Fannie Mae-No Politics (FNMA)

[kthomp19]

The advantage that preferreds have in terms of liquidation preference is really a non factor because fannie and freddie can't be liquidated.

Plausible as this might sound, it is false. The best proof is in the form of the pref series FNMAO and FNMAP. They are $50-par, variable-rate prefs that currently trade around parity with the rest of the less liquid prefs (20% of par).

The kicker is that their dividends would be nearly zero if the pref divs were to be turned on right now. FNMAP's would be $0.02 per year and FNMAO's $0.01.

Why, then, do those series trade at the same level as the rest of the less liquid prefs? The only real value in preferred shares, compared to commons, is higher preference in liquidation and dividends. Since the dividends are nearly nothing for FNMAO and FNMAP, the liquidation preference must matter quite a bit in the eyes of the market.

If liquidation preference meant nothing then shouldn't these series be trading at almost zero? At best they would be out-of-the-money call options on future interest rates.

It is possible that there can be a restructuring in which case the preferreds are higher in the capital stack than commons but I can't envision that they would be money good on full value while leaving commons with nothing.

The prefs are always higher in the capital stack, restructuring or no.

However, it is ironic that you use the word "restructuring" because it is the exact word that Calabria used to explain what has happened in past exits from conservatorships, and is also the word Ackman used when explaining why he bought prefs, and a restructuring is precisely when one would want to own shares higher in the capital structure.

Saying that the prefs will be money good and the commons get nothing is an exaggeration. This specific outcome is highly unlikely. What an investor should be concerned with, though, is whether or not the juniors will outperform the commons in the future. In a restructuring this nearly always happens, and is especially likely in the case of FnF because the common shareholders' voting rights do not apply.