Three Wall Street Deals With Warts

When the New Money Window opens up on Wall Street there is a rush to get deals done. There are always transactions that get circulated that have flaws or problems. They do not get done. I find them interesting. Very often the flaws and warts of these deals are ‘fixed’. Then they come back in a different form. The following is a description and discussion of three deals that tried to get done recently but did not make it.

(I)


When I got the prospectus on this deal I just laughed. No one would buy new Fannie Pref. The idea of a no-dividend deal seemed nutty. So I called someone on the deal team to get the scoop. The proposal makes a lot of sense.

This transaction idea comes from the deep thinkers at Fannie and FHFA. They want to address two important issues:

-They want to retire as much of the old Pref as possible. The Pref got screwed in the receivership structure. The Junior Subordinated debt was ‘money good’ while the Pref was worthless. No bankruptcy court in the United States would have allowed that treatment. The concern was that someday someone would sue in Federal Court and the precedents for Equity Subordination would prevail. If the pref is worthless then the bonds are not money good either. Go tell that to the Chinese.

- The receivership structure requires Treasury to provide additional capital to the GSE’s if their net worth falls below zero. Internally this is referred to as Drip Equity. The Agencies are currently losing about $10 billion per month (same cost as Iraq). They are going to have to go to Congress for more money and they want to put that off for as long as possible.

The new POOP securities were designed to address both of these problems. There is absolutely no economic substance to the deal but it still achieves the objectives. The deal is designed to create swap fodder for the old Pref.

The $25 new POOP stock was to be structured as an exchange offer. A buyer could ‘buy’ a POOP and pay for it with an equal dollar value of old junk Pref. To sweeten the deal the participants got a Warrant. The Warrant was essentially a subordinated IOU from Fannie to pay 35 cents in two years.

What this means is that if one was a distressed holder of the old Pref they could now get new Pref and 35 cents. Given that the old Pref was trading at 60 cents this looks like a 58% return. On a conference call one holder said, “I’ll take anything I can get”.

For Fannie this exchange gets rid of the old, troublesome Pref. It also creates some very favorable accounting treatment. Apparently they were going to book the retirement of old Pref as a “Gain From Defeasance”. Even better the new POOP was going on the books as 'equity' at the full $25 face value. If the deal were fully subscribed it would have resulted in an increase in the equity line of $80 billion! The guys at Fannie thought that this would hold off the day of reckoning with Congress for as much as a year. Well worth the 35 cents they had to pay to get it done.

So this looked like a go. But there was a snag. Second/third hand I heard the following:

One of the big houses (Goldman?) was in touch with big slugs of the old pref that wanted to do the deal. The smart guys on the trading desk wanted to get Fannie to up the value of the Warrant. So they tried a squeeze. They put a When Issued price on the Street of –40/-30 on 10mm Warrants. This implied that the Warrants had no value.

The deal team went back to Fannie with the bad news hoping to get them to make the Warrant worth 70 cents. What I heard was that the guys at Fannie could not understand how the Street could value their promise to pay 35 cents at –5 cents. They were so confused that they decided to shelve the deal.

Look for this one to come back with a Warrant value of 50 cents. It is a compelling transaction for both sides at that price.

(II)


I loved this deal and wanted in on it. The company had a very solid business plan. They were going to open up euthanasia centers in five or six big cities to role out the concept. It was a classy set up. The lucky person would go to this place with friends and family. Say hello/goodbye, drink some hemlock and fall asleep on the couch. Meanwhile every one else got to enjoy the available amenities. Music, dance floor, appetizers (no full meals), an open bar, photographer, the works, all first class. It was all very ‘upbeat’.

After the initial build of these 'owned' centers the plan was to franchise a very big growth roll out. We are talking ‘McDonald's’ type returns here.

As a Macro investor I look for the big trends. When you consider the rapidly aging population and the chaos in Social Security/Medicare this deal looks hot. At one point I heard that Fidelity’s Senior Fund was prepared to circle the entire deal. If FIDO’s in, it means the IPO will by up 20% at the opening.

This deal almost got done. But at the last minute the SEC cratered it. Their view was that euthanasia was illegal in most states and therefore the investment may be declared illegal and subject to forfeiture. They were just trying to “protect investors interests” was their excuse. Party poopers.

Last heard, the SEC was reviewing this with ‘higher authority’. Don’t hold your breath.

(III)


The minimum subscription amount for this deal was $25 billion, so I was not invited to the party. This is a new security for Treasury. There is no maturity. It never pays back. It is also unusual in that it is a re-set floater. It will be priced at a spread over the two-year note. The amount of that spread is being hotly contested.

This deal is the brainchild of Mr. Geithner. Treasury is desperate to get the average life of its liabilities stretched out. They are currently at an average of only 48 months. The goal is to have that extended to 60 or more months. As the maturity on this deal is ‘infinite’ the average life of the Public Sector debt would be significantly extended. Nice trick.

This transaction would eliminate Treasury’s funding requirement for at least six months. It would take a great deal of pressure off of the bond market. That would solve another of Mr. Geithner’s problems.

This deal is getting a lot of support from the White House. That means Summers or Volker. My bet is that Volker is pushing the idea. He was quoted recently, “Stuff the banks. We own them”.

The problem is that the only audience for this is the big banks. The same banks that just got hit over he head with the Stress Test. The word is they are whining miserably about having to take this much paper on. The concern has been that it puts too much pressure on the balance sheet and the business is not profitable.

Those problems are being addressed. The Fed will allow the banks to take this paper on with no reserve requirements. In addition they have agreed to accept this new collateral at the Discount Window with no haircut. This way the banks have guaranteed access to 100% funding for this big buy.

The accountants have been leaned on and have rolled over. They have agreed that the proper accounting treatment will be that the banks can keep this off their balance sheets.

So it is down to pricing. Last I heard the floater was going to be set at 20BP over the current two year. The really big news was that in order to get the deal done the Treasury has agreed to a one time, this deal only, fee of 1/2% to the underwriters. In this case the Buy side is the Sell side so the fees of $5 billion will stick to the banks. The dealer community is slavering to get it done with those fees in mind.

Some of the management is getting behind it too. There was a rumor on Madison Avenue that Citi was going to build an ad campaign around this. The theme is, “You helped us, so we’re helping you”. It has a ring to it. They are going for that ‘BFF’ thing.

Now everyone is interested. Possibly the mega jump in yield on the two year note last Friday is an indication this is getting closer.


Of course I am just kidding with you about all of this stuff. Sort of….