FRE and FNM - Your positions, predictions and odds of nationalization
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I think its easy to argue that all shareholders are screwed, however the market day to day is showing some wild swings. There is massive debt that needs to be rolled over soon. However, with the doomsday scenario why aren't the shares trading at .01. The other wildcard is an uptick in housing. My question is when will they runout of money for their day to day operations. Just a few thoughts. Remember trading is gambling in this case, but no one will mind if you are right.
The shares are trading above $1 because nationalisation has not happened yet.
As long as FRE and FNM can rollover their debt, they can stay in business. Given the implicit (and possibly explicit) government guarantee, this has not been a problem. Therefore running out of money for day to day operations is not really the issue here.
The real issue is the structure of the balance sheet. FRE promised to raise $5.5 billion, and has not done so as yet. With a market cap of less than $3 billion, this represents significant dilution.
Furthermore, with more losses expected in future quarters, it is likely that both companies will need to raise more equity in the future.
Given the extreme leverage both companies are using, it is difficult to see how either company (particularly FRE) can raise equity from non-government sources.
Therefore a government-induced extreme dilution of equity seems to be the best-case scenario for existing shareholders.
A more likely scenario is nationalisation of the two companies, with shareholders' equity wiped out.
As long as FRE and FNM can rollover their debt, they can stay in business. Given the implicit (and possibly explicit) government guarantee, this has not been a problem. Therefore running out of money for day to day operations is not really the issue here.
The real issue is the structure of the balance sheet. FRE promised to raise $5.5 billion, and has not done so as yet. With a market cap of less than $3 billion, this represents significant dilution.
Furthermore, with more losses expected in future quarters, it is likely that both companies will need to raise more equity in the future.
Given the extreme leverage both companies are using, it is difficult to see how either company (particularly FRE) can raise equity from non-government sources.
Therefore a government-induced extreme dilution of equity seems to be the best-case scenario for existing shareholders.
A more likely scenario is nationalisation of the two companies, with shareholders' equity wiped out.
Quote from kinggyppo:
I think its easy to argue that all shareholders are screwed, however the market day to day is showing some wild swings. There is massive debt that needs to be rolled over soon. However, with the doomsday scenario why aren't the shares trading at .01. The other wildcard is an uptick in housing. My question is when will they runout of money for their day to day operations. Just a few thoughts. Remember trading is gambling in this case, but no one will mind if you are right.
One interesting thing I think is missing from most of these discussions is exactly how the shareholders would get diluted in a recapitalization.
It seems like the most common view is that the govt buys preferreds. But from the common shareholder persepective, vanilla preferreds are just like more leverage, not dilution. They are even better than leverage via debt, because more preferreds means less distress risk. So the only ways I see a govt preferred purchase seriously hurting the commons are if the prefs are not vanilla or if the pref dividend is onerous.
If the prefs are convertible there is obviously potential for dilution. I find it kind of hard to believe this is likely though, because it would be a pretty objectionable move by the govt. The conversion is only valuable if the companies recover, and the shareholders would be pissed if the government takes away their upside with a "bailout" that looks unneccessary after the fact. This would be an especially hard move to justify now when they have adequate regulatory capital and have not defaulted on anything. Is there any precedent for something like this in the US?
An onerous preferred dividend would have to be pretty high to make much difference, or the issue would have to be huge. Just ballparking it, say their normal borrowing rate if they were healthy would be 6%, and the government buys $10B of prefs in each company with a dividend of 20%. That is ~$1.4B difference per year, ignoring taxes and stuff. Which kind of hurts, but nothing like nationalization. And I don't think that would preclude them from being profitable in the future if market conditions become favorable.
So for you guys who think the government will wipe out or massively dilute the shareholders, is there anything here you disagree with or something I am missing? How do you think they would go about it if preferreds wouldn't do it?
It seems like the most common view is that the govt buys preferreds. But from the common shareholder persepective, vanilla preferreds are just like more leverage, not dilution. They are even better than leverage via debt, because more preferreds means less distress risk. So the only ways I see a govt preferred purchase seriously hurting the commons are if the prefs are not vanilla or if the pref dividend is onerous.
If the prefs are convertible there is obviously potential for dilution. I find it kind of hard to believe this is likely though, because it would be a pretty objectionable move by the govt. The conversion is only valuable if the companies recover, and the shareholders would be pissed if the government takes away their upside with a "bailout" that looks unneccessary after the fact. This would be an especially hard move to justify now when they have adequate regulatory capital and have not defaulted on anything. Is there any precedent for something like this in the US?
An onerous preferred dividend would have to be pretty high to make much difference, or the issue would have to be huge. Just ballparking it, say their normal borrowing rate if they were healthy would be 6%, and the government buys $10B of prefs in each company with a dividend of 20%. That is ~$1.4B difference per year, ignoring taxes and stuff. Which kind of hurts, but nothing like nationalization. And I don't think that would preclude them from being profitable in the future if market conditions become favorable.
So for you guys who think the government will wipe out or massively dilute the shareholders, is there anything here you disagree with or something I am missing? How do you think they would go about it if preferreds wouldn't do it?
Quote from kinggyppo:
I think its easy to argue that all shareholders are screwed, however the market day to day is showing some wild swings. There is massive debt that needs to be rolled over soon. However, with the doomsday scenario why aren't the shares trading at .01. The other wildcard is an uptick in housing. My question is when will they runout of money for their day to day operations. Just a few thoughts. Remember trading is gambling in this case, but no one will mind if you are right.
Assuming the government doesn't do anything drastic I think it is all rollover risk in the near term, which doesn't seem high based on the government backing and the recent auctions but who knows what could spook the debt market. Last I looked the interest rate spread between their existing assets and liabilities looked pretty good, so for now checks coming in are bigger than checks going out. At longer horizons massively high defaults could do it but this would take a while.
The fair value balance sheet stuff that shows them to be practically insolvent is based on market values that capitalize expected defaults over the life of their mortgages plus a lot of risk aversion in the current market. Their stocks are overvalued compared to their components but this doesn't mean they are likely to run out of cash soon.
its likely the be more than $10b for each. preferreds wont dillute the common but will take away their earnings. plus you are hearing just about every government official(bernanke, paulson on BSC) or ex-official(like greenspan or poole) talking about wiping out shareholders and removing management, to think they will help shareholders is wishful thinking IMO.(probably fueled by human illusions of seeing their penny stock tripling or whatever)
The issue now is paulson probably can't act without management's consent and the management wants to keep the game going for as a long as they can, at the same time mortgage rates are going up and the only players in housing wont increase their balance sheet in order to preserve capital.
I believe if paulson will have to ask lockhart to say they are undercapilized(they could say the companies dont have a plan and investors to revert their capital trend even though they are still above the minimums) then they are in control and can do whatever they want, of course they would get sued but in a panic they will feel its necessary and the lawsuit can be dealt with later(plus you cant be accused of bailing out shareholders if a court ordered you to)
