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They will make up the estimated $6B in losses through forbearance by the adverse market fee of 50bps. It will add $9B per year to their income stream.
From Tim Howard:
"we’re back to asking whether plaintiffs are better off trying to settle before SCOTUS hears the case, and whether Treasury can come up with a defensible rationale for giving up its current claim to the companies’ annual income, and a $200 billion-plus liquidation preference, without having been told to do so by SCOTUS. I’m still waiting to hear an argument I find convincing for such a settlement scenario...."
"I also see the political calculus differently. This administration has been making the argument that the net worth sweep was legal and justified for over three and a half years. It’s had multiple opportunities to repudiate the “Obama-era” sweep–publicly opposed by the current FHFA Director (albeit in a prior position)–and not taken any of them. If it sticks with its current argument and loses the sweep case at SCOTUS, it can say, “well, we played the hand we were dealt, and it didn’t work out.” If it settles now, it has to both address its defense of the sweep for the past three and a half years (it can’t just say, “oh, never mind all that,”) and defend itself against the “giveaway to the hedge funds for not much in return” argument"
I think Tim is right
Exactly. So any settlement will have to treat both JPS and Commons fairly, otherwise it will be a no go.
For the record, I don't think treasury has any plans to settle. They are going to let this drag on for the next two years in the courts (once remanded back to determine damages). Meanwhile, FHFA finalizes their Capital Rule and amends the PSPA, raises G-fees (raising income to 35B), keeps retaining capital, and approves capital plans by the GSEs. After all of that, they will begin a series of equity offerings.
Based on the evidence of Calabria's first 1.5 years, I wouldn't exactly say he is in a RUSH to get to a certain level of capital.
As he often says, process dependent, not calendar dependent
I'm not sure why you keep referring to a reverse split. You repeatedly refer to the AIG reverse split, but that had nothing to do with a government recap program. In fact, it was something voted on by the shareholders in an effort to avoid a bailout:
https://www.investmentnews.com/aig-shares-drop-after-1-for-20-reverse-stock-split-22593
Also, at the same time the Preferred Shares also went through the same reverse split:
https://www.marketwatch.com/story/aig-proposes-one-for-20-reverse-stock-split
The reverse split for both common and preferred was a part of the proxy vote:
https://www.aig.com/content/dam/aig/america-canada/us/documents/investor-relations/2009-proxy.pdf
In fact, when the government made its recap plan, it offered common shareholders warrants to purchase stock:
"The warrants, which will be given to shareholders other than the government, were meant to be a sweetener that would give private shareholders the chance to profit from a rise in AIG's stock as the government sells its stake"
https://www.wsj.com/articles/SB10001424052748703730704576066544101831766
In the Capital Rule just published by FHFA this summer (p. 39285), it says:
"As the table [6] indicates, the Enterprises’ combined core capital increased from $77.3 billion in 2006 to $84.1 billion in 2008, suggesting at first glance a position of some financial strength. However, over the same time period the Enterprises’ combined tier 1 capital decreased markedly from $76.3 billion to $24.1 billion, indicating a capital position with deteriorating and substantially less loss-absorbing capacity. Similarly, the Enterprises’ combined total capital increased from $78.7 billion in 2006 to $98.5 billion in 2008, while over the same time period
the Enterprises’ adjusted total capital decreased from $85.9 billion to $29.6 billion."
So even with the more stringent capital standards laid out by MC, the GSE's still had 24B in Tier 1 Capital. Thus, they were not insolvent.
Interesting footnote from Don Layton:
"There are existing preferred shares outstanding owned by the investing public, now known as “junior preferred” in comparison to the “senior preferred” owned by Treasury. These junior preferred shares, with a face value of about $33 billion between both GSEs, can be left outstanding; however, it may be desirable for them to be eliminated in some fashion to reduce possible legal risks"
I wonder if he anticipates that the JPS will be left to languish until some legal action forces the hand of Treasury/FHFA? This is especially interesting since he was the government appointed director during the AIG release. Given his experience in that capital raising process, he obviously does not think that the primary pressure for how to handle the JPS will come from new investors, but rather from the legal side.
