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

[Guest cherzeca]

@mm

 

I think otting is on the bench.  waiting for mnuchin to bless what Phillips produces is my best guess. then they will give to calabria and say we are doing this.

[muscleman]

@mm

 

I think otting is on the bench.  waiting for mnuchin to bless what Phillips produces is my best guess. then they will give to calabria and say we are doing this.

 

This sounds as if Calabria doesn't know what's going on, or he disagrees with what's going on, so Otting and Mnuchin and Philips said to Calabria, just wait for us to make up with a detailed plan, and you tell us what you don't like. That would be inline with the confirmation hearing where he said he doesn't know the current plan. However, Otting seems to say Calabria is on board with his plan.

 

[Guest cherzeca]

I think calabria is on board with the plan in general terms, meaning recap and eventual release.  if this is the plan, admin wouldn't nominate calabria if he wouldn't implement plan given to him by treasury.  but there is a hell of a lot of details to fill in before admin releases the plan...this is not some POS like the crapo plan with XXs all over the place.  so my guess is that Phillips is fleshing it out and waiting for Mnuchin's comments/blessing.  the major issue likely is whether congress could derail it midway while admin is implementing it, and how to put in protection from that, because as has been noted upthread investors will want protection from political risk.

[Midas79]

I might post a condensed version of this on Tim Howard's blog, just the part relating to minimum capital standards, but I will try it here first to see what everyone thinks.

 

While there was a lot of wrangling and hand-wringing over the risk-based capital levels that Watt proposed (and were the subject of Tim's previous blog post), the companies have to meet another capital standard in addition to that one in order to be classified as adequately capitalized. That's the minimum capital standard, and can only be met by core capital. This is by USC 4614(a).

 

https://www.law.cornell.edu/uscode/text/12/4614

 

(1) Adequately capitalized. An enterprise shall be classified as adequately capitalized if the enterprise—

(A) maintains an amount of total capital that is equal to or exceeds the risk-based capital level established for the enterprise under section 4611 of this title; and

(B) maintains an amount of core capital that is equal to or exceeds the minimum capital level established for the enterprise under section 4612 of this title.

 

Core capital is defined in USC 4507(7).

 

https://www.law.cornell.edu/uscode/text/12/4502#7

 

(7) Core capitalThe term “core capital” means, with respect to an enterprise, the sum of the following (as determined in accordance with generally accepted accounting principles):

(A) The par or stated value of outstanding common stock.

(B) The par or stated value of outstanding perpetual, noncumulative preferred stock.

© Paid-in capital.

(D) Retained earnings.

The core capital of an enterprise shall not include any amounts that the enterprise could be required to pay, at the option of investors, to retire capital instruments.

 

This minimum capital standard is set out by statute in USC 4612.

 

https://www.law.cornell.edu/uscode/text/12/4612

 

(a) EnterprisesFor purposes of this subchapter, the minimum capital level for each enterprise shall be the sum of—

(1) 2.50 percent of the aggregate on-balance sheet assets of the enterprise, as determined in accordance with generally accepted accounting principles;

(2) 0.45 percent of the unpaid principal balance of outstanding mortgage-backed securities and substantially equivalent instruments issued or guaranteed by the enterprise that are not included in paragraph (1); and

(3) 0.45 percent of other off-balance sheet obligations of the enterprise not included in paragraph (2) (excluding commitments in excess of 50 percent of the average dollar amount of the commitments outstanding each quarter over the preceding 4 quarters), except that the Director shall adjust such percentage to reflect differences in the credit risk of such obligations in relation to the instruments included in paragraph (2).

 

It looks like the lowest this could go is 2.5% of around $5.5T, or $137.5B. That assumes the second and third parts are zero.

 

Looking at page F-50 of Fannie's 2018 10-K report, page 239 of the pdf, they list core capital of around -$115B. Freddie's is -$68B on page 337, page 341 of the pdf.

 

http://fanniemae.com/resources/file/ir/pdf/quarterly-annual-results/2018/q42018.pdf

http://www.freddiemac.com/investors/financials/pdf/10k_021419.pdf

 

This means that by statute, FnF combined are at least $320.5B short of the minimum capital standard. If the seniors are canceled or converted to some form of equity that actually counts towards core capital, this will make up $193B of that gap, but that still leaves a shortfall $127B. By the definition of core capital, the only way to make up this deficit is by selling non-cumulative preferred shares, selling common shares, or adding to retained earnings.

