Midas79

They would only have that capital if Treasury actually gives it to FnF in cash. Thompson said that his preference is to have Treasury keep the cash and issue a tax credit. I'm not sure what the relisting requirements are, but I would expect it to happen alongside or just before the SPO.

I would be extremely careful when trying to apply the Moelis plan. It includes all of 2021's earnings being retained towards the capital base. You will have to add that to the equity raise too. Page 25 has the earnings projections, which exceed earnings from 2014-2018 by a decent amount. The administration's talk of reducing FnF's footprint directly counters this. I would expect FnF's earnings to go down post-conservatorship, not up. It has the juniors converting at 1.75 to 1, when the market ratio is more than twice that. Why would they accept such a bad conversion ratio? The SPO investors get less than half of the equity in return for $75B in capital. They are providing the lion's share of the capital and are in a position of strength. Are they really going to settle for that little, especially with footprint reduction looming? I also wouldn't take the $100B ball that Mnuchin lobbed and take off with it just yet. Calabria will be setting the final capital requirements, and he pegged it at "years and years" of retained earnings. I don't think he meant 4 or 5, which is what $100B would represent. Perhaps the biggest red flag: why would junior preferred shareholders pay for and release a plan that involves the common shares gaining so much more than the juniors?

Certainly plausible. But if the administration ends the NWS by themselves, what exactly is there for them to appeal? Injunction would not be an issue, and any potential damages award by Judge Atlas would leave open its own opportunity for appeal.

Yes. It would make far more sense to do it before September ends than drag into October and possibly have to deal with one more payment. Might the September 30 payment still be made because it was for Q2's earnings? Or was June's NWS payment the last one ever? This could matter if Treasury tries to keep some or all of the $25B overage (perhaps soon to be more) as part of settling the court cases; they are evidently thinking about appealing the Count I ruling from the Fifth Circuit per Mnuchin's short pre-hearing interview this morning. It seems either ironic or carefully planned that the NWS will be ended by the administration just after a court finally called it ultra vires.

Exactly what I was looking for. Thanks!

What happens if the Collins case gets settled before Judge Atlas makes a ruling? Can Calabria still be fired at will by the president, or will it be as if the case had never happened, meaning that the en banc ruling would not be in force and Calabria would continue to enjoy for-cause removal protection? If it's the latter, that could be a carrot the plaintiffs could dangle for FHFA in settlement talks, allowing Calabria to stay in office until 2024 as long as he doesn't do something really stupid.

The best way to give the juniors more than 100% of par is just convert them to commons. A conversion at 150% of par at, say, $4 per share gets the juniors more than par without costing either Treasury or FnF a penny. The common would likely dive afterward as it did with Citi, but I would expect a recovery in the medium term, and getting more than 100% of par in the conversion is a form of protection against just such a dive. That said, I don't really expect this to happen. I bought the prefs with the expectation of par if things went well. 150% is a good starting place for a negotiation though. Far better than asking for par first and going down from there.

I want no part of WB. I think he would want preferred shares, and non-cumulative ones are the only kind that help the recap. The terms he would demand would likely be punitive to both commons and existing prefs, I think it's possible to issue new non-cumulative prefs that are nevertheless senior to the existing juniors. I would rather bring in risk-seeking hedge funds and such that are looking to buy commons.

No. The warrants can be exercised in pieces or all at once, there is no reason to believe a senior conversion couldn't be structured the same way. In the scenario we're talking about (Treasury sends FnF $120B and converts the seniors to commons), there shouldn't be a need for an SPO, Treasury would just sell its shares directly. They could sell the shares piecemeal, for example they convert $1B of seniors to X commons and sell them, rinse and repeat 193 times. The chunks just have to be sized so that Treasury's ownership never hits 80%. Actually, on further thought, the warrants allow Treasury to assign the shares rather than ever taking possession of them. A senior conversion could easily be structured the same way. Check section 7 on page 7 of the warrant document. https://www.treasury.gov/press-center/press-releases/Documents/warrantfnm3.pdf As long as the final share count is set in stone the investors will flock in, and they represent the private and third-party capital that Mnuchin mentioned. If the seniors are canceled then Treasury will be sending $25B back to FnF at the most. That is the amount past the 10% moment. This leaves a $70-100B shortfall under Watt's two proposed minimum capital requirements. The private and third-party capital would then come in via the SPO.

