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The presentation was on his site before it was advertised on Twitter. The moment I put it out here the Twitter announcement came out. Probably undercut some half-hearted marketing campaign around it.
If you re-read this article, and pay attention to the ending, this is speaking to the scenario that is “extremely bullish for commons” per ACG.
Bradford, why is it false? Please help us understand ... Please tell me why ACG is wrong and Ackman is wrong?
Please tell us the “commons outperform JPS” scenarios in Jacob’s presentation, which only received one bullet point?
Good luck!
Well, JPS will be left twisting in the wind for a long time. While in conservatorship with the PSPA deemed paid, the responsible way for raising capital will be taken. No haphazard, very fast approaches will be executed. The CBO has cited a 5 year option and FnF themselves have requested 5 years to raise the capital.
~$25 to 30 billion per year in earnings starting at roughly $45 billion gets the GSEs to roughly $170 to $200 billion. By the time the companies have generated that much capital, the SP could be high enough to absorb an extra 1.5 billion shares to raise the rest of the capital.
This haphazard, blitz approach where the largest IPOs will be front loaded is the most ludicrous belief.
Good luck!
kthomp - excellent post. Thank you.
A consent decree is needed by Jan 20th to avoid the possibility of legal review, which, that by itself, can delay a capital raise.
A PSPA amendment with no consent decree is “extremely bullish for commons” and is the path we are on given Mnuchin’s statement in front of the house finance committee, which has been corroborated by several media outlets.
Mnuchin does not want the GSEs released via consent decree with so little capital. Too risky for him. He wants more capital built up and then a consent decree, which would most likely be done via a Yellen treasury.
The question is how do you give Yellen the reigns without being able to reverse course? You amend the PSPA and figure a way for Yellen to control Calabria on a consent decree so he can’t do it until he is replaced in the spring of 2021.
It all but guarantees a slow rise. JPS need that consent decree before Jan 20th.
Good luck!
Really? A lot of people are smart. He is a “free agent” and has worked for some boutique firms.
“Commons may outperform JPS in some scenarios”
One bullet point. Care to expound?
Did Bradford have input into Jacob’s presentation? What are the scenarios where commons outperform JPS? Bradford conspicuously avoids any mention of Ackman’s endorsement, instead relying on unreliable sources.
Maybe we’ll find out more during tomorrow’s client meeting.
Good luck!
I see the text messages went out ...
Holden, you’re playing the semantics game. Any act by an FHFA director that is at odds with a President is at risk of becoming void. You need the consent decree before Jan 20th.
Good Luck!
Consent decree must be done before Jan 20th - Good Luck!
I understand and have said as much. That doesn’t stop a potential request from Biden to have Calabria tender his resignation. Calabria can refuse of course, for now.
If the President disagrees with an FHFA director’s act, does the act become null and void once Scotus most likely rules Biden can fire Calabria at will this spring? Especially considering the full director rendered a policy decision Biden did not want? 4th branch of government?
There is a risk to executing a consent order after Jan 20th ... to completely protect it from any legal review, it needs to be done pre-Jan 20th. I don’t think the consent order happens, but I do think the PSPA is amended, which is “extremely bullish for commons” per ACG.
Sort of - it is obviously intended to sell the JPS shares to potential investors and who knows who “commissioned” him to create the presentation. He is currently a “free agent” and is looking to join a company, which is fine.
None of the common scenarios where commons outperform JPS were given a second glance. The presentation pushes the rosiest JPS scenario. Also, conspicuously, it was on Bradfords site before it was published so Bradford may have had a bias hand in helping create it.
JPS need to sell their vehicles a lot more than commons for obvious reasons ...
Not sure why the capital raise needs to be front loaded. Some big assumptions being made and FnF want 5 years and I don’t see an extreme rush to raising capital 3rd-party capital.
Brickman leaving, Mnuchin’s statements on creating a plan/framework for Yellen, etc., plus a delayed consent order makes me think.
The cats outta the bag ...
Penn - I don’t think GA elections matter - but who knows ...
I don’t think there is going to be a Big Bang. It appears there will only be a Bang = PSPA amendment and no consent order.
Any consent order after Biden is inaugurated can be reversed based off of the single director for cause issue, especially if Biden asks for Calabria’s resignation on Jan 20th.
JPS better get that consent order before Jan 20th. Based on Mnuchin’s statements, it doesn’t look like the JPS will get their windfall.
Good Luck!
Courtesy of Bradford - James Jacobs GSE Analysis (Not Currently with Any Institution) - Commons to Outperform JPS in many scenarios - Echos Ackman
Long Fannie Mae and Freddie Mac “Junior” Preferred Stock –
100%+ Return Expected In Process-driven Restructuring
This Time is Different –
From Widow Maker
to King Maker
James Jacobs – December 2020
Table of Contents
Executive Summary..........................................................................3 Fannie and Freddie...........................................................................6 Reform.............................................................................................10 Recap..............................................................................................21 Release.............................................................................................26
Trade Opportunity..........................................................................31
Executive Summary
?