 

In Calabria's oft-cited white paper, where he denounces the NWS as illegal, he also had this to say on page 5.

 

https://investorsunite.org/wp-content/uploads/2015/01/Krimminger-Calabria-HERA-White-Paper-Jan-29.pdf

 

HERA requires FHFA to conduct the conservatorships in order to “preserve and conserve” the Companies and to rehabilitate them so that they return to a “sound and solvent” condition.

...

Based on the past precedents, as demonstrated below, the requirement to return to a “sound and solvent condition” requires at a minimum that the Companies must meet the minimum capital and other regulatory standards required by the regulators andthe market to conduct their normal business.

 

Calabria believes it is the conservator's job to restore the companies to a "sound and solvent condition", and that part of that is making sure they meet minimum capital standards. Thus I must conclude that he will not release the companies before that standard is met, otherwise he (FHFA) hasn't fulfilled the role of conservator.

 

Mnuchin has said that he wants the companies released by the end of Trump's term in early 2021. If Calabria is going to make that deadline, the $127B in core capital must be raised before then. Two years of retained earnings might add $50B, and that's if FnF get to keep it all (and if the administration waits all the way until the last minute). The remainder must be sold as new shares.

 

Calabria has also commented that FnF's capital should be largely common equity.

 

https://www.urban.org/policy-centers/housing-finance-policy-center/projects/housing-finance-reform-incubator/mark-calabria-coming-full-circle-mortgage-finance

 

Ultimately all BHCs, including the newly created Fannie and Freddie BHCs, should hold substantially more capital. That capital should also largely be in the form of common equity and calculated on a non-risk-adjusted basis.

 

The part about non-risk-adjusted, to me, says that he's talking about minimum capital standards, which apply to FnF even though they aren't (and won't be) BHC. This rules out the possibility of recapping with only new non-cumulative pref shares. Also, it's much easier to sell a bunch of commons now and do prefs on an as-needed basis later, compared to the other way around.

 

In addition, if Calabria decides to implement some sort of bank-like capital standards anyway, perhaps by using his FSOC vote to try and get FnF designated as non-bank SIFIs, we could see CET1-type capital standards, which set a minimum amount of capital FnF would have to have only in common equity.

 

Calabria can even invoke 4612(d) to increase the minimum capital standard temporarily, which would also increase the size of the equity offering.

 

The conclusion I am forced to come to is that FnF will be issuing a very large amount of common shares in the next 18 months. Note that none of this discussion even touches on the warrants or a possible conversion of the juniors (or even the seniors if Collins gets remanded and a settlement leaves the seniors intact). The share base is going to expand greatly, and perhaps enormously. I believe this puts severe downward pressure on the commons' upside, enough to keep me completely away from them.

[Guest cherzeca]

@midas

 

good work, I am still digesting but I wanted to respond quickly to this:  "If the seniors are canceled or converted to some form of equity that actually counts towards core capital, this will make up $193B of that gap"

 

I dont believe cancelling senior prefs releases or creates any capital...it is not debt.  new capital comes from new money.

 

now Tim will know this, but I am not sure you can read GSE's current capital position from B/S.  regulatory capital doesn't necessarily equal some B/S line item.  but placing this on Tim's blog would be the best place to get a correct answer

[Guest cherzeca]

@midas

 

re fnma 10k, p f-50 table, why wouldn't $137B deficit be the minimum required new capital raise?

 

[Midas79]

@cherzeca

 

"I dont believe cancelling senior prefs releases or creates any capital...it is not debt."

 

I think Tim addressed this before, but while you're right that it's capital neutral, it adds to core capital. Canceling the seniors would involve the seniors going from 193B to zero on the balance sheet, and retained earnings rising by that amount. Since the seniors don't count towards core capital (because they're cumulative) but retained earnings do, that's why core capital would rise by $193B. This is also why the companies' core capital is so far negative in the first place: all those NWS payments drove retained earnings through the floor and into the giant hole (accumulated deficit) we see now.

 

"now Tim will know this, but I am not sure you can read GSE's current capital position from B/S"

 

I thought we could because of how core capital is defined. All of the components are balance sheet items. But yes, it is worth asking Tim, and as I will say below, I could very well be wrong here.

 

"re fnma 10k, p f-50 table, why wouldn't $137B deficit be the minimum required new capital raise?"