Just another statement of Fannie's willingness to raise fees even as they reduce their market share, in order to maintain the same ROE:
"Fannie Mae may find it necessary to increase pricing on affordable segment
loans in order to achieve the same overall 10% return target. For example, if the guaranty fee increases on lower-risk loans resulted in a 30% reduction to Fannie Mae’s acquisition volumes for such loans, guaranty fees on affordable segment loans might need to increase by approximately 10
bps, on average, over 2019 prices, in addition to the price increase imposed on the non-affordable segments"
This is clearly a siren warning to FHFA that if they are forced to reduce market share, they will probably reduce it in the lower income/high credit risk pool of their portfolio.
Thanks for the quote and link. From the paragraph, they do mention a possible offset of 10 bps with the TCCA phase out, but then they immediately mention that the G-fees could be "compounded" by a number of other factors. This all comes within the context of several paragraphs where they are warning FHFA that the capital rule is going to force them to raise G-Fees to maintain a 10% ROE (citing the CBO study as validation of the expectation of 10% return). They go on to cite some of the factors that would cause a further "guarantee fee increase." It certainly seems that they are willing to increase G-fees however high as necessary in order to generate the ROE that investors will demand, even going higher if their market share decreases. The Dec 1 "adverse market fee" of 50 bps seems to back up their claim that they are willing to raise the fee significantly if necessary.
"This increase in guaranty fees could be offset in part if the 10
bps fee under the Temporary Payroll Tax Cut Continuation Act of 2011 is phased out as scheduled, but could also be compounded if a commitment fee such as the one established by Treasury’s preferred stock purchase agreement becomes payable. Ultimately, the level of guaranty fee increase would depend upon many factors, including market return expectations, the credit characteristics of the acquired loans, the amount of capital that management deems necessary to hold above regulatory minimums, competitor pricing strategies, and mortgage market conditions."
You've mentioned a couple of times that FnF would raise G-fees by 20 bps, then turn around and lower them by 10 bps when the TCCA expires. Could you cite the page number in the comments where they say this? I've searched in vain and can't find it
Discussions involving a "for cause" removal provision related to the POTUS are not advocating one party over another. So I don't see how that is political. To discuss various scenarios based a political appointee by DJT vs. another administration in light of the Collins case relates directly to the risk of an investment in the GSEs
Of course, any of these scenarios are moot if the Treasury decides to settle out of court before Dec 9th. The for cause provision probably remains in place, and the lawsuits with both Pfds and commons are satisfied.
Wow! Cmdr, that is a great find
That paragraph was a powerful and bold ending to his post, but given real world finance, it will inevitably prove to be true. Unfortunately, I'm just not sure how much pain will be inflicted on the American homeowner in the short-term while FHFA figures this out.
"For this reason, even if the May 20 FHFA capital standard goes into effect as proposed, it is highly unlikely that Fannie and Freddie will have to recapitalize solely through retained earnings, over a period as long as ten years. They will be given a sensible and workable capital requirement long before then"
https://tinyurl.com/y2ope5oa
As an independent regulator, Calabria can only be removed "for cause," meaning that neither Biden, Trump, Pence, or whoever can do anything to stop his release on consent decrees. Obviously, if SCOTUS rules in March-June of next year against FHFA structure that could change.
Given the fact that Calabria was once Pence's chief economist, there is NO WAY Pence would remove Calabria or go against his plan.
Biden Victory = Quick Release of FnF under consent decrees
Central bank extends restrictions on dividends, buybacks, amid cloudy economic outlook. Fed cites the need to conserve capital during the coronavirus downturn.
https://t.co/DaSWksKDsH
Calabria, who in 2015 called 10% dividends on the PSPA "unnaturally high", now links an article suggesting that 10% is excessively too low for the GSEs to pay to the Treasury
Did Banks Pay Fair Returns to Taxpayers on the Troubled Asset Relief Program? | Cato Institute https://t.co/5V389iKM4N
— Mark Calabria (@MarkCalabria) September 30, 2020
From Don Layton:
"This type of stress test is performed annually on large banks and the two GSEs. The idea is to first determine the loss that would be incurred in a severe adverse scenario, and then judge whether the remaining capital would be sufficient to maintain market confidence.
The latest available figures, from December 2018, show that the two GSEs together would lose $43 billion in a severe adverse scenario (including losing the value of the deferred tax asset, though it is questionable if that would happen; without losing the tax asset, the loss would be just $17 billion). This means that the FHFA capital proposal, which calls for $243 billion in capital, would leave a “going concern buffer” (i.e. the remaining capital) of $200 billion to hopefully maintain market confidence in the two companies, or 4.7 times the predicted $43 billion loss. A remaining capital buffer of almost five times the severe adverse loss is clearly enough to maintain market confidence. In fact, it is probably well more than what is needed. (Using the $17 billion figure instead, which reflects the deferred tax asset not being lost, results in the remaining capital buffer in excess of twelve times the predicted loss, which would be incredibly high.)
