Midas79

Yup, lots of time and patience. I'm lucky to have a work-from-home desk job that lets me both have the time to develop the model I made (been improving it for 4 years) and monitor prices. My success in this investment is no longer dependent on recap and release, though this wasn't true until recently. Ironically for a member of this board, I'm not really a value investor. I don't like stock-picking at all. I have owned stock in precisely 4 individual companies in my life, and Fannie and Freddie are two of them. If I make enough money from this stock to retire I will happily index from there and enjoy life. I also have the advantage (if you can call it one) of not believing in opportunity costs in the way that most people seem to, so I'm not bothered at all by other people making huge returns on things other than FnF. My method is working and I'm quite comfortable with it as opposed to either doing lots of research (classic value investing) or just jumping on the meme coin of the moment (FOMO-driven investing).

It's been a while since I posted here, but I am finally checking in. I run a pref-swapping model designed to take advantage of mispricings among the different series: results posted on the @midas79JPSmodel account on Twitter. Right now the liquid series (FNMAS, FMCKJ, FNMAT) are actually horrible buys relative to the others. When you can get a $50-par, albeit zero-dividend, series like FNMAP for only 10% more than the $25-par FNMAS (and they were almost at parity last week), buying FNMAS doesn't make sense at all. Par value is guaranteed to matter in the resolution of the conservatorships, while dividend rate is iffy at best. If you care about liquidity then FNMAS/FMCKJ/FNMAT are the only games in town. But if you're a small enough player or are willing to hold for a while, literally any other pref series is a better buy. Wiggins is correct above: the remedy in Lamberth's court would be based on par value and simple interest, not dividend rate.

I have all my FnF shares at IB now. I am able to trade every series I keep track of, which is 34 of them, including the variable-rates. I haven't tried to trade FNMFO or the privately-placed Freddie juniors (FREJO, FREJP, maybe there's one or two more?) though.

I still don't see this as an either/or. If the seniors are converted to common then the seniors are "toast" but the existing commons get crushed. And if the seniors are written off, they are actual toast and it's the capital raises and junior conversion that toasts the existing common.

Well put. I think this is both a legal special situation and a distressed company investment, they are not mutually exclusive. FnF are severely undercapitalized (which is the source of their distress, regardless of their profitability), even under a more reasonable capital rule, and a recapitalization is a form of restructuring. That's where placement in the capital stack comes in.

Released https://www.realvision.com/identifying-sound-anti-bubble-trades-fannie-mae-and-freddie-mac-live-with-michael-kao-and-tim-pagliara FYI Tim and Michael, and by extension the rest of us, have been asked not to share that link on Twitter. It was certainly an excellent interview and well worth listening to for any current or prospective FnF investor.

