Author Topic: FNMA and FMCC preferreds. In search of the elusive 10 bagger.  (Read 2950773 times)

allnatural

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #11020 on: December 12, 2018, 11:53:59 AM »
I don't believe its impossible for government to maximize warrant value without screwing commons over w/ dilution. It's all about sequencing. Government can easily arrange it so their 80% comes into play post the dilution/capital raise. So they retain full 80% value w/o any dilution.

He is consistent and it's crystal clear what he believes.

I agree here. I think this makes it less likely that Calabria is just going to be a yes-man for Trump, and instead that Trump actually supports Calabria's views and appointed him in order for them to be carried out.

As an aside I would just make a couple of observations: his point that housing prices would fall under his policies is correct, but his implication that housing would be more affordable is not (actually he doesn't make this point so much, more that there will be less risk, which likely IS correct); because prospective buyers would have less incentives/subsidies to buy a home..so they would be able to AFFORD less. So really this just moves prices; it doesn't necessarily make housing more affordable. And the other observation about Calabria's views (#2) is that since they will take a lot of time, they become subjected to the vagaries of political winds and changing administrations over time, which softens their impact. Thus, in my view the recap is coming, and there's no guarantee the GSEs WON'T remain dominant in housing for years to come. Commons could do quite well.

I see your point about affordable housing: Calabria argues that having lower home prices while keeping incomes unchanged makes housing more affordable, but if you can't get a loan even with a better loan value-to-income ratio, it doesn't necessarily make housing more available. Or, more accurately, home ownership.

I do agree with Calabria that increasing the housing supply is the best way to promote home ownership.

I don't share your optimism about the commons, though, for many reasons.

  • Calabria wants very, very high capital standards, arguing for at least 5% in some places and as high as 8% in others. FHFA's proposal, by contrast, calls for 3.25%. The amount of dilution needed to get to Calabria's standards while Trump is still in office is staggering.
  • Calabria and Treasury both want the GSEs to have a smaller footprint, meaning less in earnings power. Predictions based on current income levels, as Moelis includes, are likely to be overly optimistic.
  • You can get the best of both worlds if the junior preferreds are offered a conversion, because it would have to be voluntary and thus at a premium to what you could get in the market. Many see par as the ceiling for the juniors, but the plaintiffs will be starting their negotiations at par plus back dividends, interest, etc. so they might be able to get more, especially in a conversion scenario.

Every time I think about selling some of my juniors to buy commons I hesitate, and end up being glad that I did. I do think the commons have a higher upside in the best-case scenario, but there is real and substantial downside risk there if enough new shares get issued for a recap.

That has been my hesitation with owning common too but I dont seem to have a good rebuttal when someone says that a common shareholders interest is aligned with govt warrants so in turn high capital levels would dilute gov stake, unless they somehow get out first. If Sr Preferred declared paid how else does gov extract their pound of flesh besides maximizing warrant value?


orthopa

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #11021 on: December 12, 2018, 01:04:16 PM »
I don't believe its impossible for government to maximize warrant value without screwing commons over w/ dilution. It's all about sequencing. Government can easily arrange it so their 80% comes into play post the dilution/capital raise. So they retain full 80% value w/o any dilution.

He is consistent and it's crystal clear what he believes.

I agree here. I think this makes it less likely that Calabria is just going to be a yes-man for Trump, and instead that Trump actually supports Calabria's views and appointed him in order for them to be carried out.

As an aside I would just make a couple of observations: his point that housing prices would fall under his policies is correct, but his implication that housing would be more affordable is not (actually he doesn't make this point so much, more that there will be less risk, which likely IS correct); because prospective buyers would have less incentives/subsidies to buy a home..so they would be able to AFFORD less. So really this just moves prices; it doesn't necessarily make housing more affordable. And the other observation about Calabria's views (#2) is that since they will take a lot of time, they become subjected to the vagaries of political winds and changing administrations over time, which softens their impact. Thus, in my view the recap is coming, and there's no guarantee the GSEs WON'T remain dominant in housing for years to come. Commons could do quite well.

I see your point about affordable housing: Calabria argues that having lower home prices while keeping incomes unchanged makes housing more affordable, but if you can't get a loan even with a better loan value-to-income ratio, it doesn't necessarily make housing more available. Or, more accurately, home ownership.

I do agree with Calabria that increasing the housing supply is the best way to promote home ownership.

I don't share your optimism about the commons, though, for many reasons.