For some reason I wasn't drinking the Kool-Aid after the Fifth Circuit ruling, but today's Mnuchin interview got me to make a glass and chug it down. I think Mnuchin knows that he is on a tight timeline now that Calabria will likely be removable at will by a new president if Trump is not re-elected. He also emphasized third-party and private capital. Unless Calabria has had a change of heart on the correct sizing to capital standards, retained earnings are only going to play a small part of the recap due to the timeline. I think the list cherzeca made on Twitter about the recap steps is spot on. I'll paste it here for reference.

The last part of this is incorrect in your "other alternative" scenario. In that case, Treasury would send FnF something on the order of $120B, but that still would not get FnF fully capitalized because the seniors represent a negative $187B drag on core capital. If you go look at FnF's 10-K forms, they report a combined core capital of negative $181B as of the end of 2018. Adding $120B to that doesn't even make it positive, let alone get FnF all the way to fully capitalized ($103.5-139.5B of core capital by Watt's proposed rule). What it would take to finish the recap is either canceling the seniors (adding that amount to retained earnings) or converting them to a form of equity that counts as core capital, of which there are only two, non-cumulative pref shares or common shares. Canceling the seniors costs Treasury 12 figures. Not happening. Converting the seniors into non-cumulative prefs isn't really workable. The seniors are 10% cumulative with $200B in liquidation preference. They would want a higher rate to convert them to non-cumulative. $200B of prefs at 12% eats up all of FnF's earnings forever. Existing equity holders end up with worthless paper. Converting the seniors into commons is the best course for Treasury because they can recoup the $120B they send out and then some, and quickly too. In the end, FnF have very little capital now and will have to build it very quickly to get recap and release done by the end of Trump's term. The Fifth Circuit's ruling that the FHFA director can be fired at will by the president only makes things more urgent because a new president could replace both Calabria and Watt, and if FnF are still in conservatorship at that point the new president would have the power to blow up the entire recap and release effort. Building capital quickly means issuing lots and lots of new common shares. It's really the only way. Some prefs could be used but there are issues with having too many of those in the capital structure. There is no magic anti-dilution bullet. I hadn't even mentioned the warrants!

This is going to sound strange, but I think it will be rather flat overall. The weekend is enough time to digest the fact that the en banc panel did not grant the plaintiffs the big awards some were expecting. It's the same as the Treasury plan, many who bought in hopes that Treasury would say something really shareholder-friendly were disappointed. I can't put my finger on it, but for some reason I am underwhelmed by the opinion. I think it gives plaintiffs more settlement leverage but that's it. If the case ever gets to trial it means that the administration isn't nearly as committed as we thought to recap and release.

I know it's just going to sound like I'm talking my book here, but I am of the opposite opinion. The biggest uncertainty behind the prefs gaining value is whether or not the NWS will end and how quickly. The timeline for that seems to have been accelerated by yesterday's opinion. The commons, on the other hand, have a lot of uncertainty as to how much they will be diluted as part of the recap and release process. The opinion does nothing to alleviate this. In fact, I would go so far as to say that the remand, as opposed to an outright reversal with remedy, is bad for them because it allows Treasury to monetize the seniors, most likely by converting them to commons as they did with AIG.

I believe FHFA can count this towards risk-based capital, but they certainly cannot for minimum capital requirements, which can only be met by core capital defined as The commons have zero par value, so once retained earnings do what they can (which won't be enough according to Calabria), the only options left are issuing new commons and issuing new non-cumulative prefs. Converting the seniors to one of those classes would also work, in case the Fifth Circuit doesn't extinguish them. The seniors are 10% cumulative, so for Treasury to agree to a conversion to non-cumulative (so they can count as core capital) they would want a higher dividend rate. This would eat up basically all of FnF's earnings forever, a NWS-lite. If the seniors are converted I expect them to be converted to commons, and if that happens Treasury will get at least the 92% stake they got in AIG. This is because if the Fifth Circuit grants a win to the plaintiffs and lets Treasury keep the seniors, it would also order Treasury to pay $133B in cash to FnF. Treasury would then need to convert the seniors into enough commons to recoup this plus what they would have gotten from the warrants (the warrants would be useless in a senior-to-common conversion scenario).

The point of being aligned with John Paulson has nothing to do with his track record, and everything to do with the idea that Trump takes care of his friends.