[*]All Scenario 2 does is show that the seniors don't count towards core capital. So I suppose I just disagree with your overall point that the earnings FnF retain from here are fictional capital. [*]The purpose of converting the seniors is as part of a settlement for all >$5B lawsuits; converting rather than cancelling the seniors allows UST to get something in return for them. In fact, I don't think UST is allowed to just give up the seniors voluntarily for no return consideration; when the September 2019 letter agreement had the 1:1 senior pref liquidation preference increase Calabria said that things had to be done that way. In that case this hypothetical $125B payment would never happen, meaning no later increase in value upon which to base the takings claim. [*]Tying the senior pref conversion with lawsuit settlement also prevents claims of higher values in the counterfactual universe because without lawsuit settlement the prices can easily be argued to have been around what they are now. [*]A final Collins APA win is years and years away anyway. If SCOTUS upholds the Fifth Circuit's ruling that Atlas erred in dismissing the case based on 4617(f) then the case goes back to Judge Atlas's court, where she would do discovery, depositions, conduct a trial, and render a verdict. Then that verdict would be appealed, en banc panel requested, petition for cert to SCOTUS, the whole works. I think that's around a 3-year process, and there is no guarantee at any point that UST would actually have to send back that money. Just getting the SCOTUS remand should motivate UST to settle anyway because they clearly want to settle/kill all cases with a contingent liability >$5B. [*]Any lawsuit over a senior pref conversion would be a Fifth Amendment takings case in the USCFC, and the citations Judge Wheeler gave specifically cover takings cases. Do you think these DE cases you refer to would have precedential power over the cases in those citations? Personally, I doubt it. [*]If your reasoning of "instant lawsuit" was correct then there would also be instant lawsuits when the warrants are exercised. Going from 100% to 20% is more than 4 times the amount of damages of going from 20% to 1% after all. But if UST feared any lawsuit over the warrants they certainly wouldn't have insisted on exercising the warrants in full before any outside capital can be raised. Yet another reason I think UST has nothing to fear from lawsuits over a senior pref conversion. [*]UST still (unfortunately) has veto power over just about everything regarding exit from cship, and they are the ones who care about protecting the taxpayer. Calabria just waving his hands and saying that the seniors now count towards core capital doesn't fulfill the 3% CET1 exit requirement that he himself agreed to and now can't undo without Yellen's help. Wachter can't change that unilaterally, and evidenced by her testimony she wouldn't do it anyway.

I stand by the <$5B of liability to Treasury on any lawsuit involving a senior pref conversion or warrant exercise. Judge Wheeler, when he awarded zero damages in the Starr/AIG case, extensively cited SCOTUS in saying that in a takings or illegal exaction case the only thing that matters when calculating damages is what the property owner lost, not what the government gained. So whatever market or economic value Treasury's common shares later have means nothing in this context. For citations see the first paragraph on page 35. http://online.wsj.com/public/resources/documents/StarrvUS06152015.pdf The only thing that common shareholders could prove that they lost is the drop in market price per share between when the conversion/warrant exercise happened and the date of the lawsuit. Unless the commons spike dramatically before one of those events, UST faces a maximum liability of 1.8B times the common share price of $2 or so, or less than $4B. And the whole reason to do a senior pref conversion is to attract private capital, with the intent of the capital raises happening well in advance of any final ruling in Collins, which is 1-3 years away because SCOTUS is only going to remand the case at best (from the plaintiffs' point of view). So the idea that the commons will rise to much higher levels before the senior pref conversion happens is, in my mind, just wishful thinking. If I had a nickel for every time someone incorrectly overestimated a short to medium term price target on the commons I could recap FnF myself. Even if such a price appreciation were plausible, UST would just convert the seniors to common sooner to prevent that extra liability. Changing capital definitions and requirements is in the purview of the FHFA director, not the UST Secretary. Also, there is no way the seniors can count towards core capital in their current form. HERA is explicit in saying that the only kind of preferred shares that count towards core capital are non-cumulative ones, which the seniors aren't. See (7) in https://www.law.cornell.edu/uscode/text/12/4502. Core capital is what determines FnF's capital classifications, so FnF won't be anything other than "critically undercapitalized" until and unless the seniors are written down or converted to commons. Making the seniors non-cumulative alleviates the core capital problem but leaves CET1 capital unchanged and doesn't allow for outside capital raises of new common shares when those new shares would be buried behind a mountain of seniors. The seniors being cancelled or converted to common allows outside common share investors to at least rank on par with UST. The whole point of private capital raises, and recap/release in general, is to place private capital in front of UST's backstop. Handwaving the seniors into compliance with capital definitions doesn't accomplish that goal at all. One problem Calabria had with Watt's rule is that it allowed too many prefs to count towards capital (which is why Calabria put in CET1 requirements), and Susan Wachter, a candidate to replace Calabria once Biden can fire him, said "While the GSEs are now less risky, the lack of equity capital to absorb losses leaves taxpayers still exposed to credit risk." in her June 2019 written testimony to the Senate Banking Committee. I can't see her doing this handwave, and if Zandi is the next FHFA director all GSE shareholders are basically screwed anyway. https://www.banking.senate.gov/imo/media/doc/Wachter%20Testimony%206-25-19.%20PDF.pdf I don't understand Scenario 2 here. How can Fannie sell more senior pref shares?