The severe adverse loss calculated for the GSEs has declined every year since the first calculation was done in 2013. It was expected to do so again and probably be materially less than $43 billion, for the stress test based on December 2019 figures, which should have been disclosed in August of this year, but mysteriously were not. This begs the question: why have the results not been made public? A number materially lower than $43 billion would make the case even stronger that the $243 billion required by the FHFA proposal is simply excessive"
https://www.jchs.harvard.edu/blog/the-fsoc-secondary-mortgage-market-review-a-grade-of-f/
that assumes you are doing the conversion RIGHT NOW, which continues to be the fatal flaw in the JPS conversion fantasy.
By the time they get around to conversion, there will be much more certainty and transparency about the capital raise, and the commons will trade much higher, meaning there is no 4:1 ratio as there is right now.
Got it.
I didn't understand that to be necessarily restricted to only New JPS, but perhaps that is one of the options. I think they would have a hard time restricting it to one class but not to the other. So, I understood it as a restriction across all classes, meaning that in the first year or so, they would pay no dividends, or only 25% of the dividend for all classes.
The bottom line is, the FHFA clearly anticipates a phased in capital raise, which will prevent them from paying dividends. And this capital raise will take longer than a quarter (3 months), in which you would pay dividends. They appear to contemplate numerous quarters (multiple years), in which dividends are calculated differently. Depending on when they convert Pfds, this would probably make for more delay in their potential returns on investment.
This is an interesting statement in the Capital Framework:
"For example, a tailored exception to allow for some distributions on an Enterprise’s newly issued preferred stock might increase investor demand for the offerings of those shares."
This appears to suggest that they might issue NEW preferred stock, which presumably would be done in order to replace the OLD preferred stock (JPS), but with more favorable interest rates in the current interest rate environment.
One of the main reasons I examine JPS conversion is because Craig Phillips stated quite plainly that this is a serious consideration by Treasury:
"The junior preferred stock should be exchanged for common stock on a basis that is viewed as fair, based on capital markets standards and the prevailing market value of those securities. The U.S. Treasury should exercise its warrants to acquire 79.9% of the common stock of the GSEs, as agreed in the PSPAs. Since the beginning of the conservatorships, Treasury has received dividends totaling over $300 billion on its original capital infusion of $191 billion. Consequently, the liquidation preference of the senior preferred stock should be reduced to zero and the Treasury should be considered ‘repaid’"
So those owners of JPS who contemplate conversion scenarios are not contemplating something far fetched. They are responding to public and reasonable statements from the former Counselor for the Treasury. In some, perhaps many, cases, their scenarios are overly optimistic. But the idea of a conversion of JPS is a serious consideration in the recap and release plan.
https://housingfinancestrategies.com/235-2/
Of the 550M outstanding JPS with FNMA, 350M are $25 JPS. So, leaving aside the few thousand 2004-1 pfds ($100,000 per share value), a conversion at $20 per share for the $25 JPS and 2x$20 per share for the $50 JPS would create about 700m new shares at $20 per share. So, in the case of FNMA (not including FCMM) there would be:
700,000,000 JPS converted @ $20
1,150,000,000 legacy common @ $20
4,600,000,000 Treasury warrants @ $20
Total of 6.45 billion shares @ $20 each - or a value of $129 billion dollars
If you present a public offering for a company valued at $300 billion (20 billion annual earnings x 15 = $300 Billion), with only $129 billion accounted for by existing shareholders, you can offer $170 billion dollars of value. But in the case of FNMA, you only need to raise $168 billion to meet the capital requirements.
In all likelihood
1) FNMA is worth more than $300 billion, because with a 20bps increase in G-fees and the expiration of 10bps TCCA fees, their income would probably be closer to 22B per year, not 20B. Higher valuation means you can offer great value through your public offering.
2) You would not raise the entire capital through a public offering, but through a combination of public offering and retained earnings. My guess would be, at a minimum, 2 years retained earnings at 45B. Thus you would only need to raise $120 through the public offering, but they already have $17B in cash. Thus, Ackman's conclusion that they would need to raise about $100 billion.
