seekingalpha.com | November 15, 2016
By Carlos Vignote Sánchez
- Worrisome power of financial market participants to influence a US President.
- The privatization of FnF is the sale of FnF to Wall Street dirt cheap.
- FnF have already repaid the Treasury, so the warrant ought to be cancelled.
- FnF's shareholders threaten to sue the government if it exercises the warrant.
After the electoral night, we witnessed the most severe turnaround in the financial markets ever seen. The Dow Jones Index futures plummeted more than 800 points in its lows, but it was fully reversed after investors digested the surprising announcement of the President-elect, Donald Trump, that night regarding a massive infrastructure program that wasn't included in his presidential campaign, but Hillary Clinton's.
No-one else noticed it?
The next days this infrastructure program announcement was the most commented theme across the media. Copper rose to a fresh one-year high this week, boosted by bets on a rise on infrastructure spending.
But, how is gonna be paid for? Is the coming Trump Administration going to raise the Public Debt massively? We weren't told that before the elections, but the opposite. Even if they persuade companies to repatriate cash to fund this program, investors will require a return on their investment. Therefore, it has to be recorded as issuance of Public Debt.
Once Wall Street (mainly the big banks and large investment banks and private equity firms) got its infrastructure program, they passed to the second phase: outlining how to pay for this program using Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC).
Market Watch internet news outlet owned by the WSJ wrote: "Fannie Freddie surge as Trump taps advisors who back privatization", citing an op-ed written in 2014 by Ken Blackwell. But in the op-ed there isn't a word about privatization but returning the Enterprises to their private shareholders and protect their property rights.
Wall Street wants investors and FnF's shareholders to accept a privatization, signaling that the stocks surged for the prospects of a privatization.
But, how do you privatize a private company? FnF are private shareholder-owned enterprises already, even during Conservatorship. The government agrees with this fact: "Fannie Mae is a federally chartered, shareholder-owned, private company" (Fiscal Year 2016. Budget of the United States Government)
So, what does a privatization mean?
For Wall Street, privatization is allowing the big banks and other large financial institutions to assault FnF's ownership paying very little (as the current market price suggests in stocks trading outside the NYSE and under a Profit Sweep by the Treasury), by activating the scheme laid out by the previous Secretary of the Treasury and Goldman Sachs alumni, Hank Paulson, when the day of Conservatorship obliged the Enterprises to issue a warrant representing 79.9% of the common equity and an exercise price of $0.00001 per share, that was bought by the Treasury. Upon the Treasury exercises the warrant, it may assign the shares to any Financial Institution, according to the covenants: "Whenever the Holder exercises this Warrant in whole or in part, it may assign its right to receive the Exercise Shares issuable upon such exercise to any other Person". "Person shall mean any individual, corporation, partnership, trust, …"
This measure of issuance of a Warrant wasn't necessary as required by the 2008 Housing and Economic Recovery Act (HERA):
B. EMERGENCY DETERMINATION REQUIRED.-In connection with any use of this authority, the Secretary must determine that such actions are necessary to-
- provide stability to the financial markets;
- prevent disruptions in the availability of mortgage finance; and
- protect the taxpayer.
Today we can say that the warrant didn't protect the taxpayer either, because the enterprises have paid more cash to Treasury than draw requests since Conservatorship began. For instance, with the $3B dividend payment due at the end of December 2016, Fannie Mae will have paid Treasury a cumulative $154.4B versus draws of $116.1B.
So, the shareholders have here a strong case to challenge the government and its $1,000-per-hour lawyers in Court, in the event the government exercises the warrant, because the Statute of Limitations hasn't expired yet.
The government, knowing that is abusing its power in the unlawful taking of FnF's property, not only stripped out all the shareholders' rights and powers the day of Conservatorship (12 US Code §4617 (b)(2)(a)), but also it has prohibited them to go to Court, because HERA has directed the Courts to not take any action against the Conservatorship by all means: "In their motions to dismiss defendants argue the Court lacks jurisdiction because HERA prohibits the relief sought in the Complaint. Specifically, 12 U.S.C. § 4617(f) states that "[e]xcept as provided in this section or at the request of the Director, no court may take any action to restrain or affect the exercise of powers or functions of the Agency as a conservator or a receiver,"" Page 18
The U.S. government is not entitled to trample constitutional rights, like the right by a citizen to have access to a Court of Justice.
Share Price Prospects: Two Scenarios
If we assume that the Net Worth Sweep introduced in the 2012 Third Amendment will be removed sooner or later (voluntarily or under a Court order, as there are many plaintiffs challenging the Third Amendment), because the government has been fully repaid and now it's taking the profits of private companies without justification, the only bet that an investor shall place is: Will the Treasury exercise the warrant or not?
1.Yes. Under this scenario, the downside for the common stocks is very limited, as the companies already are releasing their results on a diluted basis (as if the warrant had already been exercised). Fannie Mae published 0.04 3Q EPS. If we annualize the 3Q results, Fannie Mae will be reporting $12.6 billion Net Income, assuming a dividend payout of 50%, with 6.524 billion common shares, the outcome is 0.97 EPS. Applying a 15 times PE multiple, the fair value is $14.5 pps. This is why Wall Street wants the privatization of FnF paying very little, as FnF are trading dirt cheap (FNMA $2.69 pps as of last Friday), helped by their massive short sale position (9% Short ratio per Yahoo Finance).
This scenario assumes the expected swap junior preferred shares for common equity as follows: a $25 junior preferred share equals to 2 common shares, a $50 junior preferred share equals to 4 common shares)
2.No. Under this scenario, the best interest for the common shareholders is junior preferred shareholders not converted to common shares, and restore the dividends to all series of junior preferred stocks, otherwise the fair value for the common shares would be so high that the junior preferred shareholders would get more than the par-value of the stocks ($25 or $50, respectively). This is why the current common shareholders don't want the government to exercise its warrant under the threat of tough litigation.
This is a broad analysis and it's not meant to be a detailed analysis. Make your own assumptions and analysis.
Catalyst for both scenarios: They don't discount the current turnaround in the Treasury yields. This week the 10-year Treasury yield's 4 day rise has been the largest in nearly two and a half years. The huge losses during Conservatorship have been driven by their Derivatives portfolio. This derivatives portfolio is used as a hedge, so it won't lose value over time, but FASB requires the enterprises to mark-to-market this portfolio. For example: when Freddie needs to issue long-term debt to fund its mortgage portfolio, it uses a pay-fixed swap: Freddie will pay the counterparty a fixed-rate and the counterparty will pay Freddie a short-term rate, which will be used to pay the rate on the short-term debt. Freddie will rollover the short-term debt until the pay-fixed swap matures. Every quarter, Freddie must mark-to-market this portfolio of pay-fixed swaps. When interest rates decline in a quarter like Q2 2011, Freddie Mac must report a loss, which it did to the tune of $3.4 billion. But if the Treasury yields turn around, there is more upside in their earnings.
In the end it's a bet on a Law and Order Trump Administration as promised, or the rule of a New World Order that uses the Stock Exchange as a tool to achieve their goals.
Disclosure: I am/we are long FMCC, FNMA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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