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

[Luke 532]

Capital, capital, capital by Hannah Lang, American Banker

https://www.americanbanker.com/news/fhfas-focus-in-reforming-gses-capital-capital-capital

[Luke 532]

Capital, capital, capital by Hannah Lang, American Banker

https://www.americanbanker.com/news/fhfas-focus-in-reforming-gses-capital-capital-capital

 

WASHINGTON — Even though Fannie Mae and Freddie Mac are still controlled by the government, 2019 saw some of the first signs of progress in efforts to end the mortgage giants' federal conservatorships.

 

The Federal Housing Finance Agency, which regulates the government-sponsored enterprises, gained a new Trump-appointed director with his sights set on releasing Fannie and Freddie from the government's clutches. Mark Calabria took initial steps to prepare Fannie and Freddie for the private sector, making it a priority to improve the companies' capital position.

 

Capitalizing the GSEs is expected to stay in the focus in 2020, particularly as the agency retools a risk-based capital rule Calabria inherited from his predecessor.

 

“The capital rule is one of the most important rules I will issue as director,” Calabria said in November.

 

“This rule will be re-proposed and finalized within a timeline fully consistent with ending the conservatorships.”

 

Bloomberg News

 

Two months earlier, in September, the GSEs were permitted to retain billions of dollars more in earnings to build up their capital cushions, and in the same month, the Trump administration published a report detailing its principles for an overhaul of the housing finance system.

 

Although many expected FHFA Director Mark Calabria to finalize a post-conservatorship capital framework for the GSEs that was originally proposed by former Director Mel Watt in June 2018, Calabria spent months deliberating the direction he wanted to take with the proposed rule before ultimately deciding in November to re-propose the framework.

 

The original proposal under Watt called for assessing the GSEs' credit risk for different mortgage categories, and would have included market and operational risk components in measuring the firms' capital strength.

 

While it remains to be seen what exact details of the rule Calabria might change or keep intact, he said Dec. 10 that his goal is to be able to issue his own iteration of the capital framework “sometime early in the first quarter.”

 

FHFA is also in the process of hiring a financial adviser to help the GSEs raise capital. After the agency hires its financial adviser, Fannie and Freddie will also hire their own financial advisers, Calabria has said.

 

Calabria has also said that he hopes to formalize various private directives issued to the GSEs during conservatorship as rules sometime next year and plans to enhance the FHFA’s own capability as a regulator. This will include launching a macro forecasting unit that would be able to evaluate Fannie and Freddie’s house price forecasts.

 

He also hopes to be able to lift the $45 billion retained earnings cap, he said in October.

 

But heading into the new year, mortgage policy watchers are zeroing in on how the FHFA will approach risk-based capital requirements.

 

“The final capital rule is going to be about what are the appropriate levels to protect taxpayers when they emerge from conservatorship,” said Scott Olson, the executive director of the Community Home Lenders Association.

 

And that determination will be “very significant,” said Mark Goldhaber, a principal at Goldhaber Policy Services who also serves on the board of the Center for Responsible Lending.

 

“The capital rules lead to pricing, and in this case, it's going to lead to what loans go to [the Federal Housing Administration] versus what loans really are going to go to the conventional market,” he said.

 

One of the major concerns about the original proposed capital framework that various groups expressed in comment letters to the FHFA was that the rules were too procyclical and could leave the mortgage giants severely weakened in a crisis.

 

“It requires additional capital at exactly the wrong time — once stress has already occurred,” said Tom Parrent, a principal at Quantilytic LLC, a financial and biostatistics research consulting practice. “It would not only be very difficult to raise capital under stress and would probably shut down large segments of the market, but it would also mean that the fees charged to the homeowners would increase at that time, reducing demand for new loans.”

 

A degree of regulatory forbearance is an essential tool in an economic downturn, Olson agreed.

 

“That's the way things have been done historically and that's the way it should be here, as opposed to having too strict of an adherence to very high levels of capital all the time and you freak out if your capital gets depleted in a down cycle,” he said.

 

Calabria himself acknowledged the concerns that the original proposal was too procyclical in a December speech at the Federalist Society.

