Did Seila address the SSA? It seems like that's the precedent that endangers that agency moreso than Collins, no?

Collins has the issue of the remedy w/ the SSA. But it seems easy to me that remedies are limited to redress the specific plaintiffs, and once the language is corrected on removal, the director could ratify all the past actions.

Not much different than Calabria ratifying a few things once he's subject to removal. He would definitely ratify his capital rule, for example, which might otherwise get a const challenge of its own post a Collins win.

I square the circle with realizing Calabria had one thing that was must-get: ending the cash NWS so GSEs can actually build capital.

He was willing to give anything for it and he ended up giving almost everything.

Secondly, he would have wanted FHFA to call the shots on the exit. He got most of the way there, since TSY doesn't have an explicit approval anymore. Yes, there is the warrant, but that expires in 2028. Eventually FHFA will call the shots.

More importantly, in my view, is that he now has leverage to negotiate with the new TSY secretary because he has what he needed (End to the cash NWS). He can give things to get things instead of being steam rolled. Whether new admin wants to deal is TBD, but he finally has some affordable housing carrots to offer someone who wants to eat them.

KT: B/c the capital rule explicitly gives permission to the FHFA director to decide that something counts as a certain form of capital. Simply complying with the MC capital rule would have preserved that flexibility.

The new language that the senior preferred shall not count as CET1 is a different beast. That's what takes away the flexibility. MC can't decide to count it as CET1 even temporarily (to, for example, grease an exit and external capital raise). That's how SM went out of his way to bar the exits.

KT,

2nd post. I think I see your error.

CET1 is NOT: "GAAP equity less preferred entries". That's why you think disregarding sr pfd is avoiding subtraction of a negative. Sadly, I don't think it works that way!

CET1 is basically just the retained earnings account, which is hugely negative. We don't get to add the sr pfd in the first place.

KT:

I don't think that is correct. CET1 already does not include the seniors. That's why it's hugely negative today - no credit for the $120B of sr pfd equity line on FNMA financials.

Reiterating that the sr prefs don't count doesn't change anything, so I'm confused why you think there is some sort of positive adjustment.

The reason that line is even in the amendment is to tie the hands of FHFA so that they can't decide to count sr pfd as common equity and then get out more quickly. The FHFA director has the authority under the capital rule to recategorize things as he/she sees fit, and TSY made sure the door was bolted shut on no "funny business".

Guido, you're way wrong on the capital.

"They currently have $34.6 billion in CET1 capital. "

Try negative $100B+ billion.

Don't confuse GAAP equity with CET1 capital. Totally different animals. Nearly every comment I've read has been wrong. It's 20+ years of retained earnings to hit the mark b/c starting point is very negative.

Diluted:

It seems to be a given that the credit line would stay in place in every scenario and TSY would receive some kind of fee for that backstop. As such, why would there be any change in stance from the ratings agency if the GSEs either leave c-ship (or, perhaps more likely, stay there for a while but Mnuchin gives Calabria sole control to push the exit button)?

Because Fannie and Freddie follow GAAP and that's how it requires them to be booked!

Does anyone know if TCCA fees just totally expire?

I.e. guaranty issued today pays TCCA. Does it pay TCCA until the guaranty goes away, or do the GSEs keep 10 bps more of the existing guaranty the day after TCCA expires?

FHFA called out the comments on this in their final rule.

I think years in the future they will eventually get capital credit for these entries, b/c that's the sensible economic reality. But you need a different FHFA head.

The only thing I could think of is that Freddie might have more of the G-fee as upfront fees vs. Fannie as an ongoing fee and the difference is structural.

But that's just total speculation.

Freddie is much smaller than Fannie, so why would their unamortized fees be twice as large?

Seems like it must be counting something else in there?

KT:

I never really appreciated the fact that public prefs exceed the amount available for Tier 1 capital. Thanks for pointing that out. It's interesting.

On the one hand, it's much easier to place preferred than common. So they could convert all prefs to common, then place $25B with private equity or Buffett pretty easily. Boom.

On the other hand, perhaps just the delta would be converted and the rest would remain outstanding. Keep those low coupons or floating ones outstanding, and just offer a conversion to the higher coupon issues.

