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

[S2S]

^ Love it.

This is probably old news by now, but here's an interesting exchange between Bill Ackman and Clayton Rose  on FMCC:

Mr. Ackman: So you can make decisions that are adverse to shareholders?
Mr. Rose: Correct.
Mr. Ackman: And there’s no liability to you?
Mr. Rose: Correct.

Link: http://www.cnbc.com/id/15840232?video=1786618239&play=1

The pertinent part starts around 7:30. There's another short Q&A near the end of the clip.

Thoughts, twacowcfa?

[twacowfca]

It's good to hear them tell it like it is.  The speculation is that the Treasury Dept may be about to make a big change in the way these GSE"s are managed.  If Fannie and Freddie transitioned to charging anything close to market clearing rates for their guarantees, they would soon be profitable.  If the Treasury also cut the dividend rate on their preferred from 10% to 5%, they would soon be on their way to begin paying down the government's preferred stock.  

Clayton Rose is on the Board of Directors of FMCC.  Recent news reports say that  FMCC and FNMA have been lobbying the administration to cut the 10% dividends the US receives to 5%.  If these reports are true, it is likely that the board members of these GSE's are behind the lobbying.  Keep in mind that it was Hank Paulson, Bush's Secretary of the Treasury, who slapped them with such a high dividend rate, much higher than the rate that GS et al. had to pay on the preferreds the Treasury demanded in their bailouts.  The severe treatment of Fannie and Freddie could be interpreted as payback for all the shabby dealings between their former officers and the Democrat Party.

Geithner's recent statements indicate that the first of the two big ifs that could restore Fannie and Freddie's financial health will very likely happen with a progression of fee increases, to begin soon.  The second big if about lowering the dividend rate they pay the Treasury is much more iffy.  That may be too much of a political hot potato for now.  However, if the Treasury did cut their dividend rate, these GSE's should soon be on their way to becoming profitable, steady Freddies, so to speak.  Who knows, it's possible that they could once again become the fattest cash cow ever for the Democrat party.  Fannie and Freddie used to be Barney Frank's biggest source of funds, and Franklin Raines, the former Chairman of Fannie Mae, was Chairman of Obama's campaign financial committee.

Congress almost certainly will not be able to pass any legislation changing the structure of these GSE's, given the divided control of the house and senate.  The initiative is entirely with the administration, and it looks like Geithner's plan has prevailed.  Geithner says the Treasury intends to "crowd private capital into the mortgage market."  The only sensible way for this to happen is for the US to charge much more for Fannie and Freddie's guarantees.  We should know very soon if this will happen.

[ericd1]

Wow - 'market rates' - What a novel concept. 

I agree Congress would find it difficult, if not impossible to pay any legislation to clean up the mess and Geithner’s ‘market rate’ plan is a viable solution.

Presuming the GSE’s become financially stable, the PFDs would increase in value. It might take ten years or longer, but even with that a return to par over ten years it would be huge return…There could be some bumps along the way, perhaps a change in direction if the plan doesn’t work, etc.

Yet the market seems to be reacting unfavorably to the news…

[Myth465]

Interesting comments.

http://www.bloomberg.com/news/2011-02-11/obama-administration-calls-for-ultimately-winding-down-fannie-freddie.html

[Aberhound]

1. I wonder if there is enough juice in doubling the insurance rates and cutting the government preferred dividend in half to increase the value of the commons as well.

2. Considering the massive amounts of agencies, these are at risk without continued government and Fed support unless the government can create some value in the common shares. Presumably the government and the Fed want to stop providing that support so this is a way to do it.

3. Creating value in the common shares might give the government an exit path. They can convert the preferred shares to common and double the insurance rates. This will further dilute the existing common shares but will create the exit strategy if the common shares start to rise since the government could then sell the converted common shares at a profit. Earning capital gains on the common may be more profitable than getting a 10% dividend on the preferred. The government could create the profit on the common by simplifying regulation and taxation to make US more competitive and increasing immigration or granting amnesty for illegal immigrants. There are 14 million empty homes to fill. These policies would be good for the big banks too so I am surprised that bank friendly Obama hasn't already adopted these policies. And how else are you going to fix social security and medicare unless US brings in millions of young employable people to pay for the growing number of old retirees.

4. This is a better path than simply letting banks take over the business as doing so would concentrate even more risk in the big banks where there is enough risk already. Better to split the risk of mortgage defaults like in Canada and soon Australia as well although I would prefer the risk born by the Canadian government to be born by private publicly traded companies instead. Obviously whoever starts writing market rate mortgage insurance at low real estate prices is going to make a lot of money. It could be argued whether prices have further to fall or not but that depends on government policy on competitiveness and immigration. Buffett and Munger have written previously what a wonderful business it is so the government has a good game plan to follow.