  • Calabria wants very, very high capital standards, arguing for at least 5% in some places and as high as 8% in others. FHFA's proposal, by contrast, calls for 3.25%. The amount of dilution needed to get to Calabria's standards while Trump is still in office is staggering.
  • Calabria and Treasury both want the GSEs to have a smaller footprint, meaning less in earnings power. Predictions based on current income levels, as Moelis includes, are likely to be overly optimistic.
  • You can get the best of both worlds if the junior preferreds are offered a conversion, because it would have to be voluntary and thus at a premium to what you could get in the market. Many see par as the ceiling for the juniors, but the plaintiffs will be starting their negotiations at par plus back dividends, interest, etc. so they might be able to get more, especially in a conversion scenario.

Every time I think about selling some of my juniors to buy commons I hesitate, and end up being glad that I did. I do think the commons have a higher upside in the best-case scenario, but there is real and substantial downside risk there if enough new shares get issued for a recap.

That has been my hesitation with owning common too but I dont seem to have a good rebuttal when someone says that a common shareholders interest is aligned with govt warrants so in turn high capital levels would dilute gov stake, unless they somehow get out first. If Sr Preferred declared paid how else does gov extract their pound of flesh besides maximizing warrant value?

So along the same lines are the TARP programs? I have to look at AIG bailout mechanics again but Treasury took 92% of company then sold holdings over ~3 year period afterwards. At a minimum if heavy dilution immediately doesn't crush value alone the overhang of shares outstanding will cap value for years as it did for AIG. I was an AIG warrant holder after TARP and the govt share overhang capped common value until entirely sold.

SnarkyPuppy

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #11022 on: December 13, 2018, 05:05:37 AM »
A bit stunning that the share price hasn't reacted in a meaningful way after Calabria was nominated.  Even in the unlikely event that he doesn't get confirmed, the administration undoubtedly would have been aware of his views on the treatment of shareholders and has effectively just "signaled" it's directional view on shareholder treatment.  Alternative explanation could be blatant incompetence by the Trump administration (actually not sure we can rule this out) and maybe focusing more on his views of receivership/getting rid of securitization and wanting to move to depository institutions holding mortgages on balance sheet. 

It's amazing that this paper was written by the next FHFA director:  http://investorsunite.org/wp-content/uploads/2015/01/Krimminger-Calabria-HERA-White-Paper-Jan-29.pdf

On receivership:  My quick read of what he has written is that his comments on receivership were criticism of what the government "should" have done during the small window of opportunity where it may have been feasible to move towards receivership prior to 2012. 

Regardless - in conjunction w/ comments on legality of net worth sweep and the following statement found in the paper above, I think shareholders do fine in a radical receivership given the PSPA will be (has to be) deemed paid -> assets greater than liabilities -> par liquidation preference on jr pref is paid

"Under a receivership, a troubled institution is closed and liquidated. Its assets and liabilities may be transferred to a third party, or they may be temporarily transferred to a bridge bank until the bridge bank can be sold, recapitalized, and returned to the private sector, or liquidated. But stakeholders are protected by the rules of priority of distributing proceeds of asset sales, the liquidation minimum (requiring that stakeholders receive no less than what they would receive in a liquidation), and the claims process. Under this framework, a conservator must, by definition, allow the company under its control to build capital and certainly cannot take actions that are designed to deplete its capital."

On shareholders:  As a result of investor fatigue and continued disappointment in how negative events seem to pop up out of nowhere, I'm definitely biased in reading certain things in a negative context.  With that backdrop, Calabria's paper purposely goes out of the way to use "pre-existing" or "pre-conservatorship" shareholders when talking about common/jr prefs.  This may just be parlance to distinguish between the government and other 'stakeholders'...  I'm 99% sure this is the how it should be read but I'm exhausted and simply stunned at the current share price. 

The Third Amendment implemented a “net worth sweep” that strips the Companies of their entire net worth each quarter and prevents the accumulation of any funds to repay pre-conservatorship shareholders, or build capital or any buffer against future losses.

As described below, the Third Amendment strips any net worth from the Companies with the intended effect of leaving them with a declining capital buffer against future losses and guaranteeing that the preexisting shareholders would receive no value from any future operations of the Companies.

Again, to the extent rights are transferred at the time of a stock being sold, this isn't an issue.  But Calabria seems to be a principled guy and I'm trying to handicap the likelihood that he draws the line on paying out liquidation preference to only those who held prior to 2012. 