 

This has me thinking that I made a mistake somewhere. 2.5% of Fannie's balance sheet assets are $85.458B ($3,418.318B * 0.025, from the balance sheet on page F-3), which I thought would form the basis for their minimum capital standard. But the table on page F-50 lists it as $22.216B, and says below it

 

(a) 2.50% of on-balance sheet assets, except those underlying Fannie Mae MBS held by third parties

 

That last part must make up the difference. I thought "on-balance sheet assets" meant just the total asset number in the balance sheet, but Fannie seems to disagree. This is another thing I will ask Tim.

 

 

I may have gotten ahead of myself here, it wouldn't be the first time! Thanks for the thoughts on this.

[Guest cherzeca]

@midas

 

I would encourage you raising these questions with Tim since I want to know the answers and I wouldn't trust anyone else.  it would be interesting to know what the minimum required capital addition is to authorize a release from conservatorship.  how much above that which is determined to be prudentially appropriate is another matter which is discussed at length on Tim's blog, but I can't remember Tim ever saying this is the amount that would be the statutory minimum

[Midas79]

@midas

 

I would encourage you raising these questions with Tim since I want to know the answers and I wouldn't trust anyone else.  it would be interesting to know what the minimum required capital addition is to authorize a release from conservatorship.  how much above that which is determined to be prudentially appropriate is another matter which is discussed at length on Tim's blog, but I can't remember Tim ever saying this is the amount that would be the statutory minimum

 

I made a post there, but it got removed. Perhaps I am persona non grata over there; my last two or three posts have been removed as well, including one asking why Treasury would not insist on a fast recap and/or a full recap before release (in response to Tim opining that the companies might be released before they are recapped).

 

All I did was ask why my calculation of Fannie's statutory minimum core capital ($85.5B) differs from that in their filing ($22.2B).

 

If you really want to know, you will likely have to ask him yourself. You have much more latitude on that site than I, it appears.

[allnatural]

Don't take it to heart. It seems he's pretty strict about what comments stay up and don't (for good reason, a lot of nonsense gets posted there).

 

edit: he responded to your post

 

@midas

 

I would encourage you raising these questions with Tim since I want to know the answers and I wouldn't trust anyone else.  it would be interesting to know what the minimum required capital addition is to authorize a release from conservatorship.  how much above that which is determined to be prudentially appropriate is another matter which is discussed at length on Tim's blog, but I can't remember Tim ever saying this is the amount that would be the statutory minimum

 

I made a post there, but it got removed. Perhaps I am persona non grata over there; my last two or three posts have been removed as well, including one asking why Treasury would not insist on a fast recap and/or a full recap before release (in response to Tim opining that the companies might be released before they are recapped).

 

All I did was ask why my calculation of Fannie's statutory minimum core capital ($85.5B) differs from that in their filing ($22.2B).

 

If you really want to know, you will likely have to ask him yourself. You have much more latitude on that site than I, it appears.

[Guest cherzeca]

I found this in Tim's amicus brief filed in 2015 in the Perry Capital case:  "Moreover, at the time they were forced into conservatorship, both exceeded their regulatory capital requirements—Fannie by $9.4 billion, and Freddie by $2.7 billion." (https://howardonmortgagefinance.com/2015/07/06/argument-from-perry-capital-amicus-curiae-brief/)

 

I am guessing that minimum statutory capital is not relevant since it is less than what all would agree is prudential. so it is a question that is not going to produce an answer that moves anything forward

[Midas79]

I did get a response from Tim, and as always it was very helpful and on point.

 

It does sound like Calabria could choose to change the minimum capital standard back to 2.5% of all assets, undoing the 2010 decision Tim refers to. This corresponds to the higher of Watt's two alternatives for minimum capital. Since Calabria has called for "bank-like" capital standards for FnF in the past, and Watt said on page 2 of the fact sheet that the higher (flat 2.5%) alternative is "consistent with Basel leverage capital requirements for banks", I think it is quite possible that Calabria resets the number up to the $137.5B (for FnF combined) that I calculated. At the very least, the possibility should not be ruled out.

 

https://www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/Proposed-Rule-Enterprise-Capital-Fact-Sheet.pdf

[Guest cherzeca]

I did get a response from Tim, and as always it was very helpful and on point.

 

It does sound like Calabria could choose to change the minimum capital standard back to 2.5% of all assets, undoing the 2010 decision Tim refers to. This corresponds to the higher of Watt's two alternatives for minimum capital. Since Calabria has called for "bank-like" capital standards for FnF in the past, and Watt said on page 2 of the fact sheet that the higher (flat 2.5%) alternative is "consistent with Basel leverage capital requirements for banks", I think it is quite possible that Calabria resets the number up to the $137.5B (for FnF combined) that I calculated. At the very least, the possibility should not be ruled out.