(1) Your post had asked why the government would do something to destroy shareholder value. From their point of view, it is transfer and not destruction. That was my point. (2) Only if it was very generous and the prefs have pretty good certainty about how the capital raise and release will go, i.e. how much their new commons will be worth. I always assumed that the conversion would happen first, but if that is unacceptable and Treasury is willing to let itself get diluted, the warrants could be exercised first. I expect all of this to happen before any equity raise. (3) Yes, he has. However, I read his comments about "if they are still in conservatorship in 2024 I won't push them out" to mean that if they still aren't capitalized to his satisfaction at that point he won't release them. I didn't see that statement as being supportive at all of a drawn-out recap. (4) I think I misunderstood what you said. But I do think that FnF will go "begging to the market" because that is the only source of core capital that's available to them. New common shares and new non-cumulative prefs are their only options to raise core capital quickly, and too many of the latter poses far more problems than it's worth. (5) Fully capitalized is a fair reading of that. My point was that I don't think Calabria will release FnF if they are not fully capitalized to his satisfaction.

Not sure if anyone else has noticed, but the correlation between the pref prices and dividend yields is collapsing. The R^2 value on the ask side sits at 0.44, the third-lowest value I have seen over the last three years. I wonder if Bove's newsletter is the culprit? I believe this reflects the market's view of the probability that the juniors will get converted based only on par value. I thought that a conversion that takes dividend rates into account, like Citi's, was a possibility, especially because the big name litigants hold mostly high-div series. But it appears the market disagrees. The most amusing trade today so far has been 100 shares at $23.98 on the 4.5% FNMAL. I think it was just a badly-timed market order. And no, it wasn't me! But 8070 shares of FNMAL traded at $22.55, higher than the intraday high of any other fixed-div pref series except FMCCT at $22.80. FNMAL has the lowest fixed dividend of any pref that I track, so someone being willing to pay a premium for it makes little sense unless they truly expect a conversion based only on par value. The outlier is FMCKL, which keeps trading around $12. This is higher than all the fixed-div prefs, above the 8.25% FNMAT, and not much below FNMAS/FMCKJ. I truly don't understand it.

It's only value destruction from your point of view. I think you're asking the wrong question here. Instead of wondering what's in it for the government to destroy shareholder value, you should ask what's in it for them to try and avoid it. Especially if Treasury ends up selling the warrants instead of exercising them. That would seem like good news on the surface for the commons, but it removes the floor on the offering price. Treasury would not get diluted if the conversion happens first. The boards do not have until 2024 to raise capital. They have just over a year. There is no way Treasury will approve any plan that lasts beyond this presidential term because that's the only time they have guaranteed, and Treasury has enough power here to get what it wants. $25B in capital is nowhere near enough, by the way. Sure, but there's no reason to think that $5 is any more of a reasonable near-term possibility than $2. $5 just seems to be pulled out of thin air. I remember reading predictions somewhere that the commons would hit $5 upon announcement of the end of the NWS, but with both Calabria and Mnuchin talking about FnF retaining capital, the NWS is essentially already over. And yet the commons never spiked. It is very easy to overestimate the impact of future good news, and $5 looks like a good example of that. Nope. Glen had some good links in his most recent SA post, and one of them has these words from Calabria. Every time I hear about a slow capital build or release before full and complete capitalization, I go back to what Calabria has said and realize that those two things are just fantasization. There is no reason whatsoever to believe that Calabria or Mnuchin will allow release before the recap is 100% complete, and going faster has many benefits, the biggest of which is taxpayer protection. If a big downturn hits in the next year or two, the government is going to want private capital to be in the first loss position. That means plenty of capital ASAP. Circling back, this taxpayer safety cushion is what the government gets out of doing a common stock offering at a low price. That price would attract enough capital to meet Calabria's requirements, allowing for release before a new president can direct his or her Treasury secretary to scuttle the whole thing.

Conversion and an offering at a low price isn't shareholder value destruction, it's shareholder value transfer. FnF will have the same market cap no matter how they get there. Moelis is also a poor reference point, it makes many assumptions that are unreasonably rosy for the commons. The bottom line is that the commons are highly unlikely to be the get-rich-quick multi-bagger. They could even lose money if Bove's $2.50 ends up being too optimistic. In the end, life is not fair. As for the last sentence, unfortunately that's just how these things work. Trying to rely on some future less-dilution valuation doesn't work because there can't be universal agreement on what that is. Current prices, though, are incontrovertible fact. Ackman not only bought prefs, he bought them (in part) specifically because he thinks a resolution might favor the preferred shares at the expense of the commons. If the prefs make enough money, and the commons don't lose too much, Ackman will be okay. He was around 40% prefs at the end of 2018 if I remember right. Cap Research, another large common holder, is around 75% prefs. Counting on them and Ackman to come to the rescue of the common shareholder is not realistic. "When" the commons hit 5? That should definitely be "if". If his methodology is the same 20-day average as Citi used, sure he would update his model as the prices change. Remember that it could go down just as easily! The last point is moot, there is no way that Calabria or Mnuchin will allow FnF to be released until they fully meet all capital standards. At that point there would be no reason not to turn dividends on.