?
Who – Fannie Mae and Freddie Mac (the “GSEs”) are two of the largest financial institutions in the world.
Executive Summary
Fannie and Freddie Reform Recap Release Trade Opportunity
?
What – The GSE’s restructuring is the largest single piece of
unfinished business from the 2008 Global Financial Crisis.
? The U.S. government has been more than paid back (plus interest)
for the financial assistance it provided to them.
Opportunity – I expect Fannie Mae and Freddie Mac
“Junior” Preferred Stocks to return 100%+ over the next ~12
months.
? Currently trade around 30% of Intrinsic / “Par” Value
? $30+ bln outstanding combined across several issues
? The common stocks may do better depending on many factors.
? Political risk risk is misunderstood.
“The centerpiece of our strategy is to end
the Fannie and Freddie conservatorships.” – Mark Calabria, FHFA Director, May 2019
3
Executive Summary (continued)
?
Reform – The GSEs have become simpler, safer companies since being “bailed out” and put into conservatorship in 2008.
Executive Summary
Fannie and Freddie Reform Recap Release Trade Opportunity
“We want to get Fannie and Freddie out of conservatorship, and we want to use private capital to do that.” - Craig Phillips, ex-counselor to Treasury, May 2019
?
?
Recap – The GSEs have begun building capital again, and they will likely execute large “re-IPOs” in 2021.
Release – The GSEs will exit conservatorship in phases as they meet “milestones” set by their regulator (FHFA).
?
? Process on irreversible path by Inauguration 2021
Process – “Big Bang” of events expected around year-end ? FHFA following statutory duty to rebuild and release GSEs
4
A Widow Maker Trade Turns the Corner
? A decade of false starts and legal setbacks
? Trump Administration action in 2019 gave investors hope
? COVID-19 and Trump re-election risks, combined with forced
liquidations and investor fatigue has created attractive entry point ? Recap-and-release process moving forward and soon-to-be on
irreversible, low-risk path
Executive Summary
Fannie and Freddie Reform Recap Release Trade Opportunity
“We’ll make sure that when they’re restructured they are absolutely safe and they don’t get taken over again. But we gotta get them out of government control.” – Steven Mnuchin, Treasury Secretary, December 2016
Fannie Mae 8.25% Non-Cumulative Preferred (Series T)
5
Who are Fannie and Freddie?
? Government Sponsored Enterprises (“GSE”)
? Fannie Mae - chartered in 1938 in wake of Great Depression
? Converted into for-profit business in 1968
? Freddie Mac - created in 1970 and converted in 1989
? Mortgage guaranty companies (not banks)
1. Buy mortgages from lenders
2. Package the mortgage debt into bonds (MBS)
3. Sell MBS to investors with guarantees of timely principal and
interest (P&I)
? Backbone of U.S. mortgage and housing market
? Provide liquidity, stability, and affordability to mortgage market ? Ensure availability of popular 30-year fixed-rate mortgage
Executive Summary
Fannie and Freddie
Reform Recap Release Trade Opportunity
“The primary purpose of Fannie and Freddie is to be counter-cyclical liquidity for the market - to be a floor under the market in times of stress.” - Mark Calabria, FHFA Director, February 2020
6
Simple, Critical, Profitable, Valuable
Simple
• Charge less than half of 1% in guarantee fees (“G-fees”)
• Monoline insurance model
Profitable
• Combined, ~$30 bln in pre-tax income (~60% pre-tax margins)
• Two of most profitable companies per employee in U.S.