I could see this decision happening after there is visibility on the court case. Collins could resolve in many different ways, and some of them would inject a LOT of capital back into the GSEs. Kind of need to know what that is before proceeding with the preferred. Can't really offer a conversion before a warrant exercise and sr pfd conversion / NWS amendment.

The government has settled several cases in the weeks before Supreme Court hearing.

I don't believe any of them involved money.

The last time Dems held the white house, the head of the FHFA was a senator who knew little and actually did even less. They don't care about capital at the GSEs.

Calabria actually does care. And he actually does know what he's doing. He's the best guy for the job of recap and release, he's just working slower than we would have hoped. The ultimate capital levels aren't really important, anyway. No matter what they are, they are easy to fill if Treasury is cooperative.

Anyone who wants MC out, be careful what you wish for...

Repeating FSOC's comment about GSEs maybe needing additional capital is interesting.

Ways to address that:

1. Increase capital, especially if CET1 is kept constant and the increase comes from additional Tier 1 capital to hold. But that's inconsistent with most capital rule comments about pressure on fees and ROEs raising private capital, etc.

or

2. Have it be available through an amended PSPA. Right now it wouldn't count as capital b/c the govt sr pfd is cumulative, but if TSY changed it to 10% noncumulative sr pfd then there would be hundreds of billions available to draw from the government.

#2 seems very sensible to me, and it would also be part of a big SPSA amendment before new admin.

Guido:

On those G-fees, I think they actually are on the balance sheet. They are included in the fair value of the loans. But it is the offsetting LIABILITY that carries the economic effect with regard to capital. It's basically a phantom liability. The liability evaporates over the life of the mortgage (or all at once if the mortgage pays down / refis). That liability should arguably be a capital adjustment.

So the assets ARE there. But the liability booked against them is not an actual economic liability. It only exists to create the timing aspect to recognize the upfront fees as income over time.

Anyone listen to MC keynote? Panelist said he said could finish the capital rule "quickly".

Fannie's 10% ROE assumption solely for taking remote credit risk is nonsensical.

Large financials would love to hit that profitability in a low rate world, and they take far more than credit risk.

The GSEs don't have to raise G-fees at all. If they have any sense, the G-fees should be lowered while the GSEs use recap levers that have little or nothing to do with selling new shares to the market.

They are going to defend those excess profits from banks, who will be upset that the risk weight for a 1st lien mortgage is 50% but agency MBS is 20%. I think FSOC foreshadowed that, actually.

Banks will get together and lobby to charter their own competitor with the promise of lower G-fees. Let's be real. The G-fees are absurdly high!

KT:

What if we get an amended SPSA, perhaps w/ the common exchange you are predicting, but no SC settlement by Dec 9th?

Yes, I have long wondered how the FHFA insulates the capital rule from being set aside if it is unconstitutional. Perhaps this "ratification" by FSOC gives them the necessary cover. I'm not a good enough to lawyer to know if this gets there.

Calabria has said this is the most important thing he does, so he should be protective of his baby. Plus it gives him political cover against criticisms.

I think it was corporate culture.

Made me think of Freddie's Kushner loans. Just not a great look.

Being months behind on DFAST is also bad. Not sure if that is GSEs or FHFA, though. Definitely a lot going on w/ Covid.

So.. where is the 2020 DFAST results?

"Did the TARP recipients pay to the Treasury the same rate they would have paid if they had raised funds with similar security from the private markets on the same day?"


Whatever the private market rate for senior preferred equity in the GSEs on the day of the NWS, it was very likely lower than all of the profits in perpetuity!

KT:

I think you can look at dozens of merger examples a year that involve issuing stock.

When a company issues stock to buy another company, the deal is structured to either fix the ratio or fix the value.

If the ratio is fixed, then the value will change depending on the movements of the acquirer's stock.

If the value is fixed, then the number of shares they need to issue will change depending on the movement of the acquirer's stock. To determine the price of the acquirer's stock for purposes of figuring out how many shares to issue, there is usually a pricing period. Something like the average trading price of the past week or two.

There are often collars to provide more certainty, but no need to do that in the GSEs.

For any GSE preferred exchange, I suspect they will fix the value. So the number of shares to issue will depend on the recent historic trading price of the common. As you say, the GSEs are highly diluted either way. But the FHFA publishes a recap roadmap or something that provides more certainty and the common trades at $5, that's less common to issue in an exchange and we get into positive reflexivity.

