tim howard today
"Midas–I want to address your question: “If a capital raise in light of all [the negative actions against Fannie and Freddie that Treasury has taken in the past] would be possible without a senior-to-common exchange, why would it not be possible with one? I can’t understand why outside investors would consider all of the above to be okay, but would see a senior-to-common exchange (which doesn’t affect these investors at all) as the final straw.”
I’ll start by repeating that a capital raise by Fannie and Freddie ISN’T possible as long as Treasury’s senior preferred stock and liquidation preference remain on their books. So where we seem to be in disagreement is over whether the way in which Treasury eliminates the seniors and the liquidation preference will make a difference in the companies’ capital-raising ability (and stock price).
My analysis of this question starts with the facts we know: that Fannie has 5.867 billion of fully-diluted shares of common stock outstanding (assuming conversion of the warrants by Treasury), Freddie has 3.234 billion of fully-diluted shares of common outstanding, and that as of yesterday the companies’ weighted average common stock price was $1.53. Assuming sustainable combined annual earnings of $25 billion, Fannie and Freddie’s weighted average annual earnings per share are $2.75, making their current P/E ratio just 0.56, compared with about 25 times earnings for the average common stock in the S&P 500.
Why is Fannie and Freddie’s combined P/E so low? Almost certainly it’s because the only way existing (or new) common stockholders ever will get the rights to the companies’ earnings or assets is if Treasury cancels the net worth sweep (which will kick in again after Fannie and Freddie achieve full capitalization), redeems or cancels the senior preferred, and eliminates its liquidation preference. A 0.56 P/E on the companies’ $25 billion in annual earnings is the market telling us it thinks there is little chance of any of these things happening on terms favorable to common shareholders.
Treasury can change that, if it wishes. I agree with you that all of its past actions that were prejudicial against and unfair to Fannie and Freddie will have a long-lasting and possibly permanent impact on how high the companies’ P/E can be. But I also believe that how Treasury behaves toward Fannie and Freddie in the future can, and will, make a significant difference in how far above the current 0.56 times earnings, and towards the 25 times earnings multiple of the S&P 500, Fannie and Freddie’s P/E can go.
I don’t know what Treasury wants to do with, and about, Fannie and Freddie, and it’s possible that it doesn’t either. But I do think it’s true that the negative actions of prior Treasuries against the companies in the past–forcing FHFA to place them in conservatorship while still adequately capitalized, encouraging FHFA to maximize the amount of senior preferred they had to draw by loading up their income statements with anticipatory, estimated, or overly conservative non-cash expenses, then proposing the net worth sweep just as many of those non-cash charges were about to reverse and become income–were taken because Treasury (and the Financial Establishment) intended to replace the companies with some secondary market mechanism more to their liking. That’s no longer on the table. Virtually everyone now agrees that Fannie and Freddie have the best business model for the functions they were chartered to perform. For that reason, if Treasury does implicitly agree that its past actions with respect to the companies did not have the effect it had hoped for, and unwinds the most damaging elements of those activities (the net worth sweep, the seniors and the liquidation preference), I believe the market would be inclined to put a much higher value on Fannie and Freddie’s future earnings. If, on the other hand, Treasury converts the seniors to common, that would be an unmistakable affirmation that its prior anti-shareholder policies towards the companies have not changed at all, and in that instance I don’t know why their P/E would move any higher than it is now (indeed, it likely would move lower).
Again, I’m not predicting what Treasury will do, whether in this administration or a future one. But I am saying that if Treasury decides one of its objectives is to maximize the value of its current ownership in Fannie and Freddie (via conversion of the warrants), it should do so by canceling, rather than converting, the seniors."