I don't see anything silly about converting at $2.50 at a slight discount to par. Citi did the same thing with its publicly traded prefs, converting them at $3.25 at 85-95% of par. https://www.citigroup.com/citi/news/2009/090227a.pdf?ieNocache=262 The $3.25 was calculated as a 20-day average, though I can't find where I read that. The closest a 20-day average gets to $3.25 in the run-up to 2/27/09 is the 20 days up to and including 2/17/09 (average of $3.24). It seems a crazy coincidence that the numbers 3.24 and 3.25 show up, the same as the capital standards suggested by Moelis and Watt! The 20-day average for FNMA up to and including yesterday is.....wait for it.....$2.494. Maybe there are no coincidences after all! Bove is right on point. It appears that the publicly traded prefs got 85-95% of par, with the lower dividend series getting less and the higher divs getting more. The privately held prefs got full par in the conversion. Also, by what I can tell every individual shareholder got to choose whether or not they converted, presumably an individual could convert none, some, or all of their shares. It is also interesting to note that the common share price cratered upon announcement of the conversion offer, going from $2.29 on the day before the announcement to $0.95 the next week. The commons got back to the conversion price of $3.25 two months after the conversion, though they had trouble keeping that level likely due to many of the converted shares being sold. If I got my own conversion offer I would have to think for a while before deciding what proportion of my shares to convert. I would probably settle on converting 40-50% and keeping the other 50-60% as-is. I also don't see anything illegal about a conversion offer. What law does it break?

Layton must have some agenda here, perhaps to make himself and his tenure at Freddie look good. I don't think he, Freddie, FHFA, or anyone else can take nearly as much credit for this as he would like. I would bet that having 2008-era mortgages continually rolling off, as opposed to specific actions taken by FnF, explain the lion's share of the decline in projected losses. Calabria said that he wants to fix the roof while the sun is shining. I think he's going to set capital requirements at worst-case-scenario levels and just hold them there, using the environment of the early 2010s as a baseline, rather than making them low now and trying to ramp them up over time. That last idea runs the risk of a recession coming out of nowhere. Incidentally, that's one reason why I think the recap will have to be pretty fast, with the other being that a new president could replace Mnuchin with a far less GSE-friendly Treasury secretary who could then refuse to ever let FnF out.

Nice. We also get to see how credible ACG Analytics is. If they end up being right about this I will look at their previous tweets to see what additional info can be garnered. The 2-minute video in the previous tweet is a good watch for those who didn't subscribe.

@cherzeca Regarding your comment on Tim's blog (though I would love it if the Plan was delayed and they all marched over to SBC and queried, “what’s up?”). I can just imagine Mnuchin doing this then calling Trump or Kudlow on his way out of the meeting and saying "Do it." Then the plan gets released as Mnuchin gets in the car to leave the Capitol. Ultimate boss move. About the other post where I asked around 20 questions, thanks for the response. That's what I get for having too much caffeine all at once.

@cherzeca I saw your post on Tim Howard's blog about a possible 4th amendment rescuing the 3rd. Is it possible that the sides are in confidential settlement talks and have asked the court to delay its decision until those talks either break down completely or lead to a successful settlement? From everything I can tell, Treasury is willing to give up the seniors and the NWS because those are necessary steps towards raising capital. What, then, do Treasury or FHFA have to lose by settling the case? Or are there too many potential leaks for this to be plausible given that we haven't heard anything at all about a possible settlement? One potential piece of disconfirming evidence, though, is Calabria's letter reversing Otting's position and claiming that the for cause removal is constitutional after all. If the Collins case is settled and dismissed rather than being ruled on by the en banc panel, what happens to the FHFA director removal clause? Does it remain in its original HERA state (for cause) because the state of the world would be as if the Collins case never happened? Or would it change to at will because that's what the Fifth Circuit merits panel ruled? Or would its fate be part of the negotiations?

Does anyone here think that the Citi preferred to common conversion is worth studying as a parallel to a pontial one for FnF? The circumstances are rather different given the timing, capital situations, and comparative leverage, but it could be worth looking into.