Critical
• Guarantee half of all U.S. mortgages
• Housing contribution to GDP 15% - 18%
Executive Summary
Fannie and Freddie
Reform Recap Release Trade Opportunity
“Fannie and Freddie provide services that are absolutely essential to the American way of life...No one does it better.” – Bruce Berkowitz, Fairholme Funds, January 2015
Valuable
• High, predictable, recurring earnings and cash flows
• Huge scale, barriers to entry
• Cash flow machines
7
September 6, 2008 - Conservatorship
? Housing crisis of 2007-2008 caused large losses in guarantee portfolio and mark-to-market losses on “retained portfolio”
? Placed in conservatorship in September 2008 ? Keep them solvent
? Maintain confidence in GSE debt markets
? Treasury ultimately injected ~$190 bln in capital in exchange for “Senior Preferred Shares” (with 10% dividend)
? “Primed” existing preferred and common equity
? Restricted dividends to common and existing preferred stocks
? Also received warrants for 79.9% of common equity of each
? By definition meant to be temporary “Time Out”
? Statutory process to stabilize and return to normal business ? However, does not seem to have been intention
Executive Summary
Fannie and Freddie
Reform Recap Release Trade Opportunity
“Seems like a death grip was placed on the GSEs from the start.” – Judge Margaret Sweeney, December 2019
8
August 2012 – “Net Worth Sweep”
? 2012: Profits exceeded losses
? "Third Amendment" to PSPAs
? All profits swept to Treasury
? “Net Worth Sweep"
? No ability to rebuild capital
? Shareholders left with no path
to recovery (except the courts)
? Impetus for many lawsuits
? Suspected to help fund
Obamacare
Dividends Drawn and Paid
Executive Summary
Fannie and Freddie
Reform Recap Release Trade Opportunity
“Treasury's and FHFA's actions in the conservatorships of the Companies after the 2012 Third Amendment and the advent of the net worth sweeps violate these longstanding principles of U.S. and international insolvency law as well as the express requirements of HERA.” – Michael Krimminger and Mark Calabria, January 2015
$350.0 $300.0 $250.0 $200.0 $150.0 $100.0
$50.0 $-
$181.4 $119.8
Fannie Mae
$301.1 $191.4
$119.7 $71.6
Freddie Mac
Combined
Cumulative dividend payments to Treasury Cumulative draws from Treasury
9
11 Years of Reform in Conservatorship
Reforms
• level G-fees (2x)
• no special deals for individual lenders
• common securitization platform (CSP)
• Supportliquidity and competition in MF market
Transition
• portfolio-focused-> guarantee-focused
• Dramatically reduced “Retained Portfolios”
• improved credit quality of guarantee book
Today • simple model
• stable,recurring earnings
• credit risk program • strongcreditquality
• 2019DFAST
• combinedloss $18 bln - $43 bln (severe case)
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“The reality is that almost all of the major flaws of the pre-conservatorship GSEs have been successfully addressed while the companies have been in conservatorship.” – Don Layton, Former CEO Fannie Mae, August 2019
10
“Retained Portfolio” Dramatically Reduced...
? “Fixed-income arbitrage” of retained portfolio ? Caused almost $50 bln in losses in 2008 alone
? Retained Portfolio down more than 75% since 2008
? Supports core business function (no longer for speculation)
? FHFA limit $250 bln each
? Non-agency exposure mostly gone
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
$2,000 $1,500 $1,000
$500
Retained Portfolios
“Before the crisis these institutions were basically large hedge funds and now they’re mortgage guarantee funds.” – Mark Zandi, August 2017
$-
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Fannie Mae Freddie Mac Combined
11
...And Credit Quality Improved...
? In 2008, ~13% of guarantee portfolio comprised of Alt-A or Subprime mortgages
? Accounted for half losses
? Credit quality of guarantee books much improved ? Also, ~$16 trln U.S. “Home Equity” today
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“Freddie Mac is open, open for business.” – David Brickman, Freddie Mac CEO, April 2020
Select Credit Metrics
2008
Today
Fannie Mae Avg. FICO Credit Score Originations
695
750
% of Originations with FICO Score below 680
39%
6%
Weighted Avg. Mark-to-Market LTV
70%
57%
% of loans with Mark-to-Market LTV ratios > 100%
12%
0.3%
12
...But Still Significantly Undercapitalized
? Two of most under-capitalized, large financial institutions ? Drain of capital for 7 Years means Fannie and Freddie have
very little capital now
? Taxpayer more exposed to housing market than ever before
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“We will ensure that there is both ample credit for housing and that we do not put taxpayers at risk.” – Steven Mnuchin, Treasury Secretary, May 2017
(blns of US$)
Fannie Mae
Freddie Mac
Combined
Total Assets
$3,601
$2,242
$5,843
Total Equity
$14
$10
$23
Leverage Ratio
259:1
236:1
254:1
Equity Ratio
0.39%
0.42%
0.40%
Large US Banks Equity Ratio
8.0% - 9.0%
US MIs Equity vs Insurance In Force (IIF)
1.5% - 2.0%
2020 Proposed Capital Rule
2.5% - 4.0%
13
COVID-19 Highlights the GSE’s Strength
? Reminder of the critical function and mortgage infrastructure of Fannie and Freddie
? Counter-cyclical balances provide stability, liquidity
? Carrying mortgage market thru crisis even with little capital
? Fannie and Freddie have dramatically improved their credit quality
? Reinforces case they should be recapitalized (and eventually exit conservatorship as per statute)
? Delays Fannie and Freddie’s exit from conservatorship ~3-4 months according to FHFA Director
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“Everything that we have experienced the past few months with the pandemic and national emergency reinforces the need for Fannie and Freddie to be well- capitalized and operate in a safe and sound manner.” – Mark Calabria, FHFA Director, May 2020
14
Wind-down the GSEs!...Keep the GSEs!
? Republicans - smaller footprint, less government involvement, more competition
? Democrats - more affordable housing, lower mortgage rates ? Not against recap of GSEs
? 2009 – 2014: Wind-down the GSEs!
