FNMA and FMCC preferreds. In search of the elusive 10 bagger.

[investorG]

https://seekingalpha.com/article/4357864-boom-scotus-granting-cert-on-collins-claims-and-seila-scotus-decision-is-no-longer-when-for

 

Thank you.

 

It's not as clear to me that the few comments in Seila that relate to backward relief are as transferable to Collins as you claim but there's no point in arguing that.

 

What if Calabria wants to settle but Tsy doesn't?  After all it's their 190bn not FHFA's.

[Midas79]

A train of thought I have had (crossposted from Twitter chat):

 

A footnote in a court case I read recently (I wish I could remember which one!) cited an older court decision basically saying that UST is not allowed to give up something for no consideration in return. Assuming this is true, UST won't be able to straight up forgive the seniors, regardless of if they consider them "repaid" because the seniors are equity, not debt. Also, a court cannot order the seniors extinguished as the result of any current case because FnF never had the ability to pay them off per the terms of the contract. That means UST giving up the seniors must be voluntary; they lack the "well the courts were going to take them away anyway" excuse.

 

If UST is not legally allowed to forgive the seniors, they can still sell them to FnF. Every year UST releases an internal valuation of the seniors, and that tends to be between 50% and 60% of the liquidation preference. The last valuation was around $110B on $193B of liquidation preference. Currently the seniors' liquidation preference is more like $210B due to the increases caused by last September's letter agreement and FnF retaining their earnings. Proportionally, UST's internal valuation of the seniors would then be around $120B.

 

The other thread to tie in is that if UST gives $125B to FnF (the amount of excess cash FnF paid to UST due to the NWS compared to if it had never happened) and ends the NWS, all cases except WF (now dismissed) and Perry get mooted. No settlement would be necessary, which would be a huge time saver as well as not allowing holdouts to complicate the process.

 

Putting these two together, UST can "return" $125B to FnF and simultaneously negotiate the PSPA amendment to include a sale of the seniors back to FnF (who would then extinguish them, raising core and CET1 capital by $193B) for $125B, a slight premium to the internal valuation. This ticks a ton of boxes:

 

• UST gets a fair price for the seniors, quelling Warner's concerns about what UST would get in return for giving them up.
  
• All lawsuits but WF and Perry go poof instantly. This fits what Calabria said about the lawsuits "going away".
  
• Allows recap and release to go forward.
  
• UST avoids the possibility of a ruling more adverse to them than this outcome, most likely being something similar but with a return of $25-30B.
  
• UST can claim "victory" (or at least not a total loss) in the lawsuits because they save $25-30B over what the Collins plaintiffs want from a court order.
  

 

Functionally this is the "Collins 1" remedy (seniors gone, NWS gone, $25-30B returned) but without the overpayment return. It shouldn't complicate the recap process because if the overpayment was returned as a tax credit, it only would have accured to capital at around $4B per year anyway, so the size of the re-IPO would only increase by that $4B.

 

Please tell me if I am missing something or if the logic doesn't hold up somewhere, especially the part about the lawsuits disappearing.

[Guest cherzeca]

@midas

 

my rec is to ignore that "issue". treasury as a shareholder can act like any other shareholder.

[WB_fan82]

A train of thought I have had (crossposted from Twitter chat):

 

A footnote in a court case I read recently (I wish I could remember which one!) cited an older court decision basically saying that UST is not allowed to give up something for no consideration in return. Assuming this is true, UST won't be able to straight up forgive the seniors, regardless of if they consider them "repaid" because the seniors are debt, not equity. Also, a court cannot order the seniors extinguished as the result of any current case because FnF never had the ability to pay them off per the terms of the contract. That means UST giving up the seniors must be voluntary; they lack the "well the courts were going to take them away anyway" excuse.

 

If UST is not legally allowed to forgive the seniors, they can still sell them to FnF. Every year UST releases an internal valuation of the seniors, and that tends to be between 50% and 60% of the liquidation preference. The last valuation was around $110B on $193B of liquidation preference. Currently the seniors' liquidation preference is more like $210B due to the increases caused by last September's letter agreement and FnF retaining their earnings. Proportionally, UST's internal valuation of the seniors would then be around $120B.

 

The other thread to tie in is that if UST gives $125B to FnF (the amount of excess cash FnF paid to UST due to the NWS compared to if it had never happened) and ends the NWS, all cases except WF (now dismissed) and Perry get mooted. No settlement would be necessary, which would be a huge time saver as well as not allowing holdouts to complicate the process.

