Author Topic: FNMA and FMCC preferreds. In search of the elusive 10 bagger.  (Read 5104394 times)

WB_fan82

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #16920 on: January 20, 2021, 04:48:10 PM »
A couple observations...

First on the capital.. the reason it's an economic fiction is to consider how the exact same economic scenario has different results on capital.  Scenario 1:  status quo.  Fannie earns  $5B.  Retained earnings up by $5B, sr liq pref up by $5B but no adjustment for that on the balance sheet.  Under HERA, capital is up by $5B.  Scenario 2:  Fannie sells $5B of sr pfd.  It gets the $5B but now there is a $5B higher liquidation preference on the balance sheet.  Under HERA, zero capital improvement.  Same $5B into the company.  Same $5B higher liquidation preference.  But only one form is counted as capital under HERA.  That's why it's something of a fiction.

Second on the point of exit under this current PSPA... The whole exercise is HIGHLY dependent on the capital requirements for these entities.  As they build capital, a change in the capital rule could dramatically change the equation in terms of overcapitalization.  For example, imagine Calabria's 4% goes to Wachter's 2-3%.  Or, imagine that we move away from CET1 bank regulatory concept and redefine capital to include ALL preferred (i.e. everything subordinated to creditors), or even the government's commitment to purchase preferred under the PSPA.  You could have lower capital requirements, the sr pfd counting as capital, even unfunded commitments counted as capital.  Any single one of those things could result in a lot of resources freed up that could pay down the senior preferred balance to the point where the 10% coupon is manageable. 

This is not a near-term thing, and likely wouldn't happen under Calabria (though I think there is a very good case to make to Calabria that the govt commitment to purchase capital stock should be counted as capital).  But in time, someone else with a different vision of capital could make a huge difference here.


investorG

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #16921 on: January 20, 2021, 04:53:06 PM »
I'm still absorbing what happened, and why the agreement was as such to be punitive to litigating shareholders. One thing to consider is that Paulson and co/Moelis sponsors were non-litigating shareholders, and perhaps the litigating shareholders and Treasury just could not come to a settlement between Nov 18th and Dec 9th, after which things went downhill. The new agreement leaves Treasury in a strong position as others have noted, and intends to bring litigating shareholders to their knees to settle. Perhaps they will throw the dice once again with SCOTUS, after which there will be little choice but to throw in the towel. I ended up cutting down my position in half, where I can live with it going close to zero slowly or overnight, because the new agreement made it a binary investment yet again. Neither liquidation (and taking), nor restructuring, rather the threat of an endless status quo which still leaves everyone except shareholders happy.

I agree Doc, we could be misaligned with the litigants.  Unless we win constitutional at the SC, which is unlikely, I wonder if Berkowitz holds out for the Lamberth trial (perhaps ~ $40 potential) or if he'd go ahead and settle in 2h 2021 for either a decent deal (if we get APA remand) or any deal (if we lose collins outright).  I suspect it will leak out at some point the reason for the prior admin's crunch time collapse.

investorG

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #16922 on: January 20, 2021, 04:56:23 PM »
A couple observations...

First on the capital.. the reason it's an economic fiction is to consider how the exact same economic scenario has different results on capital.  Scenario 1:  status quo.  Fannie earns  $5B.  Retained earnings up by $5B, sr liq pref up by $5B but no adjustment for that on the balance sheet.  Under HERA, capital is up by $5B.  Scenario 2:  Fannie sells $5B of sr pfd.  It gets the $5B but now there is a $5B higher liquidation preference on the balance sheet.  Under HERA, zero capital improvement.  Same $5B into the company.  Same $5B higher liquidation preference.  But only one form is counted as capital under HERA.  That's why it's something of a fiction.

Second on the point of exit under this current PSPA... The whole exercise is HIGHLY dependent on the capital requirements for these entities.  As they build capital, a change in the capital rule could dramatically change the equation in terms of overcapitalization.  For example, imagine Calabria's 4% goes to Wachter's 2-3%.  Or, imagine that we move away from CET1 bank regulatory concept and redefine capital to include ALL preferred (i.e. everything subordinated to creditors), or even the government's commitment to purchase preferred under the PSPA.  You could have lower capital requirements, the sr pfd counting as capital, even unfunded commitments counted as capital.  Any single one of those things could result in a lot of resources freed up that could pay down the senior preferred balance to the point where the 10% coupon is manageable. 

This is not a near-term thing, and likely wouldn't happen under Calabria (though I think there is a very good case to make to Calabria that the govt commitment to purchase capital stock should be counted as capital).  But in time, someone else with a different vision of capital could make a huge difference here.

I wouldn't count on this.   What Tsy scty is going to drop the equity capital requirement below 3%.  This letter agreement took the capital rules out of FHFA head's sole hands.

