WB_fan82

I think big bang could be tough but little bang is a lock. FSOC and TSY just said the GSEs need more capital. TSY's gigantic sr pfd doesn't count as capital, but would if it were converted. That's the little bang that should happen after election and it also lets Mnuchin and Calabria leave their fingerprints all over GSE reform and consent decree. I think that happens even w/ election uncertainty. The lawsuit is a bit harder. I think they should settle the lawsuits and return the $125B to further build capital (remember the govt would own 98% of this anyway via common position), but if the obstacles to that are too great then I don't see much post-election pressure to settle... There is very little capital benefit and all it does is give Calabria cover from being fired, which isn't TSY's problem anymore. Meanwhile if they go to court, it probably gets remanded anyway and if the GSEs win then the govt has to fork over $125B (+ interest?), optics be damned. And maybe the GSEs lose. But from a recap perspective, it's WAY easier to use those sr pfds as a source of capital via conversion and still have the capital infusion of $125B overpayments out there than the alternative of deeming the sr pfd paid down with a small tax credit on the balance sheet. That literally does nothing for capital, and takes away two huge buckets of capital that would be easily tapped. No reason to create a problem of raising hundreds of billions extra in the markets or retained earnings over time, imo.

"Calabria doesn't need to attract all investors, only enough to get the job done." Yes. I think the TH camp of " more capital means higher prices to keep ROE constant and attract investors" misses reality of raising capital. And there IS an investor standing by that can get the job done to 2.5% overnight. The Treasury. He only needs to attract Treasury's cooperation. Then the rest can be retained over time and other private market ways (exchange prefs into common then sell new prefs to berkshire), NONE of which involve an ROE calculation...

I listened to the whole hearing at 2x speed. Wrote this part down in caps. I think he means both. 4% capital level will remain. 2.5% core and 1.5% buffers. In other places he discussed CRTs in more open terms. I think he will very modestly tweak their capital treatment and that's about it. All of this also points to him finalizing the capital rule quickly, which would then officially trigger the next step: drafting and submitting capital restoration plans.

The opinion doesn't seem that negative. He just found distinguishing the director as "acting" was the key pivotal point. Some of the dissenting Collins judges also raised this issue, iirc. Why is the judge wrong? Seemed to me like he made a good case. You don't have to read the whole opinion -- just that part.

Why would it have to be received? A receivable is an asset. An asset increases equity. I think the default Basel III treatment would be to include in capital and he would have to make the exception to exempt it.

Midas, that's a neat idea. I hadn't thought of that (or any others) as a path to get $125B from the govt via settlement. One way is to write the check, but your way might work just as well. Instead of cash, the GSEs could book a receivable of that amount from the government stock sales. I think Calabria has the authority to decide what to treat / not treat as Cet1 or Tier 1 and maybe he would be fine counting that receivable.

Cherzeca, I don't know the answer on appropriation for a settlement payment. That's a good question. Do you have any thoughts on the answer? Does TSY need approval to settle litigation? Does it change if the FHFA requires something in exchange for that settlement? If Supreme Court orders the same remedy, does TSY need approval to pay? I only have questions, no answers, but if there's some obstacle to what seems like the perfect game theory outcome I'd love to know about it.

InvestorG: It would be done after a sr pfd conversion to common. Following AIG example, US govt would 1. exercise warrants then 2. exchange sr pfd into common, ending up with 95%+ of shares outstanding. Therefore settling Collins by putting the $125B back into the company would effectively be writing a check to itself. The economic leakage would just be a couple billion. The net impact would be a GSE that is very close to the full capitalization figures, especially if cap rule is tweaked at all. Heck, the GSEs could even be required to lower G-fees by 10 bps in return for the amendment. ROEs don't really matter when they don't need to raise additional capital. So to me, if there is a will there is a way with a couple penstrokes that serves every contingency. More capital. Lower mortgage rates.

I think there is a good reason not have settled Collins, yet. It would have been impossible! The current SPSA doesn't allow for more than $30B of retained earnings. That makes it impossible to settle for the $120B of overpayments. The alternative (and in my mind inferior for recap purposes) settlement would be considering the sr pfd paid down w/ a tax credit for overages. Well, that would required a 4th SPSA amendment to keep TSY involved. Calabria has said he wanted one big amendment to clean it up. Need the capital rule done first. So either couldn't settle or had to wait for capital rule for the 4th SPSA. This is why I expect (hope!) for a settlement in Q4, even weeks before the case is heard (I think it's unscheduled so far).

