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

[Midas79]

@cherzeca

 

Great analysis of the Supreme Court proceedings, kudos.

 

I do disagree with one thing you said on Tim Howard's blog: "and maybe, without a severability provision in HERA to hang FHFA’s hat on, the existence of the fhfa itself."

 

From my read of the SCOTUS Selia opinion, Roberts justified his change of Dodd-Frank's CFPB director removal clause even had there been no severability clause. This is the bulk of the discussion on pages 33-35. If the existence of a severability clause is all he needed, I don't see why he would have included such an in-depth discussion at all. The main quote I use to justify my argument is on page 33:

 

In Free Enterprise Fund, we found a set of unconstitutional removal provisions severable even in the absence of an express severability clause because the surviving provisions were capable of “functioning independently” and “nothing in the statute’s text or historical context [made] it evident that Congress, faced with the limitations imposed by the Constitution, would have preferred no Board at all to a Board whose members are removable at will.” 561 U. S., at 509 (internal quotation marks omitted).

So too here.

 

While Dodd-Frank does have a severability clause, the statute in Free Enterprise didn't, and SCOTUS decided it was able to sever parts of it anyway. I also don't see how any parts of HERA necessarily fall (other than 4511(a)) if "for cause" removal is changed to "at will". I could be missing some, but I don't think they would cause the whole structure of HERA or FHFA to collapse, or invalidate any previous decisions made by then-Directors or Acting Directors.

[Guest cherzeca]

@cherzeca

 

Great analysis of the Supreme Court proceedings, kudos.

 

I do disagree with one thing you said on Tim Howard's blog: "and maybe, without a severability provision in HERA to hang FHFA’s hat on, the existence of the fhfa itself."

 

From my read of the SCOTUS Selia opinion, Roberts justified his change of Dodd-Frank's CFPB director removal clause even had there been no severability clause. This is the bulk of the discussion on pages 33-35. If the existence of a severability clause is all he needed, I don't see why he would have included such an in-depth discussion at all. The main quote I use to justify my argument is on page 33:

 

In Free Enterprise Fund, we found a set of unconstitutional removal provisions severable even in the absence of an express severability clause because the surviving provisions were capable of “functioning independently” and “nothing in the statute’s text or historical context [made] it evident that Congress, faced with the limitations imposed by the Constitution, would have preferred no Board at all to a Board whose members are removable at will.” 561 U. S., at 509 (internal quotation marks omitted).

So too here.

 

While Dodd-Frank does have a severability clause, the statute in Free Enterprise didn't, and SCOTUS decided it was able to sever parts of it anyway. I also don't see how any parts of HERA necessarily fall (other than 4511(a)) if "for cause" removal is changed to "at will". I could be missing some, but I don't think they would cause the whole structure of HERA or FHFA to collapse, or invalidate any previous decisions made by then-Directors or Acting Directors.

 

well stated midas.  I dont want to put too much emphasis on the lack of a sevarability provision, but it has to be something Calabria should be giving weight to...or that Milbank would have to advise him about, in giving good complete legal counsel.

 

I think it could be argued by Ps in front of Scotus that there is a big difference between the importance of the independence of the directors at FHFA and at CFPB.  there is a lot that CFPB does by way of investigations and adjudication that goes on below the director level. at FHFA, the director is much more prominent in his role vis a vis the entire agency.  so given the greater centrality of the FHFA director to the operation of the HERA statute, the lack of a severability provision is more evidence of the importance of his independence.

 

I will have a new SA article coming out soon where in part I speculate why scotus granted cert.  perhaps the four dissenting judges wanted to try to distinguish FHFA from CFPB.  hard to make that work. perhaps four judges in the majority wanted to expand upon Seila somehow...maybe Collins will give them a chance to just grant backward relief and say about severability, "we can't really tell", and leave it undecided.

 

 

[Guest cherzeca]

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

 

[locutusoftexas]

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

Thank you for your very helpful SA article (above) and for your insights over the years.

[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.