Question on warrant dilution:

My understanding was that the warrant is adjusted for share issuances such that it is always exercisable for a 79.9% stake.

If that is correct, then the common could be much more diluted depending on the order of capital raising actions. For instance, exercising the warrant then converting sr pfd to equity would mean a lower government stake than converting the sr pfd and then exercising the warrant.

Am I wrong?

Guido:

I did them. That's why I own the preferred. It's two pen strokes away from meeting the base capital requirements. Convert the senior preferred and settle the lawsuit to inject the overage. Voila.

My gamble is whether Mnuchin has the bandwidth to do this. That guy is everywhere doing everything. I think highly unlikely he moves before the election, but things probably slow down a lot during lame duck.

But if Trump loses and Mnuchin just passes the baton, this might not work well. Even if we win $125B+ at the Supreme Court.

I have very little faith in Democrats, especially in the social media framed environment we are in, to do anything that would restore these to private ownership. Calabria gets the boot. And even if he resists, you need TSY sec to play ball. Fat chance!

Good points thinking about the exchange offer as a like for like value exchange. The 10% div and sr position makes the prefs super valuable and therefore could warrant a lot of common consideration. I think that is true.

However, we know for a fact that the government does not always act to maximize the value of its securities in the context of a transaction where they are hoping to accomplish other goals. AIG might be one example. The recent KODK loan (no equity given) is another. The airline "grants" overseen by Treasury is another. TSY recently did take an equity stake in YRCW in return for a loan. So they don't give away the store, but they seem to leave something on the table.

As you say, the exchange could just be the slug of shares so that Treasury has X% of the companies after conversion. But the usual way is to first set a price on those shares based on the market, and then issue the number of shares equal to par value. Yes, those prefs are worth far more than par. But I suspect an exchange would be set at par value with some relationship to the trading value of the stock (which is where it gets reflexive).

So while the common would be highly diluted in any case, there is a world of difference with the common owning 1% or 3% of the company. What that translates to, I haven't done the math. The prefs seems like the better risk/reward to me. But I'm going to dust off my Excel this weekend :)

KT: Per your link, what's the difference between "letter agreement" and "third amendment"?

In other words, why weren't those two letter agreements called the "fourth amendment" and "fifth amendment"?!

KT: Why does the final amendment get unwound? Are the plaintiffs even contesting it?

It feels right that it should go away, but I'm struggling to connect the dots as to why it legally has to. It doesn't appear to have been challenged.

On the one hand, the court could reason that Calabria and Mnuchin could agree to the same thing again, if they wanted to. On the other, one might say that Calabria and Mnuchin reached this final amendment, the final amendment does preserve/conserve assets up the buffer amount, and it hasn't been challenged anyway.

Maybe I'm missing something really obvious, but it seems to me the judges must ask themselves if they set aside the NWS, what happens to the amended NWS?

So $150B from a court and $125B returned via settlement. Let's get a settlement, Treasury!!!

I think it's hard to envision a scenario where the senior preferred is just cancelled. We know the court won't do it. And that shouldn't be Calabria's preferred outcome either because it doesn't build capital whereas alternatives to cancellation would be major capital infusions.

And Treasury should actually do better for the taxpayer by converting to common vs. canceling, so why would they prefer a cancel?

Which gets to my last point. It all depends on the exchange ratio. This is tricky to assess because it is very reflexive. The lower the common, the more diluted, the lower the price. But the higher the common, the less diluted, and the price goes ever higher. Ackman has written about that.

If TSY does a sr pfd exchange after a settlement or a court loss, they are probably going to get far fewer shares because the common price will probably be significantly higher.

How much would interest be?

That would be a nice way to eat up some deferred tax assets! :)

What happens if the SC sets aside the NWS?

I get that $125B can come back into the entities. Probably just a cash infusion. But what happens to the sr pfd? Calabria and Mnuchin signed off on the amendment that keeps the NWS in place but retains the capital up to a threshold instead of sending it to Treasury. But the $125B would breach that threshold. So does that stay in place and the $125B is swept back to the companies, we hit the buffers, and the excess is swept back to TSY?!

KT: Two notes on the capital raising.

1. The warrant is for 80% of the existing equity. Can't raise external common until that warranted is exercised.

2. After selling new shares, the government would be somewhere between a significant minority and an overwhelming majority stakeholder. Even outside of c-ship, those votes can dictate whatever the governments wants to do. How does this problem get resolved?

