Replies to post #617288 on Fannie Mae-No Politics (FNMA)

[kthomp19]

Thanks for the reply, I think you put in considerable thought into it.

Thank you for the kind words, and I will echo them in regards to your post.

As for unwanted replies, I suggest making use of the fact that users can now place an unlimited number of other users on the ignore list.

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.

You're right. From what I understand of HERA, Calabria can allow release (with a consent decree if FnF are undercapitalized or worse) at just about any capital level he wants: minimum, CET1, and risk-based.

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?

Conversion only adds to CET1 capital; it leaves core capital and risk-based capital unchanged. However, Calabria's capital rule envisions payout restrictions based on the level of the buffers, and FnF will have to reach certain thresholds on all three buffers (including the PCCBA for CET1) to be able to make dividend payments, buy back shares, and pay executive bonuses.

The advtange is discussed below.

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.

FnF's share count is going to dramatically expand in the near future if Calabria succeeds in his goal of recapping FnF. There are four main sources of potential dilution:

1) Senior-to-common conversion
2) Warrants
3) Junior-to-common conversion
4) The re-IPO

#1 and #2 are (most likely) mutually exclusive, though I think it is highly likely that one of the two will happen. #3 is the subject of our discussion, and Calabria said that #4 will heavily dilute shareholders.

Perhaps they'll do voluntary offers that are willing to accept a haircut and convert portions.

This is what I expect. A voluntary offer avoids having to negotiate with 2/3 of the holders of each series, and if the Citi pref conversion is any guide I would expect similar proportions of the JPS holders (95-100%) to accept.

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?

The re-IPO investors will demand a certain percentage of the overall equity for their capital. Having the junior-to-common conversion happen first doesn't affect that.

Example: there are 1.8B shares for FnF combined right now. The warrants add 7.2B. If the new investors demand 2/3 of the equity for their recap money, they would end up with 18B shares (2/3 of the total of 27B).

If a junior-to-common conversion adds 4B shares, for example, there would be 13B shares before the re-IPO. The new investors would then need to get 26B shares to still have the 2/3.

So yes, earnings per share would go down because there would be more shares. But it won't matter to the re-IPO investors.

Concerns solely about share count are easily and quickly answered with a reverse split (which I think is highly likely, at a ratio of 10:1 to 20:1).

The big reason that the re-IPO investors should insist on the juniors being converted beforehand is that liquidation and dividend preference are the two most important variable drivers of a stock's value.

Without a conversion, the new commons will have $33B of liquidation preference and $2B of dividend preference in front of them in the capital structure. With a conversion, those numbers are both zero. It stands to reason, then, that with all else equal and given a choice between the two, the re-IPO investors would insist on a conversion being offered to the juniors.

The argument that liquidation preference only matters in an actual liquidation runs into two major problems:

1) Liquidation preference (i.e. placement in the capital structure) also matters in restructurings. Calabria said that's exactly what FnF will be going through.
2) The pref series FNMAO and FNMAP have dividend rates of essentially zero, but they trade at only a slight discount to pref series that have substantial dividend rates (example: FMCKK). These series are basically liquidation preference only, and the market obviously places a lot of value on that relative to dividend rate/preference.

However I do find it amusing that Basel III believes that publicly owned shares constitute liquidity for the firm.

It isn't the shares that matter for capital, it's the money the company gains from issuing them. That's why FnF's boards will be agnostic as to the share price of the re-IPO. Since FHFA has no fiduciary duty to shareholders and must approve the terms of any capital raise, FnF's boards can hide behind that lack of fiduciary duty if and when they decide that an extremely dilutive equity raise is the best way to go.

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.

As shown above, enlarging the float is not, in and of itself, a problem. A reverse split takes care of it.

A voluntary conversion offer would have to be made before the re-IPO, though, because the re-IPO investors won't invest unless they have certainty about the final share count. That's also why I think it's unlikely that there are several capital raises because if the final share count (after all rounds of equity raises) is known before the first one, there is no need to split it up, and if it's unknown then the first one won't get off the ground. Or it might but at a drastically reduced per-share price to reflect uncertainty over the final share count.

...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.

Agreed. While I agree with Nomura on most aspects of their outline, they think that FnF can sell tons of common shares even without a dividend until 2024 and I disagree. I think the prospect of an immediate dividend will make the re-IPO much easier to conduct.

I doubt we will ever see any of MS/JPM's suggestions other than the one they end up going with, though.