WB_fan82

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #16923 on: January 20, 2021, 05:10:48 PM »
I'll tell you who... Yellen, if Wachter is the FHFA appointee.  Read her paper.

If you are the TSY secretary, it's far easier to engineer a change in the capital definitions and requirements of the GSEs than it is to lower dividends, forgive principal, or otherwise transfer economic value out of Treasury's sr pfd to GSE shareholders.  Especially when those shareholders are hedge funds.

One of the biggest issues with this trade is the " branding" problem.  The press loves to mention hedge fund speculators, which is partly true.  If this was the Ohio or Florida pension system suing, it would be looked at far differently.  It shouldn't matter, but it really does.  Detroit pensioners did better than "hedge fund vulture" muni bond holders in municipal BK.  GM union/pension creditors did far better than other creditors in that BK despite similar priority.  Just how the world works.

This note is about 10 years too early, but if nothing happens and we have a decade of retention then an additional road to recap is a change in the capital requirements.  Currently the GSEs are too far away for this to matter today, however.


investorG

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #16924 on: January 20, 2021, 05:30:36 PM »
I'll tell you who... Yellen, if Wachter is the FHFA appointee.  Read her paper.

If you are the TSY secretary, it's far easier to engineer a change in the capital definitions and requirements of the GSEs than it is to lower dividends, forgive principal, or otherwise transfer economic value out of Treasury's sr pfd to GSE shareholders.  Especially when those shareholders are hedge funds.

One of the biggest issues with this trade is the " branding" problem.  The press loves to mention hedge fund speculators, which is partly true.  If this was the Ohio or Florida pension system suing, it would be looked at far differently.  It shouldn't matter, but it really does.  Detroit pensioners did better than "hedge fund vulture" muni bond holders in municipal BK.  GM union/pension creditors did far better than other creditors in that BK despite similar priority.  Just how the world works.

This note is about 10 years too early, but if nothing happens and we have a decade of retention then an additional road to recap is a change in the capital requirements.  Currently the GSEs are too far away for this to matter today, however.

I agree there is a branding problem.  That's why a potential write-down needs to be accompanied in conjunction with a large capital raise.  Yellen can truthfully say we couldn't have gotten this equity that you see right now in the door without a write down.  And this equity can provide a) taxpayer protection, b) actual cash (via warrant monetization and/or some partial sr pref conversion) rather than mark to market gains that Midas says could take 20 years to tap, and c) no material lawsuit liability.    The Trump admin was too lazy to move in this manner.    So they bunted us to first base rather than hit the home run.

WB_fan82

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #16925 on: January 20, 2021, 06:18:07 PM »
The problem with that is it's a big fat lie.  They can convert the entire preference into common shares.  No writedown necessary.

I think TH is correct, however, that conversion means a ton of lawsuits.  Until we have clarity on Collins, at least.

I disagree with Midas that the liability is capped at $5B on a conversion and therefore the lawsuits won't be a roadblock.  The stocks are priced at < 1x PE b/c of the NWS.  Winning the lawsuits means at least $30B back to the companies, which is 6x the current market caps alone.  Bare minimum.

The more promising route might be the carrot (affordable housing) instead of the stick (lawsuits).  Calabria can offer a 20 bps reduction in affordable housing G-fees, which mostly flows to cheaper mortgages.  That's got to be worth something to Democrats.  Just exercise the warrant and drop the lawsuit caps (which seem totally irrelevant... the market will make up its own mind and what do the caps have to do with anything over at TSY?!).

Jr prefs don't really care about a modest diminution in GSE earnings power, and I don't think Calabria does either.  55 bps G-fees are way too high.


investorG

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #16926 on: January 20, 2021, 06:36:47 PM »
The problem with that is it's a big fat lie.  They can convert the entire preference into common shares.  No writedown necessary.

I think TH is correct, however, that conversion means a ton of lawsuits.  Until we have clarity on Collins, at least.

I disagree with Midas that the liability is capped at $5B on a conversion and therefore the lawsuits won't be a roadblock.  The stocks are priced at < 1x PE b/c of the NWS.  Winning the lawsuits means at least $30B back to the companies, which is 6x the current market caps alone.  Bare minimum.

The more promising route might be the carrot (affordable housing) instead of the stick (lawsuits).  Calabria can offer a 20 bps reduction in affordable housing G-fees, which mostly flows to cheaper mortgages.  That's got to be worth something to Democrats.  Just exercise the warrant and drop the lawsuit caps (which seem totally irrelevant... the market will make up its own mind and what do the caps have to do with anything over at TSY?!).

Jr prefs don't really care about a modest diminution in GSE earnings power, and I don't think Calabria does either.  55 bps G-fees are way too high.