? February 2011 - President Obama Plan to Congress
? “Corker Warner Bill” - died in 2014 over affordable housing
? “Jumpstart GSE Reform” - expired early 2018
? PATH Act – 2018; Representative Hensarling
? Post 2014: Keep the GSEs!
? September 2018 - 30 industry groups to Congress / Admin
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
? February 2019 - Senator Crapo multi-guarantor model
? February 2019 - NAR: Quasi-regulated utility model 15
“It’s a tough issue, the most complex issue I’ve worked on in my time in the United State Senate...There’s a lot of resistance, a lot of inertia.” – Senator Bob Corker October 2015
Trump Administration Takes Charge in 2018
? Housing Finance Reform has been a “priority” for Trump Administration since taking office
? June 2018 - OMB Report – “End Conservatorships”
? 2018 FSOC Annual Report – removes “legislation needed”
? Former FHFA Director Mel Watt last hurdle to action
? January 2019 – Acting Director Joseph Otting mentions plan
? April 2019 - Mark Calabria confirmed as new FHFA Director ? October 2019 - FHFA Strategic Plan: “Prepare for their eventual
exits from the conservatorships”
? September 2019 – Senator Crapo supports admin action
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“I’m determined that we have a fix to the GSEs and don’t leave them in conservatorship
for the rest of time.” - Steven Mnuchin, Treasury
Secretary, April 2018
16
Calabria Follows the Law He Helped Write
? “Libertarian” economist with bold policy views ? Eliminate 30-year fixed rate mortgage
? GSE receivership in 2008
? Net Worth Sweep “unconstitutional taking” ? GSE footprint reduction
? Assisted drafting Housing Economic Reform Act 2008 (HERA)
? FHFA as regulator/conservator of GSEs
? Conduct conservatorships to:
? Preserve and conserve
? Return to a ‘sound and solvent’ condition
? Consistent with exit from conservatorship
? “The framework is, the GSEs hit a bump in the road, they enter, they leave. That is what the statute envisions.” - Mark Calabria, FHFA Director, February 2020
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“The status quo is no longer an option. The status quo is over. And my arrival at FHFA should be seen as the opening bell for change.” – Mark Calabria, FHFA Director, May 2019
17
September 2019 - Treasury Plan
? “Define limited role for Federal Government in housing”
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“This is a pretty urgent problem...We have many geniuses looking at it and we’ll figure something out.” – President Donald Trump, May 2019
March 2019 White House Memo:
• End the conservatorships
• Promote competition
• Differentiate between reforms that require legislation and those that don’t
• Timetable for “administrative” reforms
September 2019 Treasury “Plan”
• 49 (admin / legislative) reforms
• Preserves what works
• Protects taxpayers against future bailouts
• Gov’t support explicit and paid for
• Exit conservatorship upon completion of specified reforms:
• Regulatory capital requirements
• FHFA approves capital plans
• GSEs have sufficient capital to operate “safe and sound”
18
“Parallel Path” with Administration Leading
? Mnuchin (“good cop”) urging Congress to act
? Very unlikely to reach bi-partisan agreement, especially now
? Calabria (“bad cop”) strictly following his “statutory duty”
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
Administrative Reforms
• End conservatorships
• Amend PSPAs
• Maintain defined, limited support
• End NWS
• Protect taxpayers against future bailouts
• “Solidify” changes through PSPA positive/negative covenants
• e.g. restrict certain products
Legislative Reforms
• Mostly charter changes
• “Nice to haves” but NOT necessary:
• Explicit guarantee on MBS • Multiple guarantors
• “Codify” certain reforms
• Portfolio Limitations
“But while I’m committed to working with Congress, I’m not going to wait on Congress.”
– Mark Calabria, FHFA Director, May 2019
19
(Reform), Recap-and-Release!
? Pre-conservatorship: “Private profits and socialized losses”
? In conservatorship, GSEs reformed their business
? Post-conservatorship: Private profits and private losses (first) ? Two of the most predictable and profitable “utilities” in U.S.
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
Pre-conservatorship
In conservatorship
Post-conservatorship
Guarantee
Implied
Explicit
Explicit, limited, defined
Credit Quality
Low
Improved
High
Retained Portfolio
Large, high-risk
Declining
Small, low-risk
Capital levels
Not sufficient for risk- taken
Non-existent
Sufficient and excessive
Profits
Private
Public
Private
Losses
Public
Public
Private first, Public second
Function
Provide liquidity, stability to mortgage market
“It was ‘heads we win, tails you lose.’ And it was wrong.” – President Barack Obama, August 2013
20
Why Recap-and-Release Works
? Keeps Fannie and Freddie intact but recapitalizes them:
? Private capital as “first loss” ahead of government’s risk
? Compatible with MBS-level guarantee or Treasury’s enterprise-
level funding commitment
? Recap-(and-Release) achieves several policy goals ? Protects Taxpayer from future bailouts
? Treasury compensated for explicit, limited guarantee ? Preserves 30-year fixed-rate mortgage
? Levels playing field with private sector
? No disruption to primary or secondary mortgage market
? Resolves litigation
? Strengthens housing market
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“Our fundamental view is that there should be private risk capital in front of the Government’s money, whether that’s a Government guarantee on securities or Treasury lines...”
