billion.

3) $14.7 - $3.6 billion = $11.1 billion

4) EPS = $11.1/5,762 = $1.92. 10x multiple = $19.25.

5) Jr. Pfd of $19.1 billion/5,762 = $3.32/share

6) Common value = $19.25 - $3.32 = ~$16 per share.

7) $16/4 = 4x return vs. the 2.5x return of the Jr. Pfds.

 

If they do a pfd for common swap to recapitalize, and issued shares at $4, then the EPS after the Sr. dividend is $1.05, which would give the common a 2.5x return. But, the shares would be at a much higher price if we get to this point, and perhaps the dilution wouldn't be as bad.

 

However, why would they do this? Neither the govt nor the current common shareholders would want to dilute their stake. Can't they just keep paying the Jr. dividend and then retire when possible?

[onyx1]

VIC has a new FNMA write-up today. Any VIC members willing to give a brief summary of the write-up? I'm guessing there's not much there that you can't find on timhoward17 blog, but, of course, I'm curious.

 

 

Thesis summary

 

 

Buy FNMA common at $4.00 because:

 

 

1.  Regan-appointed Judge Lamberth will invalidate the 3rd amendment (3A) via summary judgement in the Perry case soon after his current Blackwater murder trial goes to jury.

2.  He will rule based on facts that are not in dispute (which will expedite the time frame and offer investors a quick catalyst).

3. The 3A will be vacated based on either (a) a finding that Treasury violated HERA by invoking the 3A and creating a new security beyond the 2009 time limit.  (Note:  Even Treasury's own enforcement of tax law deems the 3A a new security), or (b) a finding that the 3A was arbitrary and capricious due to the fact, admitted to by FHFA, that FHFA failed to comply with the APA requirement that they compile an administrative record at the time of the 3A.  (Note:  FHFA did compile an administrative record at the time of the 1A and 2A.)

4.  Vacation of the 3A will put $80bln of excess dividends (above and beyond the 10% as required pre-3A) into question.

5.  Perry will pursue the obvious remedy and successfully have the $80bln used to reduced the $117bln Treasury senior preferred currently outstanding.

6.  The incremental gain of $80bln will be reduced by $12bln (goes to private preferred to bring them to par) and then diluted by 4:1 (80% of common shares goes to Treasury via warrants) leaving $68/ (1.15*5) about $12/share value for the non-US Govt common shareholders, or a 200% gain.

 

 

My only dispute with the thesis is that one could buy the private preferred's today and get a return of over 150% and avoid the risk of steps 4 & 5 entirely.

 

But wouldn't steps 4 and 5 be a given if the sweep is vacated? Why would the judge rule that it's illegal but not compensate the shareholders for $80 billion in excess dividends.

 

Also, correct me if I'm wrong, but step 6 only seems to value the shares based on the returned $68 billion, but not on any future earnings power. My back of the envelope calculation indicates that the common would be worth 4x, or 300% more if the 3A was revoked, and the Jr. Pfds were paid off at par. I based it by annualizing 2Q profits:

 

1) Net income of $3.7 billion x 4 = $14.7 billion.

2) Back out the $81 billion in excess dividends, arrive at a Sr. liquidation preference of $36 billion. 10% dividend on this is $3.6 billion.

3) $14.7 - $3.6 billion = $11.1 billion

4) EPS = $11.1/5,762 = $1.92. 10x multiple = $19.25.

5) Jr. Pfd of $19.1 billion/5,762 = $3.32/share

6) Common value = $19.25 - $3.32 = ~$16 per share.

7) $16/4 = 4x return vs. the 2.5x return of the Jr. Pfds.

 

 

 

    You are not wrong.  There is additional upside to the common based on a market multiple of, say, annualized 2Q earnings which appear to be somewhat normalized.  However, the market will likely enforce a large discount due to a number of looming outside events such as timing of housing reform, emergence out of conservatorship, and potential dilution from refinancing of the UST preferred.  The biggest headwind to a market multiple, in my opinion, will come from that which we saw at BAC which is the need to rebuild capital.  The scenario above leaves the GSEs without any capital at all.    Whats more, the required capital amount would have to be set first by regulators and that alone will take time and cause considerable uncertainty. 

