Fannie Mae-No Politics (FNMA)

[kthomp19]

I used to think the first reason was important, but I am no longer so sure about that. Sweeney dismissing all direct claims (so far) and Calabria's seeming assurance that the administration's actions will take care of the lawsuits makes me think that said actions will get the cases dismissed as moot, which wouldn't require a settlement with plaintiffs.

The second reason is brand new as of Wednesday, but is of critical importance. Calabria's inclusion of a separate CET1 capital standard, which includes common but not preferred equity, clearly signals two things:

1) The capital raise will be mostly or all commons. I have said that not doing so would cause the capital structure to be too pref-heavy, and Calabria's CET1 standard proves this correct. This post I wrote last year, especially point #5, is looking rather prescient on this count in light of the new capital rule.
2) A junior-to-common conversion is beneficial because while it doesn't add to core (tier 1) capital, it does add to CET1 capital.

The third reason is the most important of all. Since the capital raise will have to be at least mostly commons, those new common shareholders will want as little liquidation and dividend preference in front of their new commons as possible. Converting the existing juniors is a costless way to eliminate $33B of the former and $2B of the latter. If I were a re-IPO investor, I would insist on there being a conversion of the existing juniors first.

The only party with any power that might object is Treasury, because the conversion would dilute its warrant shares; I don't see the juniors agreeing to a conversion while the warrants are outstanding. However, Treasury allowed its Citi warrants to be diluted by a pref-to-common conversion, and Treasury has other ways to make money in the recap and release process than maximizing the value of its warrant shares at all costs; commitment fees on the backstop are the biggest one.

In light of the second and third reasons, no others are needed. Calabria and Mnuchin have both said that a conversion is possible, and it will quickly become apparent (once prospective re-IPO investors are consulted) that it will be necessary for recap and release.