Aside from that, it's always been interesting to me how the "value investor" pitches systemic reasons for mispricing due to investor fatigue, surface level news without analysis, misunderstanding of key events, and mistaking "uncertainty" with "risk".  Yet the investing community thinks this situation has so much hair on it that I'm actually not entirely sure that if recap/release is literally announced, there won't be an arbitrage opportunity
« Last Edit: December 13, 2018, 05:24:11 AM by SnarkyPuppy »

SnarkyPuppy

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #11023 on: December 13, 2018, 05:18:37 AM »
Also continued props to cherzeca who was fundamental in shifting my perspective to view this as an engineering problem with "constraints" that must be solved for.   (who is also seemingly a dead fan... talk about a misunderstood undervalued mispricing...)
« Last Edit: December 13, 2018, 05:23:02 AM by SnarkyPuppy »

Luke 5:32

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #11024 on: December 13, 2018, 05:39:28 AM »
Also continued props to cherzeca

+1. Christian is a stud. Incredibly grateful he accepted my pleading for him to join this community!  He was instrumental in my understanding of the MBIA/BAC legal mess a few years back through his blog, and I knew he would be very helpful to many people here.
Invest for retirement?  Sure.  But investing in eternity is infinitely more important.  Don't get it twisted.  "...but lay up for yourselves treasures in heaven, where neither moth nor rust destroys and where thieves do not break in and steal."  Matthew 6:20

Wiggins

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #11025 on: December 13, 2018, 05:51:08 AM »
I'm thoroughly enjoying cherzeca's and everyone's comments.
"pre-conservatorship" shareholders as used by Calabria may be intended to mean any shares other than Treasury's senior preferred stock, which are clearly post-conservatorship shares. And since he's talking about the NWS, this makes sense...the NWS benefited only that one class of shares (Treasury's). Fortunately, Lamberth clearly stated that shareholders' rights transfer when sold. It's inconceivable to me that Calabria could come down on the other side on this issue.

SnarkyPuppy

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #11026 on: December 13, 2018, 05:59:00 AM »
I'm thoroughly enjoying cherzeca's and everyone's comments.
"pre-conservatorship" shareholders as used by Calabria may be intended to mean any shares other than Treasury's senior preferred stock, which are clearly post-conservatorship shares. And since he's talking about the NWS, this makes sense...the NWS benefited only that one class of shares (Treasury's). Fortunately, Lamberth clearly stated that shareholders' rights transfer when sold. It's inconceivable to me that Calabria could come down on the other side on this issue.

Agree.  I'm trying to identify any potential holes in the thesis and I think it speaks to where we are at when this is all there is... aside from existential risks in terms of trump impeachment->administration wipeout

DRValue

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #11027 on: December 13, 2018, 06:22:12 AM »
Also continued props to cherzeca

+1. Christian is a stud. Incredibly grateful he accepted my pleading for him to join this community!  He was instrumental in my understanding of the MBIA/BAC legal mess a few years back through his blog, and I knew he would be very helpful to many people here.

+1 for cherzeca. Absolutely needed on this board.
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rros

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #11028 on: December 13, 2018, 06:53:23 AM »
Following Chris from the google board days :)

In my view, the Calabria/Krimminger 2015 paper may now be a bit overrated. It's been over 3 years, a new administration has taken over and soon a new Congress will be in place. Not to mention the real estate market has accumulated great imbalances.

Calabria may now see receivership only as a tool to achieve something else and not as the intended interpretation on that paper: liquidation (as a should-have). Whether Calabria decides the course of action is to privatize the companies, good bank/bad bank, or something else, receivership could be the transition method. If it happens this way, he will want Congress to ok any receivership scenario by making senators feel at ease with it and making it part of a legislative piece. Which may mean lots of hearings and time. Meanwhile, he may push for a 4th, kill the Srs. and recap. Time could favor the Jrs. as they may continue to add value should the Srs. go away.

Either way, I think he will not be looking to kill equity and that will be fair to shareholders. I think of Trump/Mnuchin as being on that camp too.

Jcmeg35

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #11029 on: December 13, 2018, 07:09:34 AM »
I would also like to say thank you to @Chereza as well as everyone else for your comments/thoughts over the years - as I have not made any contribution to date (mea culpa!).

While my view is that recap is the most likely scenario in 2019 and beyond, I have also been trying to figure out other outcomes. To @rros and others, I am not sure I fully follow the basis for receivership and the "good bank/bad bank" idea. What "bad assets" would be separated in this scenario and what "good assets" would remain. Under that view what would be liquidated and what would be the rational for this? 

Further to that point, as I think others have mentioned, given how messy that process is, one would have to imagine it would create disruption to the ongoing operations that currently write new business, potentially creating big issues in the US housing market.