[dowfin1]

The scenario above leaves the GSEs without any capital at all.    Whats more, the required capital amount would have to be set first by regulators and that alone will take time and cause considerable uncertainty. 

 

 

I thought capital requirements for the GSEs were set by statute in 12 USC 4612:

 

"For purposes of this subchapter, the minimum capital level for each enterprise shall be the sum of—

(1)  2.50 percent of the aggregate on-balance sheet assets of the enterprise, as determined in accordance with generally accepted accounting principles..."

 

As of 6-31-14, FNMA had total assets of $3,218 B and equity of $6.1 B or less than .2%.  But with the remaining credit line from Treasury under the SPSA ( about $83 B), one could argue under sec. 4502 (23) that FNMA has total capital of $89 B available under conservatorship or 2.76% which meets the statutory minimum.  Note that FNMA had cap ratios of 4.66%, 4.92%, and 4.98% before the crisis for YE 2005-07.

 

 

While I agree plaintiffs are likely to prevail in court, you are correct that the consequences of a victory are uncertain  -- and that's what gives me pause from increasing my position.  Bad case scenario:

 

1.  plaintiffs win

2.  Treasury ordered to return $80 B.

3.  Treasury terminates the SPSA under sec 6.7 and/or 6.12, and demands full repayment

4.  FHFA deems the GSEs critically undercapitalized and converts them to a receivership.

 

Obviously there are other possible scenarios, but it's obvious that we need Treasury cooperation/support even if the cases are won.

 

 

 

 

 

[deadspace]

I've thought about this as well

Treasury could get vindictive and force a true receivership but it's unlikely given that the result of a receivership would cause chaos in the housing market

Also a true takings argument in these cases would need to Addresss the forcing of subprime mortgages onto the books of the GSE in 2007 used to stabilize the market.  If you really want to talk receivership we need to back out all if these as well

[onyx1]

The scenario above leaves the GSEs without any capital at all.    Whats more, the required capital amount would have to be set first by regulators and that alone will take time and cause considerable uncertainty. 

 

 

I thought capital requirements for the GSEs were set by statute in 12 USC 4612:

 

"For purposes of this subchapter, the minimum capital level for each enterprise shall be the sum of—

(1)  2.50 percent of the aggregate on-balance sheet assets of the enterprise, as determined in accordance with generally accepted accounting principles..."

 

As of 6-31-14, FNMA had total assets of $3,218 B and equity of $6.1 B or less than .2%.  But with the remaining credit line from Treasury under the SPSA ( about $83 B), one could argue under sec. 4502 (23) that FNMA has total capital of $89 B available under conservatorship or 2.76% which meets the statutory minimum.  Note that FNMA had cap ratios of 4.66%, 4.92%, and 4.98% before the crisis for YE 2005-07.

 

 

 

 

There are very few certainties in life, but incrementally higher required capital levels on the GSEs if they were to emerge from a conservatorship could be one of them; then throw in a SIFI buffer and stress tests on top of all that.  This, or the potential of it, would weigh on any historically-based market multiple.

 

While I agree plaintiffs are likely to prevail in court, you are correct that the consequences of a victory are uncertain  -- and that's what gives me pause from increasing my position.  Bad case scenario:

 

1.  plaintiffs win

2.  Treasury ordered to return $80 B.

3.  Treasury terminates the SPSA under sec 6.7 and/or 6.12, and demands full repayment

4.  FHFA deems the GSEs critically undercapitalized and converts them to a receivership.

 

Obviously there are other possible scenarios, but it's obvious that we need Treasury cooperation/support even if the cases are won.