The great irony of this entire situation is that the 0.5% fees don't have to matter. The 4% capital requirement and ROEs don't have to matter. All Calabria has to do is get TSY on board with converting the sr pfd and settling the lawsuit to send the $125B back to the GSEs (which would be like writing a check to itself given the warrants and shares issued on a pfd exchange). The GSEs would be fully recapped almost immediately. You don't have to worry about raising new capital at X ROE, or raising fees on mortgage holders or people looking to refi. Heck, the government could release them from c-ship with the mandate that they have to LOWER g-fees by 10 bps for 5 years. The GSEs would still be profitable and the shares will trade wherever they trade, even if it's a discount to book value (like every other fin institution right now). None of that matters b/c they don't need to raise additional common equity and the government can sell its shares into the market over time. This is so darn easy. I really hope this is the game plan and we are just waiting for the first steps first: capital rule finalized, recap plans submitted, then one big SPSA amendment to wrap it all up the day after the election.

Reading the CMLA comment on the cap rule.. what are "G fee reserves"? It's an odd letter in that it spends one line on a suggested capital adjustment, but does not define nor quantify it. All the rest is policy preferences post c-ship. Anyone know what those are?

It might help to write the overage check if TSY first converts the sr pfd. I haven't done the math, but let's assume after warrant exercise and conversion the government holds 98%. Now write the overage check and the story is the government is basically paying itself. The lawsuits are settled, the taxpayer is protected, GSEs are super capitalized and will support a healthy mortgage market, the shares can re-list, etc. Then the next administration can decide what to do with the shares (sell them). But the GSEs would be out of c-ship, or under a consent decree with the govt shares likely held in a voting trust like YRCW so there aren't concerns about the govt using its 98% power to replace the board. Everyone wins! The main issues I see would be: 1. Is Calabria's consent order reversible by Biden if the FHFA is later found unconstitutional? (I don't know why he would pick this fight, but it's possible) 2. The Lamberth lawsuits where damages would be paid BY the GSEs. This might be an obstacle to new CET1 equity, but probably not Tier 1 prefs. Or maybe the CET1 equity is just raised that much cheaper to reflect the risk I know Mnuchin is a busy guy but this does not seem like a heavy lift to me post-election.

I think it's a walk in the park to raise the capital. Most of it is already there. $125B of excess sr pref divs over the 10% pre-NWS rate + the existing liquidation pref converted into either common or non-cum pfd = more than $300B of capital. All it needs is the stroke of a pen from TSY/FHFA. And to that end, I find the new FSOC review encouraging. The obvious conclusion of that body is GSEs need capital. And two of the members of that body have the authority to create that capital through the above. Seems like this gives them cover. The Financial Stability Oversight Committee is much harder to argue with than unilateral actions from Calabria/Mnuchin.

Or it's a tell that he thinks converting the sr. pfd to some sort of capital instrument is a foregone conclusion! So all of this higher liquidation preference eventually becomes capital (CET1 or Tier 1, TBD) at the stroke of a pen.

https://www.cato.org/multimedia/cato-daily-podcast/mortgage-markets-covid-19 This one?

Orthopa: What would exchanging jr pfd for common accomplish? It doesn't increase capital. It just converts Tier 1 capital to CET1 capital. The 30 day trailing price is as good a mechanism as any for setting the ratio, but I'm struggling to understand the rationale for such an exchange.

Pretty easy to substitute "receipt of common shares"!

If the goal is the most efficient return to private ownership, isn't this scenario it? 1. It maximizes the amount of capital the GSEs would have as a starting point for private capital. No other scenario gets close to what this scenario does. 2. It moots the lawsuits. 3. The taxpayer is protected b/c by converting sr pref to common, the government ends up with high 90% ownership. In effect, they own most of the excess dividend refund check that would come back to the GSEs. So optically it might look bad for a second, but economically it's a wash to taxpayers. 4. Also optically, it might impair the common so the articles can't be written about bonanza to GSE equity holders (which are always referenced to be HFs / speculators) 5. If FHFA cap rule has no amendments, it leaves about $65B of total capital to raise at year-end to get to fully adequate capitalization. That is a very doable figure. With a few tweaks to the rule, we might basically be there... Isn't this the solution hiding in plain sight? Also: optics don't matter in a lame duck... The main question I have is what authority does TSY have to write that check and then the legal issue Midas posed earlier of the FHFA being unconstitutional and Biden wanting to reverse all of this in a new admin. Cherzeca, would the court give a ruling on the constitutional issue from the bench in the fall or do we have to wait for the summer opinion for them to officially amend the statute to make the FHFA constitutional?

