Fannie Mae-No Politics (FNMA)

[ashes15]

Thanks for the reply, I think you put in considerable thought into it. There's some people that sent messages that bashed me for asking some questions, so it's good to see actual counterpoints. Makes having a conversation not as enjoyable. Some thoughts I'm thinking through:

1) It increases CET1 capital by the par value of the juniors converted. If all of them convert, that's $33B, a significant chunk of what FnF need ($76B CET1 requirement plus $99B PCBBA buffer).

Not denying the CET1 benefit of conversion, but I'm not seeing anything that prevents the GSEs from being released from conservatorship or being prompted corrective actions by FHFA for not meeting CET1 or other PCCBA requirements.

Reading the Framework (pg.14), it's almost as if the FHFA is acknowledging that buffers will fluctuate over time and only dictating enforcement once the "core capital leverage ratio requirement or the risk-based total capital requirement are breached." In theory, those buffers should be tested in tough financial times...that's why they exist in the capital rule.

So if CET1 is not a hard mandate by FHFA for the GSEs to reach prior to release from conservatorship, then what's the advantage of this conversion towards the minimum total capital requirement?

I'm thinking this will be a situation for the underwriters to think through, and a conversion may very well be in the cards if they want to hit CET1 requirements faster than mandated. But conversion will affect key financial metrics (per share basis), I think that's certain...just not sure how big of a hit to say PE or future dividend yield it'll result in but currently it would be huge. Perhaps they'll do voluntary offers that are willing to accept a haircut and convert portions.

2) It clears $33B of liquidation preference and $2B of dividend preference from in front of the re-IPO commons. It is quite possible, and likely in my opinion, that said re-IPO investors will insist on the existing juniors being converted to commons.

The dividend preference would be stopped until CET1 and PCCBA buffers are reached so it seems like it's not an immediate reason to convert. How does liquidation preference play into the ability to re-IPO common equity? I don't think it's an issue if there is no going concern for the firm.
And on your other point...why would new investors want existing juniors to be converted? Wouldn't it result in less earnings on a per share basis if the pool is significantly enlarged?

Check page 15 of the capital rule fact sheet. It shows that counts towards CET1. Namely, common equity, some types of AOCI (which are a rounding error for FnF), and retained earnings.

I did some research after posting and went through about a half-dozen bank 10Ks to see how they're computing CET1. It's literally taking SE and subtracting a couple areas [PS, Treasury, etc.]. Concur with your point. However I do find it amusing that Basel III believes that publicly owned shares constitute liquidity for the firm.

Oh and for the record, I'm not an accountant or a banker, I did my service elsewhere for the government. People were telling me not to quit my day job, that was really nice of them.

Again, completely wrong. A junior-to-common conversion both directly adds to CET1 capital and makes the re-IPO easier.

In addition, there is no reason not to do it. The conversion is completely legal and advances the recap/release agenda.

I think this'll ultimately be up to how JPM and MS will want to raise capital for the GSEs and also contingent on how the final capital rule takes shape. There are multiple paths that they can take, I just don't think there's any mandate to force a conversion, and it seems like time is on the government's side on dealing with PS.

If nothing is forcing them to meet CET1 on day 1 of exiting conservatorship and you want to make the firms as attractive as possible, then why significantly enlarge the float? I think it would make more sense to make voluntary conversion offers after the IPO...seems like you'd get more bang for the buck if there's an IPO pop.

...But, I'm not an IB working on those teams...so who knows, maybe on the roadshow they're realizing they need to reinstate a dividend to entice institutionals to invest. I can see this playing out in many ways, it'll be interesting to see what the financial advisors recommend.