– Steven Mnuchin, Treasury Secretary, May
2019
21
Capital, Capital, Capital
? Capital is the Foundation of: ? Safety and Soundness
? Exit from Conservatorship ? Housing Affordability
? Bipartisan acknowledgement that GSEs need more capital
Safety and Soundness
Capital
“It was insufficient capital that triggered the conservatorship, and it’s going to be sufficient capital that triggers an exit.” – Mark Calabria, Director FHFA, May 2019
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
Affordability
Exit C-ship
May 2020 Capital Rule > Finalized November 2020
? Framework of capital requirements for Fannie and Freddie ? Balance of making companies:
? Economically attractive to new money investors
? Rule implies may have to raise guarantee fees (G-fees)
? Sufficiently capitalized for stressed environment
? Increases potential total capital from ~$180 bln to $245 bln
? $135 - $150 bln minimum plus 3 “buffers” (non-capital requirement) with capital distribution restrictions
? Improves on pro-cyclicality of Watt’s 2018 Rule
? Headline total capital requirement higher than expected
increases execution risk, but:
? Buffers allow for implementation flexibility
? Likely adjusted after indirect discussion with private investors ? Political cover for PSPA amendment and exit
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“I’m never one to let the perfect get in the way of good.” - Mark Calabria, FHFA Director, April 2019
23
“Fourth Amendment” to PSPAs...
? Expected “Fourth Amendment” to PSPAs to include:
? Deem forgiven (and write-down) or convert (to equity) Senior
Preferred liquidation preference
? End “Net Worth Sweep”
? Move PSPA funding facility to “catastrophic” position
? Positive / negative covenants to shape GSE business
? Outlines roadmap for exits from conservatorship ? “Framework” for recap and release installed into PSPA
? Announcement can be framed as positive:
? Necessary to raise private capital and protect Taxpayer
? Secures many policy priorities
? Commitment fee economics for Treasury’s ongoing support ? ‘Best investment since the 1803 Louisiana Purchase’
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
‘I am likely to agree to a modification of the bailout agreements “to them on the right direction.”’ – Steven Mnuchin, Treasury Secretary, September 2019
24
Senior Preferred – “Linchpin” of the Recap
? Once Senior Preferred written down (or converted):
? Economic value flows to Junior Preferred (first) and Common
? Capital structure cleared to allow for new capital raising ? Most legal claims effectively settled / resolved
? Politically sensitive issue in DC – “giveaway to hedge funds” Fannie Mae Senior Preferred Write-down
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“The taxpayer’s actually been, in some ways, in many ways repaid from the bailout of Fannie and Freddie...” - Craig Phillips, Former Treasury Counselor, May 2019
Today
Post Write-down
PSPA Funding Facility - $114 bln
Potential Enterprise Value - $100 bln+
Senior Preferred - $135 bln (Blocks all value below)
Junior Preferred –
$19 bln Par Value (5x “covered”)
Junior Preferred – $19 bln Par Value
Common Equity
Common Equity
Consent Order
? FHFA can use as bridge between conservatorship and full exit ? Would make recap-and-release process hard to reverse
? Binding agreement between two parties (FHFA and Fannie/Freddie)
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“There is likely to be a time when we’re hitting a critically undercapitalized level...maybe...exit conservatorship... operate under a consent decree.” – Mark Calabria, FHFA Director, October 2019
Full Exit
• ‘Safe and Sound’ • FHFA - regulator
Consent Order
• Exit subject to Capital
Restoration Plans • FHFA - regulator
Conservatorship
• Significantly Undercapitalized
• FHFA - conservator
26
Administrative “Big Bang” Year End 2020...