 

“The very purpose of Fannie and Freddie and the Federal Home Loan banks is to be countercyclical, and my belief is that they have been a little too procyclical in the past,” he said. “I think it’s critical as we re-propose the capital rule that how do we make sure that we’re having a capital rule that is countercyclical rather than procyclical?”

 

To combat procyclicality, Parrent suggested that the rule incorporate a contingency reserve that could be built up over time, a device used by some insurance companies. For it to work at Fannie and Freddie, a portion of guarantee fees could be set aside in a reserve that would only be used to pay claims during periods of financial stress.

 

“Once the reserve dollars have been held for 10 years, they can be released and replaced with fees generated on new loans,” Parrent said.

 

In fact, the FHFA should contemplate a capital regime by looking at the GSEs through the lens of insurance companies and not banks at all, Goldhaber said.

 

“You've got to start with a baseline that says nobody wants to see them in an undercapitalized state as they were before the crisis,” he said. “The question really becomes using the right capital framework to achieve the appropriate level of capital, and the reality is, these entities look a lot more like insurance companies than they do banks.”

 

The GSEs’ capital framework could also be a hybrid of a bank and insurance company capital framework, said Pete Mills, senior vice president of residential policy at the Mortgage Bankers Association.

 

“That's where I think there will be differences as a guarantor versus a holder of risk. Banks lay off risk as well, but they retain capital against the risks that they lay off,” he said. “So it won't look exactly like bank capital either, but in terms of overall levels of capital for various mortgage exposures, they're going to try and get some rough equivalency is my guess.”

 

Olson said it’s critical that the capital framework take into account the development of the credit risk transfer programs at the GSEs and the two companies’ risk-sharing activities.

 

“Particularly if it's a utility model that's being used — which we think is the right way — they're more of an insurance company type of operation, as opposed to a risk-based operation,” he said. “It's a pretty vanilla product. It's not that it's not risky at all, it's just that bank capital standards seem inappropriate, because they're not doing commercial loans. They're doing more of an insurance.”

 

If the FHFA developed a capital framework that either required the GSEs to hold too much or too little capital, there could be serious consequences, Parrent warned.

 

“If you had a capital structure that was too liberal, as the market feels that stress is approaching, the reinsurance and transfer trades would stop, and the GSEs would end up holding all of that risk because they would have a beneficial capital position relative to the reinsurers,” he said.

 

But at the same time, “you don't want the GSEs to have to hold a punitive amount of capital where the reinsurers are basically arbitraging that,” Parrent said.

 

In that kind of a regime, not only could people be pushed out of the housing market, but they could be forced into the less-regulated mortgage spaces, like the subprime and nonqualified mortgage markets, he added.

[Luke 532]

Curious of everybody's thoughts on Bove's comments below.  This was in the text of his e-mail this morning...

1. For preferred shareholders the next event will be in mid-January when the Supreme Court decides whether to hear arguments on the many GSE lawsuits. Failure to review would be devastating and but it is widely believed that the court will take up the GSE issues.

 

The rest is in the attached document, but I'm more curious of your thoughts on the quote above.

Bove12-29-2019.pdf

[onyx1]

Curious of everybody's thoughts on Bove's comments below.  This was in the text of his e-mail this morning...

1. For preferred shareholders the next event will be in mid-January when the Supreme Court decides whether to hear arguments on the many GSE lawsuits. Failure to review would be devastating and but it is widely believed that the court will take up the GSE issues.

 

The rest is in the attached document, but I'm more curious of your thoughts on the quote above.

 

He also says:

 

"If one is only interested in the value of the preferred issues in these companies, the only consideration that they need to consider is court decisions."

 

He's way off the mark here, and apparently isn't even considering the possibility of a negotiated settlement.

[Wiggins]

Bove seems to ignore the major court victories that have already happened. For JPS, the only factor is time.

[allnatural]

Bove has it backwards, for common the only thing that matters is the courts. A favorable judgement = less dilution cramdown = better for common and vice-versa. As PFD holder you should get par any which way (legal route, admin route, or organic recap).