I disagree that the NWS has been ended. I know, even Calabria has claimed that. But as long as the Sr Pfd balance increases right along with retained earnings, the GSEs are only building fictional capital. The NWS is not really ended as long as this continues. One thing that has been lost along the way is what exactly is meant by "capital". I'm seeing similar problems in my discussion with Tim Howard on his blog. I can see five different ways to define capital: [*]Total stockholder equity on the balance sheet [*]Amount of liquidation preference owed to shareholders upon liquidation [*]Core capital: stockholder equity minus cumulative prefs and AOCI [*]Tier 1 capital: core capital minus DTAs [*]CET1 capital: Tier 1 capital minus non-cumulative prefs When you say that only "fictional" capital is being built, that tells me you are using #2 as your definition, or perhaps something not on the list. All other entries on the list will go up with FnF's retained earnings because they are balance sheet calculations: the earnings go on there but the senior pref liquidation preference increases don't. The key is that core capital is defined under HERA, and FnF's post-release capital classifications are defined by HERA. Thus increasing core capital, which retained earnings now do, is important even if the senior pref liquidation preference increases along with it. This is real capital being built in the eyes of the law. The letter agreement might have been thin gruel, but it wasn't a complete nothingburger. The date at which the true NWS would have turned back on has been pushed from around now to 2044 or so. While not being nearly enough to accomplish recap and release, it's a significant step.

That's now how I understood it. [*]FnF never had (and currently does not have) the ability to pay down the seniors voluntarily because the funding commitment still exists: this is in Section 4(a) of the original contract that is not being contested. More technically, they can't pay down liquidation preference increases due to draws, which have been the source of all such increases. Thus the proposed remedy that pays down the seniors violates the original contract, while the other remedy (UST keeps the seniors but sends back $125B) respects it. Why would the Fifth Circuit choose the former over the latter in that light? [*]The funding commitment, whose removal could very well collapse the housing market, is tied to the existence of the seniors. Extinguishing the seniors entirely would alter large parts of the original contract, and I would imagine even the plaintiffs don't want this. Writing the liquidation preference down to its original value of $1B helps, but then the 1:1 increases in last week's letter agreement as FnF retain capital would stay in force. [*]My interpretation of the questions before SCOTUS is that they won't be determining the form of backward relief on the constitutional claim anyway, only if it should be available; the form would be remanded back down to the Fifth Circuit. Is this correct? [*]The same reasoning applies to the APA claims. On that front SCOTUS is only being asked if the APA claims should be dismissed due to either 4617(f) or the succession clause. A victory for the plaintiffs there merely means upholding the Fifth Circuit's ruling on that front, remanding the case back down the Judge Atlas, right?