? Expected “Big Bang” around year-end 2020 (lame duck) will
cement progress thus far and secure process on irreversible,
irrevocable path
? Capital Rule Finalized (Done)
? PSPA Amendment (Senior Preferred restructured, NWS ended)
? Must be completed before Secretary Mnuchin term ends
? Consent Order (subject to CRPs)
? Can be completed after Inauguration by FHFA Director Calabria
? FHFA (with advisors) developing “roadmap” with “milestones”
? Fannie and Freddie hired their own financial advisors (June 2020) ? Capital Restoration Plan (CRPs), PSPA Amendment, Capital Raises
? Phased exit depends on each Enterprise’s ability to raise capital and meet “milestones”
? Progression from Congress -> Admin, Politics -> Corp Finance
Capital PSPAs CRPs Consent Settlement? Capital Full Rule Orders Raises Exit
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“If I can end the sweep, reach some changes to the Share Agreement with Treasury, we can get them out of Conservatorship, we can start to build capital.” – Mark Calabria, FHFA Director, May 2019
27
...Followed by Large “Re-IPOs” in 2021
(blns of US$)
Capital Requirement
Retain / Raise Amount
Existing
Minimum
Total
Minimum
Total
Fannie Mae
$ 13.9
$ 89.0
$ 145.0
$ 75.1
$ 131.1
Freddie Mac
$ 9.5
$ 63.0
$ 101.0
$ 53.5
$ 91.5
Combined
$ 23.4
$ 152.0
$ 246.0
$ 128.6
$ 222.6
?Recapitalization has already begun with capital retention! ? September 2019 Letter Agreement: $45 bln combined
? Combination of retained earnings / capital raises
? Combined need to retain / raise ~$130 bln - $220 bln ? Likely raised over period of years but front-end loaded
? Capital Rule “buffers” allow for phased-in capital distributions ? Necessary to attract new investors
? Likely to be the largest “IPOs” ever
? Two very large, dividend-paying “utilities”
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“Based on this timeline, 2021 is the most likely target for an external capital raise by the Enterprises.” – Mark Calabria, FHFA Director, February 2020
28
Checking the Boxes of Preconditions for Exit
?September 2019 Treasury Plan states FHFA should exercise its authority as conservator to begin the process to end GSE’s conservatorship, subject to certain preconditions
?FHFA has prescribed regulatory capital requirements (November 2020) ?FHFA has approved the GSE’s capital restoration plans, and GSE has
retained sufficient capital
?The PSPA between Treasury and GSE has been amended ?Appropriate provision has been made to ensure no disruption to the
market for the GSE’s MBS
?FHFA, after consulting with FSOC, has determined that the heightened
prudential requirements in the amended PSPAs are appropriate to
minimize risks to financial stability
?Other: FHFA has prescribed liquidity requirements (Proposed December
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“Let me emphasize that this effort will continue to be process dependent, not calendar dependent.” – Mark Calabria, FHFA Director, February 2020
2020)
29
Recap Roadmap Favors Speed
? Fannie Mae potential recap roadmap: ? ~$25 bln retained by 1H2021
? $50 - $60 bln offering in 2H2021
? = $75 - $85 bln total capital
? Common equity and new preferred equity
? Convert existing Junior Preferred to common
? Retain and follow-on offerings to meet total requirement ($145 bln) over time
? Results in significant dilution to existing
common stock
? Ex. 18 bln pro-forma shares (15x current)
? 2022 – 2024 EPS : ~$0.66 - $0.77 (Nomura) ? Stock value: $5.00 - $10.00 (8x – 13x P/E) ? Upside: 80% - 310%
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
? Minimum capital requirement met 1H2022 ? Total capital requirement met 2024
30
Litigation – Guard Rails on Administrative Action
? Lawsuits apply pressure on Treasury to settle / resolve ? Political cover for administrative action
? Capital raises require resolution of “shareholder issues”
? Fifth Circuit Court of Appeals – Collins v Mnuchin ? September 9, 2019 - En Banc Opinion
? NWS is unconstitutional (lost on remedy) ? FHFA structure is unconstitutional
? District Court of DC - claims against the companies themselves ? NWS was “breach of the covenant of good faith and fair dealing”
? U.S. Court of Federal Claims - Fairholme Funds v U.S.
? Massive Potential (Money) Liability for Government - $125 bln ? Derivative unconstitutional taking claim
? District Court of Minnesota - Bhatti v FHFA
? Structure of FHFA violate Constitution’s “separation of powers”
? Supreme Court of the U.S. - Seila Law v CFPB
? CFPB (and FHFA by implication) an “unconstitutional violation of separation of
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“I think that if we can get them out of conservatorship and then we can set a path, I think a lot of those issues will go away.” – Mark Calabria, FHFA Director, May 2019
powers”
31
SCOTUS for the Win!