[Luke 532]

Thanks for the responses. I agree with you guys, just looking for opposing viewpoints if anybody has one.

[Guest cherzeca]

the best thing for shareholders is for scotus to tell govt that it will defer taking up case until it sees the district court's final order granting relief...and a large judgment (which would itself then be appealable) would fit nicely in the recap timeline. 

[ValueMaven]

Stay long -- many catalysts for both commons and preferred holdings in 1Q 2020. 

[beaufort]

"Failure to review would be devastating [...]."

 

I prefer failure to review could be devastating in the short term.  These stocks move around a lot on nothing, or when it's been quiet too long.  We're in illiquid securities with a limited pool of buyers.  In the short term, anything can happen, including the stocks going up.  I know it's a truism, but it boils down to that.

[Midas79]

Curious of everybody's thoughts on Bove's comments below.  This was in the text of his e-mail this morning...

1. For preferred shareholders the next event will be in mid-January when the Supreme Court decides whether to hear arguments on the many GSE lawsuits. Failure to review would be devastating and but it is widely believed that the court will take up the GSE issues.

 

The rest is in the attached document, but I'm more curious of your thoughts on the quote above.

 

I can't agree with Bove here. What is there for SCOTUS to review anyway? Are they really going to bypass the entire district and appeals process by issuing a final ruling now? I would instead expect them to defer their decision on whether to take the case until after Judge Atlas makes her ruling, and probably after that ruling gets appealed and ruled on (again) by the Fifth Circuit.

[Guest cherzeca]

Curious of everybody's thoughts on Bove's comments below.  This was in the text of his e-mail this morning...

1. For preferred shareholders the next event will be in mid-January when the Supreme Court decides whether to hear arguments on the many GSE lawsuits. Failure to review would be devastating and but it is widely believed that the court will take up the GSE issues.

 

The rest is in the attached document, but I'm more curious of your thoughts on the quote above.

 

I can't agree with Bove here. What is there for SCOTUS to review anyway? Are they really going to bypass the entire district and appeals process by issuing a final ruling now? I would instead expect them to defer their decision on whether to take the case until after Judge Atlas makes her ruling, and probably after that ruling gets appealed and ruled on (again) by the Fifth Circuit.

 

after atlas issues a final order, the govt would then repetition for scotus cert the 5th C en banc decision, now with a final order providing for relief in accordance with that appellate decision...but I suppose you are right that if Ps think judge atlas misapplied the 5th C en banc decision, there could be an interim appeal to 5th C. 

 

we will find out in 10 days but I have seen scotus bend over backwards to accommodate a solicitor general request for cert sometimes and not at other times, so this is a hard one to call.

[Luke 532]

Trades Express Opposition to Re-Proposing GSE Capital Rule

https://www.insidemortgagefinance.com/articles/216794-trades-express-opposition-to-re-proposing-gse-capital-rule?v=preview

 

Trade groups representing independent mortgage lenders and homebuilders aren’t too thrilled with the Federal Housing Finance Agency re-proposing the regulatory capital rule for Fannie Mae and Freddie Mac.

 

In a recent letter to FHFA Director Mark Calabria, the groups were critical of the move, warning that a re-proposal would ultimately delay the process.

 

The letter was written by Ed Wallace, executive director of the Community Mortgage Lenders Association, and signed by the executives of the Independent Community Bankers of America, the Community Home Lenders Association and Leading Builders of America. The American Bankers Association and the Mortgage Bankers Association were not part of the group.

 

The signees agreed that some of the previously issued capital rules may require “adjustment,” but still, they’re concerned. For more details, see the new edition of Inside MBS & ABS, now available online.

 

 

[Guest cherzeca]

little late in the day to object to reproposing.  I just think calabria and mnuchin agreed to the timeline of GSEs retaining earnings to build capital for 2 more Qs and so Calabria thought he had nothing to lose, and he clearly wants to be implementing "his" rule, not a rejiggered Watt rule

[Luke 532]

little late in the day to object to reproposing.

 

Agreed.  They probably just wanted to publicly state their objection to delays, knowing it won't have any impact on the process.

