Investing (Gambling), FNM Preferreds

Comment on FNM (indirectly, FRE), and the common and preferred shares. Courtesy of Michael Steinberg at Click Broker.

Investing (Gambling) in Fannie Mae Preferreds

Gretchen Morgenson’s New York Times “What Will Mac ’n’ Mae Cost You and Me?” column states that “no bailout exists in a vacuum”. Gretchen spends most of her column discussing the effects on Fannie Mae’s (FNM) unsecured debt and the related possible large dollar value of credit default insurance being traded on it. Fannie is required to defer interest payments for up to 5 years on the unsecured debt if their core capital falls below certain levels. The assumption being the Treasury would only intervene because of inadequate capital, so if the Treasury intervened the unsecured debt would be in default from an insurance standpoint.

In "Banks Lose, but You could Win on Fannie and Freddie Preferreds", I wrote that the best GSE opportunity for individuals (with a high risk tolerance) could be in the preferreds. I said retail investors with a long time horizon should wait until the common and preferred dividends are completely halted. The deferral of interest payments on the unsecured debt would further enhance my case for the GSE recapitalizing through earnings as shareholder owned companies.

Gretchen amplifies my case. She writes that the common and existing preferred shareholders would be hurt most because dividends paid on preferreds issued to the Treasury would take preference to existing shareholders of any kind. I say fine, common only pays a few pennies anyway and new investors should hold off buying the preferreds until they’re priced for no dividend at all. As long as the common and preferreds still exist after the Treasury’s actions, elimination of all dividends and deferral of unsecured debt interest clearly benefits existing common shareholders.

Gretchen does throw in the caveat that everyone’s liquidating preference is bumped down with any Treasury involvement. Liquidation or complete nationalization is the only way common shareholders can lose more from here. Substantial dilution is already built in to the GSE share prices. Gretchen does not address common stock dilution directly, but most analysts believe that the Treasury will demand predatory conversion rights for its preferreds. I think that the Treasury will be more cautious about exerting pain on the common shareholders.

Fannie Mae provides links to the offering circulars of its outstanding preferred issues on its Investor Resources web page. All of the preferred issues are non-cumulative meaning undeclared preferred dividends are lost forever. Of course, no common dividends can be paid if any preferred dividends are skipped. I have prepared a summary of the easily traded Fannie preferreds below:

FNMpD $50 non-cumulative 5.25%, fixed $2.625 dividend, $150M issued, 3M shares, callable September 30, 1999

FNMpE $50 non-cumulative 5.10%, fixed $2.55 dividend, $150M issued, 3M shares, callable April 15,2004

FNMpF $50 non-cumulative, variable dividend after March 31, 2002 based on the two-year CMT Rate minus 0.16%, subject to a cap of 11% per year, $600M issued, 12M shares, callable March 31, 2002 and every 2 years thereafter

FNMpG $50 non-cumulative, variable dividend after September 30, 2002 based on the two-year CMT Rate minus 0.18%, subject to a cap of 11% per year, $250M issued, 5M shares, callable September 30, 2002 and every 2 years thereafter

FNMpH $50 non-cumulative 5.81%, fixed $2.905 dividend, $400M issued, 8M shares, callable April 6, 2006

FNMpI $50 non-cumulative 5.375%, fixed $2.6875 dividend, $300M issued, 6M shares, callable October 28, 2007

FNMpL $50 non-cumulative 5.125%, fixed $2.5625 dividend, $300M issued, 6M shares, callable April 29, 2008

FNMpM $50 non-cumulative 4.75 %, fixed $2.375 dividend, $400M issued, 8M shares, callable June 10, 2008

FNMpN $50 non-cumulative 5.50%, fixed $2.75 dividend, $225M issued, 4.5M shares, callable September 25, 2008

FNMpO $50 non-cumulative, variable dividend after March 31, 2005 based on per annum rate equal to the greater of (1) 7.000% and (2) the sum of the Ten Year CMT Rate plus 2.375%, $2.5B issued, 50M shares, callable in steps beginning at $52.50 in 2008

FNMpP $25 non-cumulative, variable dividend December 31, 2007 based on per annum rate equal to the greater of (i) 4.50% and (ii) the sum of the 3 month LIBOR and 0.75%

FNMpQ $25 non-cumulative 6.75%, fixed $1.6875 dividend, $375M issued, 15M shares, callable September 30, 2010

FNMpR $25 non-cumulative 7.625%, fixed $1.90625 dividend, $500M issued, 20M shares, callable November 21, 2012

FNMpS $25 non-cumulative, fixed 8.25% ($2.0625) dividend until December 31, 2010 after which per annum rate equal to the greater of (i) 7.75% and (ii) the sum of the 3 month LIBOR plus 4.23%

Most of these are trading with effective yields around 20%, but FNMpS offers the most generous upside if interest rates climb. Look for floors on the variable rate issues.

Disclosures: Author is long FNM and FRE, but no preferreds.