? July 2020 – Supreme Court agrees to hear cases about
Net Worth Sweep and FHFA structure
? Collins v Mnuchin – FHFA is unconstitutional as structured
? Mnuchin v Collins – NWS is illegal b/c FHFA exceeded its powers ? Issue of appropriate “remedy” for both cases is very important
? SCOTUS taking BOTH cases:
? Substantially reduces “election risk”
? Extends FHFA Director Mark Calabria’s worst-case term length under
Biden Presidential victory
? Increases pressure on government to settle cases and resolve
“shareholder issues”
? Increases political cover for administrative action
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
“We’re not gonna let this stand in the way, one way or another, with housing reform...regardless of that case we will restructure Fannie Mae and Freddie Mac so that they have private capital in front of any taxpayer risk.“ – Steven Mnuchin, Treasury Secretary, September 2019
32
The Trade Opportunity
? I expect Fannie Mae and Freddie Mac Junior Preferred
Stocks will return 100%+ over ~12 months
? Currently trade ~35% of intrinsic value
? Likely converted to equity as part of initial capital raise (or settlement) –
further equity appreciation possible
? Combined ~$33 bln outstanding across several issues
? Asymmetric trade with high expected value
? 4:1, 18-month reward:risk ratio
? Potential downside ~30% if NOT on irreversible path by Inauguration
? 20% “implied probability” of success too low given progress to date
? 12 month process-driven trade with multiple catalysts along the way
? I expect stocks will trade higher post “Big Bang” events
? Trade requires understanding of complex issues (political,
restructuring, legal)
? Understanding of political “gamesmanship” is critical
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
Several series of Junior Preferred Stock for Fannie Mae and Freddie Mac (FNMAS, FNMAT, FNMAJ, FNMAH, FMCKJ, FMCKL, FMCKI, FMCKN, FREJP, etc) with different “claims” based on various coupons, various issue sizes and varying degrees of liquidity
33
Risks Are Misunderstood
? Election Risk – President Trump loses November re-election -> Biden administration replaces Calabria and halts process
? PSPA amendment (incl. Senior Preferred write-down (or conversion) and
ending NWS) AND consent orders make process irreversible, irrevocable ? I expect both before Inauguration 2021, even if after November election
? Political Risk - too politically difficult to write-down Senior Preferred
? Trump Administration may wait on “Big Bang” until “lame duck”
? Recent events provide significant political cover for GSE recap
? Trump Administration aligned on ending conservatorships
? Treasury executing against Treasury Plan requested by White House ? FHFA strictly following statutory duty
? Execution Risk - Capital Rule too high and increases execution risk ? Framework provides capital raising flexibility and negotiating room
? Mostly execution now with many financial and legal advisors involved
? Legislative Risk – Congress doesn’t like plan
? Congress does not need to approve the “recap-and-release” plan
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
About the Author
? James Jacobs is a 15+ year veteran investor with a focus in event- driven and value situations across equity and credit markets. He spent 12+ years at Gruss Capital Management as a senior investment professional investing in event-driven and value strategies from merger arbitrage to distressed debt. More recently, for the last 2 years he managed a long / short equity portfolio at Shay Capital, where he focused on event-driven and special situations. James has a core competency identifying and analyzing “mispricings” within equity and credit markets.
? James is currently a “free-agent” and is looking to rejoin a team of like-minded investors where he can continue feeding his thirst for (investment) knowledge.
? James lives in Westchester County, NY with his wife and three children.
? James can be reached by email at jamesejacobs80@gmail.com
Executive Summary Fannie and Freddie Reform Recap Release Trade Opportunity
35
At a minimum the NWS will be cancelled allowing for a long, slow capital build. Ok to good for commons, bad for JPS ...
ACG Analytics is about to recommend commons ...
Good Luck!
ACG about to recommend commons ...
Amelia - do you remember the day the Cap Rule came out?
What happened to commons the whole day? A large sell block was put on top of the commons to allow for JPS to go up. All the JPS posters were declaring victory.
Then, the very next day, the sell block was removed and Commons exploded higher and JPS fell back. That is manipulation pure and simple on the OTC. The vast majority of institutional investors are not permitted by their charters to purchase OTC stocks. Get off the OTC and most of the obscene manipulation is removed.
The PSPA amendment gets us there.
Pay attention to the PSPA. JPS are not going to get the Big Bang they are looking for.
Good Luck!
JPS continue to be under pressure. Hope is fading for your/their Big Bang. It will most likely be a bang with a PSPA amendment and that is it.
Good luck!
The JPS risk is that they will be left waiting to be converted while commons appreciate.
The suggested approach is to hold a mix of JPS and Commons. Holding 100% JPS is like holding Treasuries instead of the S&P 500.
Extremely conservative given the length of time JPS will wait to even possibly be converted ...
Donot - hard to follow your contrived writing style.
A PSPA amendment can happen without a consent order. In fact, it is the most likely scenario given the recent comments we've heard from Mnuchin.
Good luck with your "equity"
Per ACG Analytics, a Bang is "extremely bullish for commons" ... not good for JPS. See below for confirmation.
PSPA amendment only and no consent decree = quote “extremely bullish for commons” as it sets the stage for retained earnings over the next 5 years, which is even what FnF want.
Start at 33 min mark and goes to 36:30 min mark - You’re welcome ...
https://www.realvision.com/the-ultimate-election-trade-fannie-and-freddie-live-with-gabriella-heffesse
What will happen with JPS? Will they rebound today? Or is the market finally realizing there will not be a Big Bang ...
Good luck!
Holden - who gets the proceeds from a PSPA conversion? Who gets the proceeds from a warrant conversion?
