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Fannie Mae Preferred FNMFO
May 30, 2019 - 11:39am EST by
gman
2019 2020
Price: 45,000.00 EPS 0 0
Shares Out. (in M): 24,922 P/E 0 0
Market Cap (in $M): 1,121 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT 0 0

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  • disappointing writeup of a complex situation
  • Preferred stock
  • two posts in one day
 

Description

 
FNMA Preferred Stock
 
• 10 year saga, light at the end of the tunnel
• At ~50 cents on the dollar, meaningful upside remains with more certainty than ever
• Administrative activity in the next 1-6 months will push shares towards par
• Court developments compress the timeline
• Uncorrelated to the broader market
 
Most of you are probably familiar with Fannie and Freddie (the “GSE’s”) and their saga since the
financial crisis. For more background see Socratesplus’s write-up or the 1259 and counting pages of
discussion on the Corner of Berkshire.
 
If not, here is the quick summary:
 
• Financial Crisis – every levered financial co is blowing up, the GSE’s are arguably the backbone of
the American economy, and the US gov’t steps in with essentially unlimited funds to support the
GSE’s
o US takes 10% running and 80% of the equity in warrants. GSE common shares go to zero
and the junior preferred shares (the ones we are pitching today) go to pennies on the
dollar
• Post Crisis
o Housing starts to recover, US economy starts to recover, GSE’s get their house in order
(see what I did there), and although they have not kept up with the 10% running owed
to the gov’t (and have a PIK option), they are about to start printing money as they did
for most of their history
• 2012 
 
3rd Amendment/Net Worth Sweep
o On the eve of massive profits, the US Treasury changes the 10% running into 100% of
everything
o At the time, it seemed shady and now it’s just criminal
o Preferred shares had climbed ~400% to 10 cents on the dollar, collapsed ~70% back to
cents on the dollar
• Lawsuits
o Perry, Fairholme, and a whole bunch of people sued over the 3
rd amendment
o The lawsuits are ongoing, have mostly been defeated, but…
o Fairholme has uncovered numerous documents via discovery that don’t look good for
the government and still has a shot at their lawsuit
• Since
o The lawsuits progressed, congress did some stuff
o The preferred shares rallied up near 50 cents on the dollar in 2014 and then…
o Judge Lamberth tossed out the Perry lawsuit with the justification that the “government
can do what they want”, more or less
o The preferreds dropped ~70%
 
 
 
 
 
o Trump was elected and his Treasury Secretary, Mnuchin, said GSE reform is a priority
and will be done super-duper, bigly fast with the help of congress
o The prefs went from ~15 cents on the dollar to ~40 cents on the dollar in late ’16, early
‘17
o Turns out tax reform, repeal of Obamacare, etc were more important than GSE reform
and Congress was not helpful
o Prefs drifted back down to ~25 cents on the dollar for most of ’17-‘18
 
Now, what has happened recently to change the calculus on the “always on the come” preferreds?
Simply, Trump appointed Mark Calabria as the head of FHFA, the GSE’s regulator, and he has been
explicit about ending the conservatorship and doing it quickly. Importantly, as head of FHFA, he has sole
authority to release the GSE’s and end the net worth sweep.
 
Trump issued a directive for Treasury and FHFA to provide plans for GSE reform. Calabria has been doing
a speaking circuit talking about a potential 2020 IPO. My guess is these claims get walked back to a more
reasonable timeline, but the cow is out of the barn and GSE reform is coming. The Prefs have rallied
back to roughly 50 cents on the dollar and are up roughly 100% year to date.
Why now? Isn’t the Calabria rhetoric priced in?
 
“Whether we can do some kind of conversion with preferreds, or whether they would get
par, it’s way too early to figure that out.” – Mark Calabria, CNBC, May 20, 2019.
 
We don’t think so. We think the next 3-6 months will cement the path forward and the market will begin
to discount some recovery some 2-3 years in the future. We believe active court cases and decisions
expected in the next year will hold the administration to the expressed timeline of “late 2019”.
 
 
Immediate par recovery is possible we suppose, but we think unlikely. A par recovery 3 years out, after
many machinations of capital raise and restructuring, discounted back at 15% per year would be about
65 cents on the dollar or another 30% from here. A 10% discount rate on a 2 year time horizon would be
~80 cents on the dollar or a 60% return from here. You can use whatever discount rate you prefer and
whatever time horizon, but we believe this trade is morphing from “hail mary” to regular way “merger
arb” and the required return for the market is dropping from multiples of capital to ~10% IRR. There is
still meat on the bone and it is likely to be realized in the next 6 months.
 
There are many different preferred issues that trade for both FNMA and FHLMC. I used FNMFO because it is the one trading at the largest discoutn to face value.
 
Happy to add more in the comments.
 
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1) Treasury Secretary Mnuchin's characterization of GSE reform as a "priority". Mnuchin is close with John Paulson, a large FNMA preferred holder.

2) Trump's appointment of Mark Calabria as head of the FHFA

3) GSE reform now a front burner item for the Trump administration

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