[Luke 532]

Nothing new to us here, but Calabria confirms today that Congress is not needed to exit conservatorship...

 

Calabria at WHF lunch: “I can only call it a myth, the belief that somehow got out there that [Fannie and Freddie are] not supposed to exit conservatorship without congressional action.”

[beaufort]

Nothing new to us here, but Calabria confirms today that Congress is not needed to exit conservatorship...

 

Calabria at WHF lunch: “I can only call it a myth, the belief that somehow got out there that [Fannie and Freddie are] not supposed to exit conservatorship without congressional action.”

 

I know it's not new to us, but I still like hearing it as long as Calabria continues to answer questions in public.

[Guest cherzeca]

1/10 scotus will consider two 5C en banc collins petitions, the successful APA claim and the denial of backward relief in the constitutional claim. 

 

imo, the best outcome for shareholders is for scotus to decide it will defer consideration of the APA claim until the district court enters a final judgment, and may consider the constitutional remedy claim at that later time as well.  this will result in a half year or so, when the administration has said it will pursue a recap plan, in which fact finding adverse to govt will be presented to the district judge, who can be expected to enter a massive judgment against the govt.  this is a scenario the govt does not want to see happen.

 

less favorable would be for scotus to hear both claims, and even less favorable would be for scotus to hear just the APA claim...for if scotus reverses the APA collins 5th C decision and leaves intact the denial of constitutional remedy, then Ps are empty handed.

 

normally I would expect the most favorable result because scotus does not like to review interlocutory appeals, as opposed to final judgments.  but the solicitor general pressed its APA petition as being urgent, and scotus has a way of accommodating a sister branch of govt.

 

and so what if scotus grants review, when will argument be heard?  see https://www.supremecourt.gov/orders/19grantednotedlist.pdf for a listed of cases for the time period between granting petition and hearing oral argument.  ranges over a 6-8 month period mostly...so you can expect oral argument sometime late summer...at a time when fhfa should have finalized its capital rule, GSEs retained financial advisors, another 2 Qs of retained earnings contributed to capital etc...and basically at same time as the district court judgment would issue...and then no scotus decision until early 2021 likely. 

 

still thinking what treasury's end game is with respect to scotus review...since a "good" result for treasury (Ps lose) is not necessarily a good result for the recap...

[Luke 532]

Joint status report due today has requested 14 day extension. Typo in document...should be January 24, 2020.

[Guest cherzeca]

nothing yet. https://www.scotusblog.com/2020/01/justices-grant-three-new-cases-2/#more-291173

 

we will find out Monday

[muscleman]

nothing yet. https://www.scotusblog.com/2020/01/justices-grant-three-new-cases-2/#more-291173

 

we will find out Monday

 

Still nothing? Does it mean the case would not be heard or does it mean it would be pushed for consideration in the next term?

[Guest cherzeca]

I dont know.  it seems they decided many petitions, but I dont see collins mentioned.  https://www.supremecourt.gov/orders/courtorders/011320zor_4fc5.pdf

 

it may mean collins will be reconsidered next Monday.

[DRValue]

Another gse delay?

Colour me surprised.

[allnatural]

@cherzeca

 

SCOTUS - best to worst case (my personal views)

 

1) rejects APA, accepts CONSTITUTIONAL REMEDY

2) rejects both

3) delays case until 2021 term (same effect as rejecting as it increases urgency to address before election)

4) accepts both

5) accepts APA, rejects CONSTITUTIONAL REMEDY

 

4 is most likely, 5 would be net negative, 1-3 would be nice surprise

[Guest cherzeca]

I agree, though rejecting APA is highly unlikely.  there is a split in the circuits, and in event of rejection, district court in Texas would follow 5th C Willet opinion and reach some kind of order adverse to govt...at which point govt would seek to restrain the order in some C favorable to it, such as in DC...a potential mess.

 

this is a highly settle-able case (not saying an easy negotiation, but something that both parties can see as in their best interest to settle), and the best near term pathway to settlement would be to have govt have to sit through a trial/summary judgment motions in Houston imo