 

https://www.fhfa.gov/Media/PublicAffairs/PublicAffairsDocuments/Proposed-Rule-Enterprise-Capital-Fact-Sheet.pdf

 

@midas

 

thanks for pursuing that.  now, dont FnF now have around $6B of net worth, and does this also equal their  current capital?  how does this tie into the 10K p.F-50 deficit of core capital?

 

 

 

 

 

 

 

 

 

 

[Seahug]

I don't believe the cancellation of the senior pref and the exercise of the USG warrants add to equity.

 

The cancellation of the senior pref is effectively a transfer of rights to take 100% profits to existing jpprefs and common - there is no benefit to the co. But in the event the co's choose not to pay out divs, then it allows the build up of equity over time

 

it is not like the cancellation/forgiveness of a debt obligation of a company which becomes profit of the company (i.e. a transfer of value to the co).

 

The exercise of warrants also adds no capital

 

 

 

[Midas79]

now, dont FnF now have around $6B of net worth, and does this also equal their  current capital?  how does this tie into the 10K p.F-50 deficit of core capital?

 

Net worth is just balance sheet assets minus balance sheet liabilities. Core capital is a very specific statutory formula, including only non-cumulative pref stock, common stock, additional paid-in capital, and retained earnings.

 

Fannie's recent 10-K doesn't have an additional paid-in capital line, I assume that's zero. Adding up the other three things on the balance sheet, and adding in the -$7.4B of Treasury stock (I'm not quite sure why this is included), gives core capital of -$114.918B. This is within a rounding error of the -$114.916B they report on page F-50.

[rros]

Who can write that about midas? That is insanity itself.

[rros]

BET

 

I bet we see old 2014 highs by March 31st.

 

Hello, Lamberth!

[Guest cherzeca]

Who can write that about midas? That is insanity itself.

 

to block Emily, go to profile--> account settings---> modify profile--->buddies/ignore list-->edit ignore list---> type Emily in add to ignore list box and enter

[orthopa]

Who can write that about midas? That is insanity itself.

 

to block Emily, go to profile--> account settings---> modify profile--->buddies/ignore list-->edit ignore list---> type Emily in add to ignore list box and enter

 

Thank god there is a way. Everyone should do this.

[Midas79]

to block Emily, go to profile--> account settings---> modify profile--->buddies/ignore list-->edit ignore list---> type Emily in add to ignore list box and enter

 

Her post was dregs-of-IHub bad. Thanks for the details on how to do this. CoB&F doesn't make this option easy to find!

[muscleman]

to block Emily, go to profile--> account settings---> modify profile--->buddies/ignore list-->edit ignore list---> type Emily in add to ignore list box and enter

 

Her post was dregs-of-IHub bad. Thanks for the details on how to do this. CoB&F doesn't make this option easy to find!

 

Done. Thank you!

I am so frustrated talking to her. She still doesn't understand capital structure, bankruptcy investing, and why preferred have a lower risk than common etc..... 

[rros]

Getting back to business... we had some fireworks in Jan. (Otting) and a somewhat quiet Feb. Let's see what March brings.

[muscleman]

Getting back to business... we had some fireworks in Jan. (Otting) and a somewhat quiet Feb. Let's see what March brings.

https://www.wsj.com/articles/u-s-china-close-in-on-trade-deal-11551641540?mod=hp_lead_pos1

 

When is the full senate vote on Calabria? If trade deal is likely signed around March 27th during the summit, then probably material things will happen after this date. March 31st is another dividend sweep. I wonder if something material will happen between these two dates.

[Guest cherzeca]

Getting back to business... we had some fireworks in Jan. (Otting) and a somewhat quiet Feb. Let's see what March brings.

https://www.wsj.com/articles/u-s-china-close-in-on-trade-deal-11551641540?mod=hp_lead_pos1

 

When is the full senate vote on Calabria? If trade deal is likely signed around March 27th during the summit, then probably material things will happen after this date. March 31st is another dividend sweep. I wonder if something material will happen between these two dates.

 

this is totally up to Mitch McConnell.

 

I dont expected t anything of significance happening re GSEs before 3/31

[hardincap]

the first real tell will be 3/31 and whether dividends are paid

 

@cherzeca if dividends are paid, how would that change your expectations/interpretation of the current state of play? also, im not up to date in recent news, when is calabria's full senate confirmation decision expected?