Fannie Mae-No Politics (FNMA)

[kthomp19]

Unfortunately, this arrangement largely resembles the Accounting Treatment in the AIG rescue agreement. The Liquidation Preference was converted into common shares and sold under an IPO/SPO process recouped fully by Treasury.

Exactly. This is why a senior-to-common conversion is the biggest source of dilution danger to the existing commons, forget the warrants.

FnF need the seniors to be gone (converted or extinguished) and an extra $100-125B of capital to be fully capitalized. The fact that doesn't seem to be sinking in around here is that Treasury is never going to both send FnF $125B and cancel the seniors. It will only be one or the other.

If Treasury cancels the seniors, they are not going to send back $125B but instead just $25-30B (the overpayments past the 10% moment, as if the seniors could be paid down), and even that might be in the form of a tax credit that only gets earned at a rate of $4B per year. That leaves FnF having to raise $75-100B of capital in an equity raise. This explains Calabria's quotes of "It has always been my view that an exit from conservatorship is going to require a large capital raise by Fannie and Freddie." and "The shareholders will be heavily diluted when we raise capital."

This scenario also involves Treasury exercising the warrants to recoup that $25-30B. Double dilution whammy, and a junior pref share exchange could make it a triple.

If Treasury does send the $125B, they keep the seniors. That leads to Treasury monetizing the seniors to recoup that money, i.e. converting the seniors into commons as with AIG.

This is even worse than the above scenario because there is no upper limit to the percentage of the commons Treasury can get. With AIG it was 92%, showing that Treasury knows how to structure the transaction to avoid the 80% balance-sheet-consolidation threshold. But there is no reason for Treasury to stop at 92%; the higher that goes, the more money they get. It could easily go to 99.5%, which is likely why ACG Analytics said that a senior-to-common conversion makes the existing commons worth about 30 cents.

I would not be welcome to any such redux with the GSEs, nor should any common equity loyalist.

This makes perfect sense.

What it also shows is that Treasury exercising the warrants is the best case for the existing commons. Treasury is going to maximize its total return, but it doesn't have to do so via the warrants. If it doesn't, existing common shareholders will at best share the fate of AIG common shareholders at the time of their dilution.