Gov final Reply in Lamberth Case ... + plus the Seeking Alpha Article below: https://storage.courtlistener.com/recap/gov.uscourts.dcd.160910/gov.uscourts.dcd.160910.436.0_1.pdf ******************************************************************************************************************************* Fannie Mae Preferreds: A Safer Choice Than Common ...... Summary ....... --- Fannie Mae is likely to be recapitalized in the event of a Donald Trump victory. --- The value of the common stock would be highly uncertain in a recap, but preferred issues --- The three most liquid preferred have compounded average annual returns above 100%
Jul. 17, 2024 1:45 AM ET
are likely to be redeemed or converted at face value.
in the base scenario.
The last few weeks have seen renewed interest in the stocks of Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC). The government-sponsored enterprises have been the Schrodinger's cat of the market, alive and dead at the same time, since the mortgage insurers were taken into conservatorship during the 2008 financial crisis.
SA analyst Chris DeMuth Jr. recently highlighted the GSEs as a good way to bet on a Donald Trump election victory because of the likelihood they would be recapitalized and released to private investors--turning the zombie cat into a roaring kitty.
Rather than echo his arguments, I will address the differences between common stock and the various preferred issues, focusing Fannie Mae since I've followed it for at least 25 years.
Common Has Negative Equity
The reason the preferreds carry less risk in the event of a successful recapitalization is found on the balance sheet. The GSEs were prohibited from accumulating equity by the Obama administration. Instead, all profits were subject to a net worth sweep, in which the Treasury Department confiscated profits in return for implicitly guaranteeing the GSEs' debt in case of failure.
As a result, Fannie showed negative common equity of over $130 billion until the Federal Housing Finance Agency reversed the policy under Trump's director, Mark Calabria. While Fannie is now retaining profits, common equity still stands nearly $58 billion underwater.
Balance sheet of Fannie Mae
Preferred equity, which is divided between the government and private investors, shows a positive balance of $139 billion. It is senior to the common. Under any normal reorganization plan, for common shareholders to get anything of value, preferred issues would have to be made whole first, either by being redeemed at par or by being converted to common. (Caveat: Nothing is normal about this situation.)
Calabria, an advocate of recapitalizing and releasing the GSEs, was replaced by the Biden administration, which has not reimposed the net worth sweep but has taken no steps toward release.
Calabria explained his views that the net worth sweep was illegal and release is legally necessary as well as desirable in a June recorded interview with Bloomberg. An especially relevant portion begins around 30:30 of the audio.
When people ask me, you know even in a Trump term, it's not going to be a 2025 exit. 2026, '27 is more likely."
Interviewer: "Do you feel that the 2028 warrants are a meaningful deadline?"
Calabria: "No. (Laughs). The reason it's really not is if you look at the total value pie for Treasury, it's a rounding error. The value really is in the senior preferreds..."
To understand what he's saying, it's important to know the government owns warrants to buy 79.9% of the common stock, which expire Sept. 7, 2028. The government also owns senior preferreds that were issued to support FNMA during and after the financial crisis. Investors own about $35 billion in junior preferreds. These are senior to the government's common warrants and thus cannot be diluted if they are issued, unlike the common stock.
So what Calabria says about the Treasury's shares would also hold true for those held by investors--most of the value is in the preferreds.
Release Scenarios
In 2020, the Congressional Budget Office released an analysis of three release scenarios, with optimistic, median, and pessimistic assumptions.
In some scenarios, the GSEs would raise enough from the common-stock sale to achieve three goals: meeting their capital requirements, redeeming their outstanding senior and junior preferred shares, and providing the Treasury with some value for the warrants it received from the GSEs. (Those warrants give the Treasury the right, though not the obligation, to buy common stock in the GSEs for a nominal price in the future.)
The middle of these scenarios called for redemption of approximately $35 billion in outstanding junior preferreds but ascribed a value of zero to $100 million to the common stock warrants owned by the government, which implies that the investor-owned common shares would be worth less than $20 million.
That's not to discount the possibility of a good return on the common. One possibility is that current shareholders will receive rights to buy new shares, which like many IPO's could be at a favorable price.
Also, if recent profits continue, common equity would turn positive around 2028, and existing shares would have a positive book value. And unlike the preferred, there's no theoretical limit to the value of the common.
However, the preferreds have to be taken care of before any recapitalization can take place, and thus offer a better chance of success. The common stock is more of a bet on a Trump victory and could be risky after the election even if he wins.
Which Preferreds To Buy?
Fannie Mae has 15 issues of preferreds that are trading over the counter, according to Quantum.
Most of them do not trade a lot of shares. By far the most liquid is FNMAS, with average daily volume of 471,000. Others with fair volume are FNMAT (63,000) and FNMFN (65,000).
Let's use FNMAS as an example. It recently closed at $5.55, or 22% of face value of $25. If investors purchased 1,000 shares for $5,550, and it was redeemed for face value in July 2026, they would receive $25,000, for a compound annual growth rate of 112%.
Other issues would give even greater gains, as there is a tradeoff between return and liquidity. FMMAT would have a compound annual growth rate of 127% under the same assumptions. FNMFN is at 147%. Some of the others are still higher, but stocks with low liquidity are not recommended for most investors.
If instead of redeeming the preferreds, the reorganization plan calls for resuming quarterly dividends, the calculations would be different. This does not appear likely, however, as 8.25% fixed coupon on FNMAT and the variable rates on FNMAS and FNMFN represent higher-cost capital than a huge, well-capitalized financial Fannie should need to pay. All of the securities are non-cumulative, so there will be no payment of arrears.
Risks
Re-election of President Biden likely would mean a continuation of the "dead" version of the cat and a tumble in both common and preferred prices. Even if Trump wins, there are various legal and regulatory obstacles to completion of recapitalization. A serious recession that freezes the mortgage or IPO market could make recapitalization untenable before the 2028 election.
Conclusion: FNMA should continue to do well through Election Day as long as there is anticipation of a Trump victory, but its value in a recapitalization plan is speculative. FNMAS, FNMAT, and FNMFN are recommended for investors who can afford to take risks.
This article was written by - Vlae Kershner