 

 

A bad scenario indeed, and with the gov't anything is possible.  But they had a chance to do this in 2008 and choose not to (and they are paying the price for it in terms of this litigation).  One of the reasons they avoided it in 2008 was so as not to throw a wrench into the agency MBS market which operates with a slightly less than government guarantee.  There are trillions ($5? currently, I don't know the exact number) of these securities in hands all over the world and a receivership would crater the world financial markets overnight; (FHFA head Mel Watt is currently under oath that a mere disclosure of discussions about the future of the GSEs would throw the world into financial crisis).  The only way to avoid the chaos is to declare all agency MBS fully guaranteed by the US gov't (like GNMA).  The problem for the UST is that all that debt would be placed on the US gov't balance sheet raising the debt levels from $17 trillion to $22 overnight.  There would be heavy credit and political prices to pay for this avoidable action and in the end the logical political calculus would likely be that it is not worth the $80 billion when your legacy is at stake.

 

 

 

 

[dowfin1]

There are very few certainties in life, but incrementally higher required capital levels on the GSEs if they were to emerge from a conservatorship could be one of them; then throw in a SIFI buffer and stress tests on top of all that.

 

Post-C capital is more problematic than I thought which means that a substantial new capital raise with long transition rules will likely be necessary for the GSEs to emerge with substantial value for the common.    It's a political calculus not a legal issue.  IMO the jr. preferred is the smarter bet but a blend ala BB is not a bad idea either just in case.

[Mephistopheles]

VIC has a new FNMA write-up today. Any VIC members willing to give a brief summary of the write-up? I'm guessing there's not much there that you can't find on timhoward17 blog, but, of course, I'm curious.

 

 

Thesis summary

 

 

Buy FNMA common at $4.00 because:

 

 

1.  Regan-appointed Judge Lamberth will invalidate the 3rd amendment (3A) via summary judgement in the Perry case soon after his current Blackwater murder trial goes to jury.

2.  He will rule based on facts that are not in dispute (which will expedite the time frame and offer investors a quick catalyst).

3. The 3A will be vacated based on either (a) a finding that Treasury violated HERA by invoking the 3A and creating a new security beyond the 2009 time limit.  (Note:  Even Treasury's own enforcement of tax law deems the 3A a new security), or (b) a finding that the 3A was arbitrary and capricious due to the fact, admitted to by FHFA, that FHFA failed to comply with the APA requirement that they compile an administrative record at the time of the 3A.  (Note:  FHFA did compile an administrative record at the time of the 1A and 2A.)

4.  Vacation of the 3A will put $80bln of excess dividends (above and beyond the 10% as required pre-3A) into question.

5.  Perry will pursue the obvious remedy and successfully have the $80bln used to reduced the $117bln Treasury senior preferred currently outstanding.

6.  The incremental gain of $80bln will be reduced by $12bln (goes to private preferred to bring them to par) and then diluted by 4:1 (80% of common shares goes to Treasury via warrants) leaving $68/ (1.15*5) about $12/share value for the non-US Govt common shareholders, or a 200% gain.

 

 

My only dispute with the thesis is that one could buy the private preferred's today and get a return of over 150% and avoid the risk of steps 4 & 5 entirely.

 

But wouldn't steps 4 and 5 be a given if the sweep is vacated? Why would the judge rule that it's illegal but not compensate the shareholders for $80 billion in excess dividends.

 

Also, correct me if I'm wrong, but step 6 only seems to value the shares based on the returned $68 billion, but not on any future earnings power. My back of the envelope calculation indicates that the common would be worth 4x, or 300% more if the 3A was revoked, and the Jr. Pfds were paid off at par. I based it by annualizing 2Q profits:

 

1) Net income of $3.7 billion x 4 = $14.7 billion.

2) Back out the $81 billion in excess dividends, arrive at a Sr. liquidation preference of $36 billion. 10% dividend on this is $3.6 billion.

3) $14.7 - $3.6 billion = $11.1 billion

4) EPS = $11.1/5,762 = $1.92. 10x multiple = $19.25.

5) Jr. Pfd of $19.1 billion/5,762 = $3.32/share

6) Common value = $19.25 - $3.32 = ~$16 per share.