Apart from lawsuits, converting the whole sr pref to common is a circular disaster, not really workable due to low current mkt caps of jr pref and public common to squeeze value from combined with the relative ownership demands from fresh money investors potentially putting in well over $100bn.

edit:  Doubt the 30bn gets returned in any scenario.  Govt can keep the $190bn sr pref and just send back the $125bn.  Investors don't want this and so if we won Collins we'd negotiate to write down the sr pref instead and would have to give up something.

edit 2:   The odds of Calabria working out a deal pre-collins are low.  why are they going to give up the house in april when they can wait 3 months and get most of what they want with a new fhfa head.
« Last Edit: January 20, 2021, 06:43:34 PM by investorG »

Midas79

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #16927 on: January 20, 2021, 08:33:58 PM »
The problem with that is it's a big fat lie.  They can convert the entire preference into common shares.  No writedown necessary.

I think TH is correct, however, that conversion means a ton of lawsuits.  Until we have clarity on Collins, at least.

I disagree with Midas that the liability is capped at $5B on a conversion and therefore the lawsuits won't be a roadblock.  The stocks are priced at < 1x PE b/c of the NWS.  Winning the lawsuits means at least $30B back to the companies, which is 6x the current market caps alone.  Bare minimum.

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.

If you are the TSY secretary, it's far easier to engineer a change in the capital definitions and requirements of the GSEs than it is to lower dividends, forgive principal, or otherwise transfer economic value out of Treasury's sr pfd to GSE shareholders.  Especially when those shareholders are hedge funds.

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

First on the capital.. the reason it's an economic fiction is to consider how the exact same economic scenario has different results on capital.  Scenario 1:  status quo.  Fannie earns  $5B.  Retained earnings up by $5B, sr liq pref up by $5B but no adjustment for that on the balance sheet.  Under HERA, capital is up by $5B.  Scenario 2:  Fannie sells $5B of sr pfd.  It gets the $5B but now there is a $5B higher liquidation preference on the balance sheet.  Under HERA, zero capital improvement.  Same $5B into the company.  Same $5B higher liquidation preference.  But only one form is counted as capital under HERA.  That's why it's something of a fiction.

I don't understand Scenario 2 here. How can Fannie sell more senior pref shares?

WB_fan82

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #16928 on: January 21, 2021, 07:38:33 AM »
On Scenario 2:  It doesn't matter whether they can't or don't.  The point is to show how two economically equivalent things are accounted for differently.

On the takings liability:  Imagine sr pfd conversion is done pre Collins.  Public shareholders go from 20% to 1% ownership.  And then Collins APA is a win.  $100B++ back into the companies.  Instant lawsuit, because the common holder share of that went from 20% to 1%.  The govt basically took the fruit of the lawsuit away.  You are limiting your analysis of damages to some assumption of the change in stock price, but that is not correct.  Value is not confined to stock prices, and the courts are well aware of that.  Look at how the DE courts have awarded damages in excess of merger prices during appraisal proceedings, for example.  It's complicated and messy.

I'd say the whole point of private capital raises isn't to protect the taxpayer but rather to exit from c-ship.  That's all Calabria cares about.  He doesn't care about "protecting the taxpayer", or minimizing dilution, or maximizing GSE earnings power or really anything except insofar as it's a box to check to accomplish his primary objective of exiting c-ship.  Because he's the rare person who has strong conviction in following the statute.





COBFInfinity

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Re: FNMA and FMCC preferreds. In search of the elusive 10 bagger.
« Reply #16929 on: January 21, 2021, 07:51:14 AM »
On Scenario 2:  It doesn't matter whether they can't or don't.  The point is to show how two economically equivalent things are accounted for differently.

On the takings liability:  Imagine sr pfd conversion is done pre Collins.  Public shareholders go from 20% to 1% ownership.  And then Collins APA is a win.  $100B++ back into the companies.  Instant lawsuit, because the common holder share of that went from 20% to 1%.  The govt basically took the fruit of the lawsuit away.  You are limiting your analysis of damages to some assumption of the change in stock price, but that is not correct.  Value is not confined to stock prices, and the courts are well aware of that.  Look at how the DE courts have awarded damages in excess of merger prices during appraisal proceedings, for example.  It's complicated and messy.

I'd say the whole point of private capital raises isn't to protect the taxpayer but rather to exit from c-ship.  That's all Calabria cares about.  He doesn't care about "protecting the taxpayer", or minimizing dilution, or maximizing GSE earnings power or really anything except insofar as it's a box to check to accomplish his primary objective of exiting c-ship.  Because he's the rare person who has strong conviction in following the statute.

Simple: Sr Pfd can't be converted to common (if that's even being considered) unless all litigation is resolved. End of litigation is the first step in all of this.