Thus, if you made that public offering @ $20 per share with 5 billion more shares, it would yield $100B in cash. Thus you end up with 11.45 billion shares to divide between a $330B company, yielding a final share value of $28.82. That is a lot of upside for commons and a decent return for JPS. This per share price valuation, by the way, is why I believe most JPS would JUMP at at conversion rate of just 80% of par.
None of this accounts for possible (probable) monetary damages through the court cases, which obviously could have a big impact on the share price. If those monetary damages are dealt with via a settlement before Dec 9th, that value redounds completely to the common shareholders, since Calabria will not have dealt with any formal capital plans by the GSE's at that point (and thus no formal JPS conversion discussions)
Given what is stated in Calabria's Capital framework about phased in dividends, I will stand by my assumption that there will be limited or no dividends on the Pfds. There is little reason to offer dividends on new issues, since lots of IPO's offered shares with no dividend. Alibaba, the largest IPO in US history does not pay a dividend.
I couldn't find the reference to restrictions on pages 82-83, but I did find this on 101-102:
"If an Enterprise is subject to a maximum payout ratio, the payout restrictions would apply to all capital distributions, which generally extends to dividends or payments on, or repurchases of, CET1, tier 1, or tier 2 capital instruments"
"FHFA is soliciting comments on whether some or all of the payout restrictions should be phased-in over a transition period. In anticipation of the potential development and implementation of a capital restoration plan by each Enterprise, tailored exceptions to the payout restrictions might be appropriate to facilitate an Enterprise’s issuances of equity to new investors, particularly to the extent that any tailored exception would shorten the time required for an Enterprise to achieve the regulatory capital amounts contemplated by the proposed rule or otherwise enhance its safety and soundness. For example, a tailored exception to allow for some distributions on an Enterprise’s newly issued preferred stock might increase investor demand for the offerings of those shares. Similarly, a tailored exception for some limited regular dividends on an Enterprise’s common stock might increase investor demand for those shares."
I'm not sure where they will land, but it sure sounds like FHFA wants to restrict dividends to some extent in the early days, then slowly phase them in. This, in turn, will incentivize JPS to convert earlier, below par, so that they could get a return on the share price appreciation over time (instead of waiting for the re-instatement of full dividends somewhere down the road).
I'm trying to understand conversion rights of the Pfd shares. On page 30 of the prospectus for Series T, it outlines ALL of the preferred stock that was outstanding in the year 2008 and says:
"Each of our outstanding series of preferred stock has no par value, is non-participating, is non-voting, and has a liquidation preference equal to the stated value per share. None of our outstanding preferred stock is convertible into or exchangeable for any of our other stock or obligations, with the exception of the Series 2004-1 Preferred Stock issued in December 2004 and the Series 2008-1 Preferred Stock that is expected to be issued on May 14, 2008."
It would appear that Pfds have no conversion rights and no contractural par value (with the exception of the 2004-1 and 2008-1 series). In other words, they are not guaranteed any particular number of shares in a conversion. Their only rights are to the coupon rate, which is not worth much while the companies are restricted from paying dividends. Thus, they might be offered a conversion at $20 per share (which in 1 year will be a good deal), or the option of holding their Pfd share which will pay them nothing until FnF are fully capitalized. My guess is that if they made such an offer, many pfds would take it.
https://capmrkt.fanniemae.com/resources/file/ir/pdf/stock-info/series_T_05152008.pdf
Ackman estimates ~35 billion (if I understand his 40bps correctly) in earnings through a combination of the 1) addition of 20bps in G-fees and 2) the expiration of TCCA fees (10bps) at the end of 2021.
This not only significantly increases the value of the company (at 15x earnings), but it also accelerates the retained earnings power.
If they raise $140B in capital over 2 years, offering 170B worth of shares in exchange for that cash, there is still significant value for the current common equity.
"Judge Barrett has been especially attuned to overreaching by administrative agencies. She joined several opinions declining to defer to government agencies’ interpretations of their own regulations—a controversial doctrine known as Auer deference, which four Supreme Court justices said last year they were prepared to overturn.
She has also been aggressive in scrutinizing agencies’ factual determinations, particularly in Social Security cases. If C.S. Lewis was right that “integrity is doing the right thing even when no one is watching,” then these decisions deserve special appreciation, because they hold the government to its burden when the outcome matters to no one but the litigants."