7) $16/4 = 4x return vs. the 2.5x return of the Jr. Pfds.

 

 

 

    You are not wrong.  There is additional upside to the common based on a market multiple of, say, annualized 2Q earnings which appear to be somewhat normalized.  However, the market will likely enforce a large discount due to a number of looming outside events such as timing of housing reform, emergence out of conservatorship, and potential dilution from refinancing of the UST preferred.  The biggest headwind to a market multiple, in my opinion, will come from that which we saw at BAC which is the need to rebuild capital.  The scenario above leaves the GSEs without any capital at all.    Whats more, the required capital amount would have to be set first by regulators and that alone will take time and cause considerable uncertainty. 

 

Thanks onyx. IMO for this reason the best thing to do is to hold a little bit of both common and preferred, as others have pointed out.

[Mephistopheles]

Separate question. Does anyone know if I sell FNMA at a loss and buy FMCC, if that counts as a wash sale? And what if you sell preferred and buy the common, or vice versa?

[TwoCitiesCapital]

The scenario above leaves the GSEs without any capital at all.    Whats more, the required capital amount would have to be set first by regulators and that alone will take time and cause considerable uncertainty. 

 

 

I thought capital requirements for the GSEs were set by statute in 12 USC 4612:

 

"For purposes of this subchapter, the minimum capital level for each enterprise shall be the sum of—

(1)  2.50 percent of the aggregate on-balance sheet assets of the enterprise, as determined in accordance with generally accepted accounting principles..."

 

As of 6-31-14, FNMA had total assets of $3,218 B and equity of $6.1 B or less than .2%.  But with the remaining credit line from Treasury under the SPSA ( about $83 B), one could argue under sec. 4502 (23) that FNMA has total capital of $89 B available under conservatorship or 2.76% which meets the statutory minimum.  Note that FNMA had cap ratios of 4.66%, 4.92%, and 4.98% before the crisis for YE 2005-07.

 

 

While I agree plaintiffs are likely to prevail in court, you are correct that the consequences of a victory are uncertain  -- and that's what gives me pause from increasing my position.  Bad case scenario:

 

1.  plaintiffs win

2.  Treasury ordered to return $80 B.

3.  Treasury terminates the SPSA under sec 6.7 and/or 6.12, and demands full repayment

4.  FHFA deems the GSEs critically undercapitalized and converts them to a receivership.

 

Obviously there are other possible scenarios, but it's obvious that we need Treasury cooperation/support even if the cases are won.

 

 

I'm pretty sure this scenario can't happen. The Conservator has a set time limit to transfer from conservator ship to receivership and that time is long past. I don't think they could get away with ending the conservatorship before the purpose of conservatorship (stability) has been achieved only to turn around and liquidate it since it could be argued that this wouldn't be substantially different from simply transferring to receivership which isn't allowed.

 

My concern is that they find a way to screw shareholders through the recap (which only hurts themselves and tax payers). I think this is unlikely. It's more likely that they'all try to build political support around saving the institutions by touting how much money th govt will make off of them and maximize those earnings...just need a new administration without egg on its face to do it.

 

I think the common makes out pretty well here. Just a question of how well and how long. Ackman's presentation said could be as long as 7-10 years to recap based on retained earnings and released from conservatorship. Share offerings after a clear schedule is in place could accelerate this return to common holders but also clearly dilutes it. I think we'll see a nice pop if 3A is overturned. That might be a time to take profits, reduce position, and re-evaluate time frame/expected returns going forward with development of the companies.

 

 

Separate question. Does anyone know if I sell FNMA at a loss and buy FMCC, if that counts as a wash sale? And what if you sell preferred and buy the common, or vice versa?

 

They are substantially different securities even if they are similar companies. Wash sale doesn't apply here.

[Mephistopheles]

I'm thinking that if the 3A is overturned the govt would focus their attention on maximizing the value of their 79.9% stake. So perhaps this risk of being declared undercapitalized or forced to dilute is not as likely, because it would be to the detriment of the headline number when they liquidate the warrants.