A Biden government? Hmmm
I hope you guys get your consent order - good luck!
And BTW the bankruptcy that kthomp posts often re Calabria and the Cato interview, he doesn’t reference exactly what Calabria says afterwards, which relates to an emphatic Calabria statement about how FnF will be responsible for raising capital = 5 years.
Moderators ... please keep these posts for historical reference.
Holden - please go speak with Gaby - I know you follow her - she said it plain as day here
PSPA amendment only and no consent decree = quote “extremely bullish for commons” as it sets the stage for retained earnings over the next 5 years, which is even what FnF want.
Start at 33 min mark and goes to 36:30 min mark - You’re welcome ...
https://www.realvision.com/the-ultimate-election-trade-fannie-and-freddie-live-with-gabriella-heffesse
JCRod - you got it ...
PSPA amendment only and no consent decree = quote “extremely bullish for commons” as it sets the stage for retained earnings over the next 5 years, which is even what FnF want.
Start at 33 min mark and goes to 36:30 min mark - You’re welcome ...
https://www.realvision.com/the-ultimate-election-trade-fannie-and-freddie-live-with-gabriella-heffesse
Holden - it doesn’t change the fact Gaby laid out the scenarios plain as day. Nothin has changed since Oct 12 re her scenarios. The one that seems most likely at this point given Mnuchin’s comments are a PSPA amendment and no consent order.
I’m sorry but that seems to be where we are and per Gaby’s scenarios, it looks like it will be “extremely bullish for commons.” Her words, not mine ...
You may want to speak candidly ... I seem to recall Gaby telling you publicly commons will do very well with a PSPA amendment and consent order. You better hope for that consent order otherwise ... good luck!
Holden - why don’t you have an open conversation for all to see on twitter with Gaby from ACG Analytics and let’s see what happens?
I am only quoting exactly what she said within the context of what she said = PSPA amendment only and no consent order = per Gaby “extremely bullish for commons.”
What do you want me to say? Take it up with Gaby = Twitter = @GabyHeffesse
I look forward to your debate with her. Good luck!
Worth watching again from ACG Analytics.
PSPA amendment only and no consent decree = quote “extremely bullish for commons” as it sets the stage for retained earnings over the next 5 years, which is even what FnF want.
Start at 33 min mark and goes to 36:30 min mark - You’re welcome ...
https://www.realvision.com/the-ultimate-election-trade-fannie-and-freddie-live-with-gabriella-heffesse
With a long, methodical capital raise, JPS will continue to erode as there is no impetus for conversion. FnF’s books are the cleanest they’ve ever been, they have a world class regulator overseeing them, there is no need to raise capital quickly, only to make it more difficult to attract the very same investors who won’t touch a low SP.
A long road to retaining capital. Probably no consent order and only a Bang via a PSPA amendment. Even an NWS amendment cancelling the NWS tees up SCOTUS to end it all.
Interesting times to be a common shareholder. JPS not so much ...
JPS is in trouble ... no need for a JPS conversion for a long, long time. Especially if there is no consent decree. Read other posters at your own risk but there will not be a Big Bang. It will be a slow, gradual raise and 100% JPS ownership really overweights the minimal upside of JPS.
I would only own a mix, and now that there most likely won’t be a consent order (only Bang), a slow, methodical capital raise will happen. The amount of oversight is large, and the risk to taxpayers is quite small given the amount of regulation that’s been implemented. A Biden administration will not be in any rush. If Trump won, JPS stood to do better but now all indications and real analysis leads to a methodical build.
Good luck!
Per ACG Analytics
Bang-Lite (PSPA NWS amendment only) = retained earnings = OK for commons and bad for JPS
Bang (PSPA Write down and NWS amendment) = retained earnings = very good for commons and OK for JPS
BIG Bang (PSPA Write down, NWS amendment, Consent Order and 5yr capital restoration plan) = good for commons and good for JPS - depends on timeframe for capital raise.
BIG Bang (PSPA Write down, NWS amendment, Consent Order and 3yr capital restoration plan) = OK for commons and very good for JPS - depends on timeframe for capital raise.
That’s about it from the most reasonable scenarios ... good luck!
PSPA amendment is the only thing happening - and even then the minimum will be an NWS amendment done in such a way it can’t be turned back on. That is fine news for commons as it points to retained earnings.
Even with a full PSPA amendment, I don’t think there will be a consent order so, again, retained earnings rule the day. Commitment fee will not be an impediment and is only a talking point to keep the broader JPS community suckered into their investment.
I also love how Bradford says Biden will likely reimplement the sweep with SCOTUS on the horizon. Really? What imagination, and again, a bridge too far. Biden will wait for SCOTUS before doing anything.
Nice try, Bradford ...
Who knows? Could happen at any time ...
Stimulus bill most likely bypassing a “veto” on Monday ...