That's important, because Tim Howard punches all kinds of holes in the factual determinations alleged by the Treasury
https://www.wsj.com/articles/what-kind-of-judge-is-amy-coney-barrett-11601154273?mod=hp_opin_pos_1
I thought it was worth posting again
ACB judicial tendencies relates to taxpayer cases reflects "consistent and unyielding application of exactly what is written" in the statutes that guide government agencieshttps://t.co/okJLF28DV9#GSE #GSEs #FNMA #fanniemae@GabyHeffesse@JoshRosner@amacker@CNBC
— Jarndyce Jarndyce (@JarndyceJ) September 26, 2020
"Judge Barrett has been especially attuned to overreaching by administrative agencies. She joined several opinions declining to defer to government agencies’ interpretations of their own regulations—a controversial doctrine known as Auer deference, which four Supreme Court justices said last year they were prepared to overturn.
She has also been aggressive in scrutinizing agencies’ factual determinations, particularly in Social Security cases. If C.S. Lewis was right that “integrity is doing the right thing even when no one is watching,” then these decisions deserve special appreciation, because they hold the government to its burden when the outcome matters to no one but the litigants."
https://www.wsj.com/articles/what-kind-of-judge-is-amy-coney-barrett-11601154273?mod=hp_opin_pos_1
Stern, you need to post more often. You are spot on.
Today's Daily GSE Brief
Your Daily GSE Brief: #GSE #GSEs #FNMA #FMCC #fanniegate @GabyHeffesse @CGasparino @CNBC https://t.co/57JLIm2Smx pic.twitter.com/t3CVRilWRy
— Jarndyce Jarndyce (@JarndyceJ) September 25, 2020
I don't disagree with that.
Yes. This is based on history, clear public statements by principles and sound business practice (i.e. not fantasy scenarios).
The real strength of the JPS is the almost guaranteed return at Par. Whether that will include past dividends or not will be determined by whether the the NWS is set aside. It will turn out to be a nice investment. With the increasing role of retained earnings while this process works itself out, obviously the benefit redounds to commons.
Todd Sullivan believes that the retained earnings will not be that great because of deterioration in the entire economic outlook. This, I believe, is where there is the greatest risk. But FnF have the power of increased G-fees and the potential of a big injection of cash via derivative claims in the courts, all of which can speed the process.
Yes, SCOTUS is the wildcard. I still expect a favorable outcome, but it may not be until June 2021 before they issue the opinion. Obviously, there is always the potential of a settlement between Nov 3 and Dec 9, which would be great.
More JPS conversion fantasy
Long, slow process for Capital Raise.
It is going to take years to build capital, even CET1 capital. Those who imagine it will be done within a month or two of consent decrees are dilusional
1. The combined TOTAL of IPO's this year (2020) is $95B, last year $84B. That is the total for ALL companies, not just one, and most of them were growth companies, not insurance companies like FnF. It will take FnF years to raise the capital they need.
"This year is shaping up to be one of the busiest years for IPOs on record, as investors leap at opportunities to invest in fast-growing technology upstarts. Issuers had taken in $95 billion from U.S.-listed IPOs through the end of Wednesday, exceeding the $84 billion raised at this point in 2000, the previous record year, according to Dealogic."
https://www.wsj.com/articles/palantir-expected-to-be-valued-at-nearly-22-billion-in-trading-debut-11600990739
2. The largest single US IPO on record is Alibaba at $22B
https://www.statista.com/statistics/226152/largest-ipos-in-the-united-states-by-issue-volume/#:
3. The largest worldwide IPO was Petrobas, most of which was not actually cash. The cash portion was only $36B
"Brazil’s government - which already controls 40 percent of the company and more than 50 percent of its voting stock - will receive $43 billion in shares in exchange for allowing Petrobras to drill for 5 billion barrels in reserves. The other $36 billion will be cash raised from investors"
https://www.france24.com/en/20100924-petrobras-70-billion-dollars-largest-ever-share-offering-brazil-oil
4. AIG went to market 6 times to raise their cash. Converting Pfds did not happen until they went to market first. They went to market in 2010, but did not convert legacy Pfds until 2011.
https://www.courthousenews.com/class-claims-aig-took-it-for-5-billion/
http://www.timelessinvestor.com/2019/01/10/history-of-aigs-recapitalization-and-stock-price/
5. I expect FnF to follow suit. Since it will take them a few years to raise core capital, they will not be in a rush to convert Pfds.