I think you could be on to something and would love your feedback on my comments: If TSY wrote a check back to the GSEs for a $125B excess dividend "refund", retained earnings (CET1) goes up by that amount. But in your scenario, why spend CET1 to retire the govt preferred when the govt can just exchange it to Tier 1 by striking cumulative provision, or alternately convert it to CET1 via common exchange? Keeping the cash would be a great way to build capital quickly, no? $125B return of excess dividends + converting the entire $193B of sr liq pref into common = $318B of capital raised. By my math, it gets them past minimum capitalization overnight and very near the minimum payout ratio. $83B total to raise to get to adequate capitalization (assuming no FHFA rule changes), probably less after 2020 earnings and continued DTA conversion to CET1 as tax credits utilized, and a chunk of that $83B could be Tier 1 to boot since the Tier 1 leverage ratio is gating. This scenario never dawned on me. The main obstacles would be: 1. Optics of writing that check. 2. figuring out the exchange ratio for the sr. pfd conversion into common. 3. Is this all reversible if Biden challenges the action since FHFA was unconstitutional when Calabria did it

I think relist would be a significant positive. Not only would it be a very strong intent signal, but it could herald the start of the recapitalization with setting exchange ratios on conversions based on listed equity price and not OTC equity prices.

He's so keen on treating these like banks, maybe they will price the backstop similar to the FDIC insurance premiums that banks pay to federally guarantee their deposits. Just a few bps per year...

Great post Midas. The bigger capital deficiency is on the total leverage test, which they can meet with any amount of Tier 1 capital (prefs). But probably the more difficult capital hole to fill is the smaller deficiency on the risk-weighted test since they still need to gin up tens and tens of billions of CET1 (no prefs). It is somewhat helpful that the GSEs are organically retaining CET1 capital internally on a pre-tax basis, since the DTAs are used up and that asset is effectively replaced with cash (assuming the higher liquidation pref gets converted to CET1 in the future). What do you make of this random thought... Wouldn't the recap be a cinch if the government exercised its warrant for the 80% of common, then did a rights offering at the appropriate common share multiple (X shares for each share owned)? The government buys its slug of common to maintain the 80% it already has, existing shareholders pump in the small minority of the common raised, the GSEs hit their thresholds (at least the minimum level), and the government can then sell its shares in the market over time?

How do you propose FnF get capitalized without the re-IPO? Where is that much money going to come from? A senior pref writedown, with a concomitant return of $25-30B from Treasury to FnF, doesn't fully capitalize them; they would be around $75B short. This is also unlikely to happen fast enough to save the servicers, if that is even the purpose of the exercise. Anything more than a modest discount to par for the prefs means the commons go to near-zero. Placement in the capital structure matters. A couple ideas: 1. Do a Citi-style exchange offer to the agency BONDS. Raise capital through a giant arbitrage. Citi did it with trust preferred. Maybe even sub debt (recollection is foggy). 2. Calabria capital rule can permit other asset/liab accounts to be equity. These include the net unamortized premium/discounts related to the upfront G-fees. These WILL be booked into revenue over time, and the cash has already been received, so why not consider these accounts capital if Calabria has discretion?

Only thing is whether there is an obstacle to owning > 80% of the GSEs, since this conversion would put the government at nearly 100% ownership. From my notes, the government went > 80% in AIG so it should be doable. But presumably the warrant was limited at 79.9% for some reason. Second, with a potential new TSY sec in 2021 does Treasury ever decide to sell their controlling stake? Controlling all the votes isn't that far removed from being under government control in c-ship. TSY doesn't need to convert to common to fill up the equity capital account. They can also just amend the preferred to take away the cumulative feature. That would qualify the entire senior preferred as capital, similar to the junior prefs.

Agree the rights xfer for the lamberth case. But because damages would be owed by the GSEs, Rship would limit those damages to the old companies and the claims wouldn't transfer to the new successor entities that hold the charters. Though now that I think of it... wouldn't those JPS damage claims against the estate be senior to the govt senior preferred in a run-off and therefore the JPS do fine even in r-ship? Sometimes neurons fire as I type, but I never thought of that.