I think you are misunderstanding how the SPS dividend works. The SPS don't get a dividend until FnF hit their full with-buffers capital level of 4% of adjusted total assets, even if a future FHFA director makes a new capital rule due to Section 5.15, unless Yellen and the new FHFA director amend that out. Once full capitalization is reached ("Capital Reserve End Date") the SPS get the lesser of any net worth increase from the previous quarter and 10% of the SPS liquidation preference. But dividends to other classes of shareholders subtract from net worth just as earnings add to it. So once dividends are paid out to other preferred and common shareholders, the SPS gets the rest of what FnF earned in that quarter. What that means, paradoxically, is that the SPS are at the back of the line in terms of dividends once full capitalization is achieved, and the SPS get no dividends at all before that. It remains to be seen how easy or possible it will be to sell new common shares who have zero liquidation preference ever but will get normal utility-like dividends. Without a settlement to the lawsuits and private capital raises the SPS will get no money from FnF for decades. Not even a commitment fee, unless a future FHFA director and UST Secretary reinstate it. Altogether this agreement actually gives Treasury an incentive to move quickly on raising private capital: slow accumulation of retained earnings provides less taxpayer protection (in terms of how much capital stands in front of UST's LOC) compared to fast and large capital raises, and those raises accelerate UST's timeline to getting payments on its SPS. The SPS dividend also answers a question I had, which was "what would FnF do with all their earnings once they hit full capitalization?" I couldn't imagine the government would be okay with private shareholders getting enormous dividends, and FnF would have no reason to save any money past full capitalization anyway. Now we know: UST gets all the extra money. Something else to consider is that 4% of adjusted total assets, the threshold at which the SPS divs turn on, was $265B as of last June and grows with FnF's asset base. I use 2.5% per year as a ballpark. FnF's combined core capital, though, was negative $167B at that time. That's a $432B gap! FnF make around $20B in earnings per year, but the 4% target grows at $6.6B per year right now and faster in the future as the 2.5% increases compound. Carrying out the math, that means not only will FnF not be fully capitalized through retained earnings by 2028, it will never happen at all! The smallest the gap between FnF's core capital and the requirement gets is $72B in 2065, then the compounding of the 2.5% becomes greater than $20B per year and the gap starts to widen again. Now, assuming flat earnings of $20B per year is probably unrealistic. If they also grow at 2.5% per year, which I think is reasonable because FnF's earnings are also roughly proportional to the size of their asset base, the $432B gap closes in a finite amount of time, but not until 2044. Note: only the SPS balance on the balance sheets count (negatively) towards core capital, a total of $193B for FnF combined. Increases to the liquidation preference due to the letter agreements, including the one from Thursday, are not reflected on the balance sheet and thus don't affect core capital at all.

What if Collins is settled? Does it depend on the settlement parameters? And if the Collins plaintiffs drop the case and ask SCOTUS not to rule, in order to preserve Calabria in office (until Biden files a copycat suit but that adds at least a year to the timeline), would SCOTUS comply?

To be honest I think that last part is true also. New money is always willing to step over the corpses of old money. That's why I believe the commons have so much more downside than the juniors: everyone is aligned against them; even Treasury because they have no reason to both maximize the warrants' value and write off the seniors.

UST writing off the seniors but trying to maximize the value of the warrants makes no sense whatsoever. If UST is in maximization mode they will convert the seniors (and it must be to commons due to CET1 capital requirements), not cancel them. The warrant shares were always going to be diluted by later capital raises anyway; there's a reason UST has never valued them at a full 80% of FnF's estimated market cap (Craig Phillips said UST's internal valuation was around $60B, or $8.33 per share). Also, Perry is the only case that affects the viability of capital raises because it holds the GSEs themselves liable. All other cases only involve UST eventually paying money to FnF if the plaintiffs win; with the seniors and NWS gone there is nothing else to fight over. Prospective investors would then price the capital raise shares conservatively relative to the assumed probability of success in the court cases. Any upside surprises in those cases would then mostly accrete to the new investors. In a SCOTUS loss scenario, there is no such thing as retained earnings, at least not for FnF or shareholders. UST would continue to sweep all profits because the NWS would be legal.

The PSPA would still have to be amended for this to work. Right now, any missed dividend payments add to the SPS liquidation preference, which prevents any later recap; by the time FnF have enough capital to think about exiting the SPS balance will be worth more than their market cap. At that point, even if new investors would be willing to invest enough money to pay off the SPS, they would demand 99.999% of the equity and wipe legacy common shareholders out. UST does have to give permission for release per the terms of the current PSPAs, so #5 will also require an amendment. What's the purpose of keeping the NWS on non-cumulative shares if FnF will never pay it anyway? An incentive to pay down the SPS as quickly as possible? That would increase taxpayer risk because FnF wouldn't be able to retain any capital beyond the thin cushion they have now.