 

Putting these two together, UST can "return" $125B to FnF and simultaneously negotiate the PSPA amendment to include a sale of the seniors back to FnF (who would then extinguish them, raising core and CET1 capital by $193B) for $125B, a slight premium to the internal valuation. This ticks a ton of boxes:

 

• UST gets a fair price for the seniors, quelling Warner's concerns about what UST would get in return for giving them up.
  
• All lawsuits but WF and Perry go poof instantly. This fits what Calabria said about the lawsuits "going away".
  
• Allows recap and release to go forward.
  
• UST avoids the possibility of a ruling more adverse to them than this outcome, most likely being something similar but with a return of $25-30B.
  
• UST can claim "victory" (or at least not a total loss) in the lawsuits because they save $25-30B over what the Collins plaintiffs want from a court order.
  

 

Functionally this is the "Collins 1" remedy (seniors gone, NWS gone, $25-30B returned) but without the overpayment return. It shouldn't complicate the recap process because if the overpayment was returned as a tax credit, it only would have accured to capital at around $4B per year anyway, so the size of the re-IPO would only increase by that $4B.

 

Please tell me if I am missing something or if the logic doesn't hold up somewhere, especially the part about the lawsuits disappearing.

 

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 

 

 

[Guest cherzeca]

"This scenario never dawned on me."

 

hasn't dawned on calabria and mnuchin either.  I dont think mnuchin wants to go to trump right now and say he is writing a big check to F/F.  cancelling a piece of paper at least a little more palatable.

[WB_fan82]

"This scenario never dawned on me."

 

hasn't dawned on calabria and mnuchin either.  I dont think mnuchin wants to go to trump right now and say he is writing a big check to F/F.  cancelling a piece of paper at least a little more palatable.

 

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?

 

[Guest cherzeca]

"have is what authority does TSY have to write that check"

 

HERA makes clear that amounts that treasury invests via its current credit line has been appropriated, so whatever the remaining amount is would be authorized.  that line is for receipt of senior pref, but that could be amended.

 

but this wont happen

[WB_fan82]

Pretty easy to substitute "receipt of common shares"!

 

 

[orthopa]

If the Jr. Preferred are converted to common (as I expect) as discussed the trailing 30 day share price will likely be used for conversion. I would think Calabria would want both the common and Jr preferred on the big board for true price discovery for a fair bit more then a month. Thinking that there is a big bang just after election if Trump loses or in Dec/Jan time frame if Trump wins there is a good chance these get up listed in late summer early fall which is right around the corner. Prices will likely jump for both classes but will be interesting to see where the common settles.

 

Exchange of 5-6 for 1 possible at a minimum to full par. If not exchanged at full par the Nomura piece out a couple of weeks ago speculated warrants may also be part of the deal for Jr Preferred with a $2.50 strike price and expectation of $5 common re IPO price. This would give the optics of Jr preferred not getting a windfall as a % of par and make it up on the back end with the IPO. Something I never thought about.

[Guest cherzeca]

If the Jr. Preferred are converted to common (as I expect) as discussed the trailing 30 day share price will likely be used for conversion. I would think Calabria would want both the common and Jr preferred on the big board for true price discovery for at least a month. Thinking that there is a bing bang just after election if Trump loses or in Dec/Jan time frame if Trump wins there is a good chance these get up listed in late summer early fall which is right around the corner. Prices will likely jump for both classes but will be interesting to see where the common settles.

 

Exchange of 5-6 for 1 possible at a minimum to full par. If not exchanged at full par the Nomura piece out a couple of weeks ago speculated warrants may also be part of the deal for Jr Preferred with a $2.50 strike price and expectation of $5 common re IPO price. This would give the optics of Jr preferred not getting a windfall as a % of par and make it up on the back end with the IPO. Something I never thought about.

 

can anyone link to the nomura piece?

[WB_fan82]

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.

[Guest cherzeca]

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.

 

current junior prefs have very high div rates on average.  clearing decks for common followed by some new cheaper prefs more efficient cap structure

[Guest cherzeca]

https://seekingalpha.com/article/4357864-boom-scotus-granting-cert-on-collins-claims-and-seila-scotus-decision-is-no-longer-when-for

 

Thank you.

 

It's not as clear to me that the few comments in Seila that relate to backward relief are as transferable to Collins as you claim but there's no point in arguing that.