5. My bet is the best way to play it is to buy the preferred for now and then switch to the common shares if the government swaps the preferred shares for common shares. Hopefully the dilution will cause the commons to fall in price but that depends on the terms so can't be predicted. I think the desire to get the agencies self-supporting gives the government and the Fed no choice but to follow this path. 

[twacowfca]

1. I wonder if there is enough juice in doubling the insurance rates and cutting the government preferred dividend in half to increase the value of the commons as well.

2. Considering the massive amounts of agencies, these are at risk without continued government and Fed support unless the government can create some value in the common shares. Presumably the government and the Fed want to stop providing that support so this is a way to do it.

3. Creating value in the common shares might give the government an exit path. They can convert the preferred shares to common and double the insurance rates. This will further dilute the existing common shares but will create the exit strategy if the common shares start to rise since the government could then sell the converted common shares at a profit. Earning capital gains on the common may be more profitable than getting a 10% dividend on the preferred. The government could create the profit on the common by simplifying regulation and taxation to make US more competitive and increasing immigration or granting amnesty for illegal immigrants. There are 14 million empty homes to fill. These policies would be good for the big banks too so I am surprised that bank friendly Obama hasn't already adopted these policies. And how else are you going to fix social security and medicare unless US brings in millions of young employable people to pay for the growing number of old retirees.

4. This is a better path than simply letting banks take over the business as doing so would concentrate even more risk in the big banks where there is enough risk already. Better to split the risk of mortgage defaults like in Canada and soon Australia as well although I would prefer the risk born by the Canadian government to be born by private publicly traded companies instead. Obviously whoever starts writing market rate mortgage insurance at low real estate prices is going to make a lot of money. It could be argued whether prices have further to fall or not but that depends on government policy on competitiveness and immigration. Buffett and Munger have written previously what a wonderful business it is so the government has a good game plan to follow.

5. My bet is the best way to play it is to buy the preferred for now and then switch to the common shares if the government swaps the preferred shares for common shares. Hopefully the dilution will cause the commons to fall in price but that depends on the terms so can't be predicted. I think the desire to get the agencies self-supporting gives the government and the Fed no choice but to follow this path.  

We closed out our remaining relatively small position in the preferreds a few days ago, keeping only a token
amount to remind us to look at them periodically and assess developments.  

Comparing the market caps of the commons and preferreds, I don't see any way that purchase of the commons could be worth more than buying the preferreds if there is ultimately some value for the equity.

  The new plans all raise the fees they charge for their securitizations, but it may take more than that to get them out of the hole.  Cutting the dividend on the Treasury's preferreds may be necessary to turn them around.  If this happens, things could get interesting.  Exchanging the Treasury's preferred for common would be even better, but that may be a long shot in the current political climate.  Meanwhile, I still haven't figured out how to multiply by zero!  

[kasi]

Freddie reported 1q2011 earnings. Official release, financial supplement, and an article from Wsj attached below.

[BargainValueHunter]

Fed keeping rates stapled to the floor through 2013 and the downgrade of Fannie and Freddie...

Any updates on how one may take advantage of this new information with regards to the preferreds?

http://www.insidestocks.com/quote.asp?sym=FNMAT

http://www.insidestocks.com/quote.asp?sym=FMCKM&code=BSTK

[onyx1]

Freddie is leading Fannie on the way to eventual profitability but they haven’t been able to get over the huge 10% Govt preferred coupon hurdle.  Like last quarter, they are like a dog eating its own tail.  They were forced to borrow $1.5bln from the Treasury, so they can turn right around and pay the Treasury a quarterly coupon of $1.6bln.  Crazy.  At some point, the politicians will see the GSEs as a money pot and will allow them to cut the preferred dividend and raise guarantee fees.  Cash will poor in, the allowance for tax deferred assets will be eliminated, and the taxpayer will get their money back in full with an IPO like GM/AIG.  Everyone wins, and the holders of the private preferred make a fortune!

[twacowfca]

Freddie is leading Fannie on the way to eventual profitability but they haven’t been able to get over the huge 10% Govt preferred coupon hurdle.  Like last quarter, they are like a dog eating its own tail.  They were forced to borrow $1.5bln from the Treasury, so they can turn right around and pay the Treasury a quarterly coupon of $1.6bln.  Crazy.  At some point, the politicians will see the GSEs as a money pot and will allow them to cut the preferred dividend and raise guarantee fees.  Cash will poor in, the allowance for tax deferred assets will be eliminated, and the taxpayer will get their money back in full with an IPO like GM/AIG.  Everyone wins, and the holders of the private preferred make a fortune!

I agree.  This seems to be the most likely outcome, eventually.  But it may not happen while there is a stalemate in Congress.  The probability goes up dramatically if the Democrats win the White House and both houses of Congress in 2012.