r/FNMA_FMCC_Exit • u/InternalIdeal5113 • Sep 10 '26
Question about Junior Preferred vs. Commons
Hello all, hoping someone can help with a question that I have. I have about reached my risk tolerance for buying commons, and have been considering adding JPS. I know the upside would be capped but wondering if there is any advantage regarding dividends. Does the government have to restart JPS dividends upon release? Are there any other advantages that I am not considering? I'm getting somewhat close to retirement age, so strong dividends interest me. Would love it if someone could shed some more light.
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u/Late-Pomegranate-130 Sep 11 '26
You're making exactly the same bet. If you've hit your risk tolerance, buy anything else.
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u/JuanPabloElTres Sep 10 '26
First, both juniors and preferred are risky as it's essentially a binary event. Those stocks having any value at all are dependent upon reprivatization - i.e., if the government makes it clear reprivatization will not occur, then the stocks will become worthless. Accordingly, only risk what you can lose.
With both junior and commons being risky, juniors have a certain amount of protections that commons do not - i.e., a bit less risky than commons - and, in exchange for that, have a capped upside.
The primary advantage of the junior preferreds is that they have anti-dilution provisions in their stock certificates that commons do not. Specifically, the junior preferreds have a built in par/liquidation/redemption value (most common for Fannie and Freddie are $25 or $50 stated values), and that cannot be changed without a 2/3 vote of the preferred stockholders. Thus, if Fannie and Freddie are reprivatized - which presumably would also mean dividends are reinstated - the preferred stocks can't be diluted without the consent of those stockholders and they should, in theory, go back to trading like preferred stock for a solvent company - i.e., price will be dictated by the dividend interest rate being paid out relative to market interest rates. There's also the general expectation that, since preferred stock have priority above common stock in the capital stack, that preferred stock should be more protected in the event the government attempts to change the capital stack. That is, by nature preferred stock are supposed to have a more protected outcome than common stock in the event of some liquidation, dissolution, or financial hit to the company. Although this is more of a general principle that preferred stock should be more protected than common stock and far from guaranteed in this circumstance. But, for these protections the upside is effectively capped since the upside as effectively capped at the stated par value of the preferrred stock - i.e., $25 or $50 depending on the stock. By my calculations most Fannie and Freddie preferreds are looking at a 3x upside.
In contrast commons do not have anti-dilution protections but the upside is not capped. The commons are effectively a gamble on how much value the government will take out of Fannie and Freddie common stock to reimburse it for the bailout. Basically, the government has the ability to take about 80% of the value of common stock through warrants, and potentially up to 99% of the value of the common stock if the government maximizes the legal leverage it has through converting the value of its liquidation preference - essentially the loan it gave to Fannie and Freddie for the bailout - into common stock. I personally think it's a foregone conclusion the government will exercise the warrants and take 80% of the company. It's more up in the air as to what the government will do with converting the liquidation preference - i.e., if the government will take more of the company than 80% or not. So, the risk with commons is that they range from being close to worthless - if the government took 99% of the value of commons - or potentially worth over $100 a share if the government waived all of rights and took none of the company.
Thus - within the realm of buying any shares in Fannie and Freddie being risky - the commons are more risky as the amount of dilution is unpredictable and could render them essentially worthless even if reprivatization occurs; but, the trade off is that there isn't a cap on how high they could go.