 

But then again, warrants didn't stop the regulators from forcing banks to raise substantial capital/dilute.

[Mephistopheles]

 

They are substantially different securities even if they are similar companies. Wash sale doesn't apply here.

 

Ok great thanks, and I assume you mean it for both cases right (selling fannie for freddie and selling fnma common for pfds)?

[onyx1]

 

The Conservator has a set time limit to transfer from conservator ship to receivership and that time is long past. I don't think they could get away with ending the conservatorship before the purpose of conservatorship (stability) has been achieved only to turn around and liquidate it since it could be argued that this wouldn't be substantially different from simply transferring to receivership which isn't allowed.

 

 

Huh?  There is no set time limit on declaring a receivership.  HERA not only gives the option to FHFA to declare a receivership if, in the Directors opinion, it appears that assets < liabilities or the enterprise will not be able to meet its obligation when they come due, but requires the appointment of a receiver if the Director determines that for any period of 60 days assets < liabilities.  The accounting standard is not specified so there is wide latitude for interpretation and misuse.  Note also that a receiver can be appointed even if current cash and payment obligations are being met.

[TwoCitiesCapital]

 

The Conservator has a set time limit to transfer from conservator ship to receivership and that time is long past. I don't think they could get away with ending the conservatorship before the purpose of conservatorship (stability) has been achieved only to turn around and liquidate it since it could be argued that this wouldn't be substantially different from simply transferring to receivership which isn't allowed.

 

 

Huh?  There is no set time limit on declaring a receivership.  HERA not only gives the option to FHFA to declare a receivership if, in the Directors opinion, it appears that assets < liabilities or the enterprise will not be able to meet its obligation when they come due, but requires the appointment of a receiver if the Director determines that for any period of 60 days assets < liabilities.  The accounting standard is not specified so there is wide latitude for interpretation and misuse.  Note also that a receiver can be appointed even if current cash and payment obligations are being met.

 

I'm sure you're right. I must have misinterpreted what I read. What recourse do investors have against the FHFA for gross negligence as conservator? None?

 

Also, I still think receivership is unlikely not that the hedge funds are getting press. It's clear to drive with a brain that the gov's 80% is worth something and throwing it away is irresponsible. I think it's also clear that the private sector simply doesnt have the scale to put up capital like us required for their proposed solutions

[onyx1]

What recourse do investors have against the FHFA for gross negligence as conservator? None?

 

 

To the extent gross negligence is a part of breaching fiduciary duty, we'll get an answer to that question when Judge Sweeney gives us a ruling.  Sooner the better.

[merkhet]

My favorite part of the Ackman complaint is the following:

 

For example, FHFA summarily denied valid written demands by Pershing Square to the Companies’ boards of directors for a books and records inspection, thus violating a fundamental right of common shareholders under state corporate law. In doing so, FHFA asserted that Pershing Square, as a common shareholder of the Companies, had no rights or powers at all.

 

It's funny when you deny a 10% holder the right to inspect books and records.

 

The Ackman complaint is actually very, very good. If you guys haven't read it yet, I would highly recommend it. (Attached.)

2014-08-15_Pershing_Square_Complaint.pdf

[Mephistopheles]

Just playing devil's advocate here, but don't the shareholders lose all non-financial rights in a conservatorship? So does he really have the right to review the books?

[merkhet]

Just playing devil's advocate here, but don't the shareholders lose all non-financial rights in a conservatorship? So does he really have the right to review the books?

 

Yea, they do. I just found the concept of denying Pershing access to the books to be funny. Maybe it's because it brought up thoughts of Valeant and Allergan. Ackman just can't catch a break as a shareholder, lol.

 

In any case, Ackman brings up some interesting points regarding the case that haven't been mentioned before in the other cases.

[TwoCitiesCapital]

How does one look up all the currently outstanding preferred shares and their terms?

 

Also would this source contain those also issued to the U.S. gov? Wouldn't think there'd be a difference but you never know