Calabria says the need for capital is urgent, but he's in a funny situation where the TSY can't really take incremental steps. The warrant means if the govt is in for a penny, they are basically in for the pound.

I think the argument would be a simple one:

If the market considers GAAP equity as "loss absorbing" capital, then these unamortized accounts don't cut the mustard. When the GSEs lose half of their equity in the next crisis, that is going to spook people and they aren't going to worry about these arcane capital adjustments.

Personally, I agree with making the adjustment. In a 4% capital world with a TSY backstop in place, there should be plenty of room to do the sensible economic thing.

I mean you make these adjustments, convert sr pfd to common, settle the lawsuit and reimburse the $125B, Berkshire writes a $40B check for preferred and these things are totally recapitalized without raising a dime. AND they could have the GSEs cut the G-fees by 10 bps to lower mortgage costs for Americans.

I'm just shaking my head at how easy this should be. Everybody under the sun wins. The common might not do so hot depending on the dilution equation, but that just means it's a win on political optics too.

I just don't think the voices on this capital adjustment are loud enough to get heard. Looks like this message board is the only one talking about it!

Spent time reading the GSE SEC filings.

I think these upfront fees are already recorded as assets. It's just the reason that doesn't result in net income or equity is there are offsetting LIABILITIES against them.

When Quinn letter says unamortized upfront fees, the unamortized part is the liability. Not the asset. I posted to kthomp on this. You can see the liabilities on the trust bonds is greater than the actual unpaid principal on the trust debt - that difference is the unamortized liability.

Those liabilities go poof as and when the mortgage balance is paid down (paydown, refi, default, prepay, doesn't matter).

But I'm not sure the entire balance has to do with the upfront fees. The accounting is over my head, but a quick sanity check suggests there are other moving pieces in those accounts: FMCC balances are higher than FNMA. But FMCC has half the market share.

There just isn't much visibility into this. One would have thought if it made a ton of sense that Tim Howard would have advocated for it and he didn't. I wonder why!

Me too, but I can't think of any analogous banking activity to compare it to.

Maybe comparable to how an insurer would treat receiving upfront payments for assuming some kind of insurance risk, but I don't think Basel 3 applies to insurers.

TRCPA:

It seems to me like Calabria is moving about as fast as his goals would permit.

He had to redo the capital rule. I say "had" b/c the original rule didn't have a buffer on the 4%. It was a hard floor. The new rule hard floor is 2.5% with a 1.5% buffer. That's a big structural change, plus all the other tweaks.

He could have punted to extend the comment period but didn't.

TBD how quickly he finalizes it. I think in his mind it's basically done except for some CRT changes.

But ultimately, the speed isn't up to him. It's up to Mnuchin. He's kind of busy. Although if I were TSY secretary I could recap this thing in 30 seconds AND lower mortgage rates for all Americans, I think Mnuchin has other fish to fry until the election.

I cringe every time he talks about several years of retained earnings, b/c time is not the friend of his job security or the ally of having a cooperative TSY secretary... But so far I think he's moving with good speed.

KT: Thanks for the thoughts. It fired some more neurons of my own on the creative options part. How about this one:

Offer to exchange common shares for agency corporate debt.

This would retire GSE liabilities and replace with newly issued common. In total, the GSEs have well over $100 billion of bonds outstanding. They are priced very much like Treasuries. And while I'm sure the holders bought these as a proxy for Treasuries and therefore wouldn't participate in the exchange offer, Calabria could set a ratio to create an economic incentive. Similar to what they did in the C exchange offer way back when they exchanged trust preferred (essentially debt) for common shares to increase CET1.

Then the price of the bonds will go up in the market and the holders can sell them to arbs who will participate in the exchange offer. Heck, the TSY could exercise the warrants and lend their shares for arbs to short the common to hedge the exchange!

I bet they could raise $50B of CET1 this way. It sort of synthetically creates the recapitalization that would happen in any BK process as credit is equitized. Except here they harness market arbitrage forces and avoid BK.

I like your idea of preferred exchange to clear the decks (maybe leave the floaters outstanding!). I bet would Buffett would buy $30B of GSE preferred all day long with all that CET1 ahead of him.