 

What if Calabria wants to settle but Tsy doesn't?  After all it's their 190bn not FHFA's.

 

@IG. just ask yourself why scotus remanded for govt to press its claim that the CID was ratified.  if there is no backward relief in Seila, then there is no need for govt to argue that there was ratification.  only rational way to understand the case

[orthopa]

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.

 

Agree does not raise capital but FHFA put emphasis on CET1 capital in the capital rule and their presentation afterwards. Converting preferred to common is a zero cost transaction and instantly raises 33B. Also once the Sr preferred is gone it puts all shareholders; treasury via warrants, jr preferred once converted, and legacy common on a level playing field going forward.

 

I cant think of any reasons why they would not convert them? Why deal with the headache of paying or not paying a div on expensive legacy jr preferred while trying to build capital? Then how do you sell additional preferred at expected lower interest rates then the jr preferred. Too many headaches.

[Luke 532]

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.

 

Agree does not raise capital but FHFA put emphasis on CET1 capital in the capital rule and their presentation afterwards. Converting preferred to common is a zero cost transaction and instantly raises 33B. Also once the Sr preferred is gone it puts all shareholders; treasury via warrants, jr preferred once converted, and legacy common on a level playing field going forward.

 

I cant think of any reasons why they would not convert them? Why deal with the headache of paying or not paying a div on expensive legacy jr preferred while trying to build capital? Then how do you sell additional preferred at expected lower interest rates then the jr preferred. Too many headaches.

 

Also makes plaintiffs happy and very likely removes legal overhang, which is a massive impediment to any capital raise.

[Luke 532]

Tim Howard submitted his comment on cap rule proposal...

 

https://howardonmortgagefinance.com/2020/07/13/comment-on-fhfa-capital-re-proposal/

[Guest cherzeca]

apparently calabria gave a recent speech at Cato.  anyone have a link?

[WB_fan82]

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

 

This one?

[Guest cherzeca]

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

 

This one?

 

thanks.  Bove mentioned a new speech at Cato, but I imagine it is this. tidbit at end was constructive though not much meat on bone

[DocSnowball]

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

 

This one?

 

thanks.  Bove mentioned a new speech at Cato, but I imagine it is this. tidbit at end was constructive though not much meat on bone

 

Actions speak louder than words. One thing that is dissonant is his counting current retained earnings as capital, whereas the amendment they did only increases the liquidation preference to that amount. If it was true retained capital, our property would not be what it is. Probably things are very very complex at his end, but actions are speaking louder than words for me. It's only the stick of the courts that is a comfort - it'll be difficult hosing shareholders at this juncture with the NWS and FHFA in the spotlight for the next year or so.

[WB_fan82]

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.

 

 

[Midas79]

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.

 

If the seniors are either converted to common or straight up extinguished, $193B gets added to both CET1 and Tier 1 capital instantly.

 

That might sound like a lot, but the problem is that FnF's Tier 1 capital deficit (current Tier 1 capital minus Calabria's standard, no buffer) is $322B and it's $279B for CET1. Raising those amounts is essentially impossible, especially with the seniors in place. This just reinforces the fact that the seniors have to go one way or another.

 

Also, the extra liquidation preference doesn't get added to capital because it that amound has already accrued to capital through the retention of earnings. The dollar-for-dollar increase of the seniors' liquidation preference has not shown up on FnF's balance sheets. It's the amount of the seniors on the balance sheets ($193B, not the current liquidation preference of $210B) that would get added to Tier 1 and CET1 capital upon cancellation or conversion of the seniors.

[WB_fan82]

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.

 

 

[Midas79]

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.

 

This route does result in FnF being instantly recapped. It also requires Treasury to write a $125B check to FnF, and they can only recoup that money by converting the seniors to commons (conversion to prefs, even if they are non-cumulative and mandatory convertible, leaves CET1 capital negative) and selling them.

 

That has the side effect of squishing the existing commons into almost nothing, and any share exchange of the juniors would have to come from the goodness of Treasury's heart.

 

I think it's the giant check that stops this from happening. That's hugely negative political optics, and while I do expect Trump to go scorched-earth in a lame duck session, I don't think even he would go that far.

 

That's why I brought up the idea of Treasury sending FnF $125B but then selling the seniors back to FnF for the same sum. It accomplishes the same thing (mooting the cases, removing the need for settlements) and allows Treasury to claim they got "something" for the seniors.

[WB_fan82]

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.