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

[james22]

jr pref conversion @ 75pct of par and $5 common valuation

 

Works for me.

[Midas79]

"@midas

Is a prepaid asset (ie the dividend overage from the NWS) classified as equity under GAAP?"

 

I asked TH once and he said no

 

Technically, that's not what I asked.

 

I previously did some calculations on FnF's balance sheets in their 10-K forms, and the numbers they report for core capital were precisely the sum of all equity-section balance sheet entries other than senior pref stock and AOCI.

 

When (if?) FnF get a tax credit from Treasury, they will book it in the asset section of the balance sheet. The offsetting entry has to go in the equity section somewhere. My question is: will it go to a line item that counts towards core capital (tier 1) and/or CET1? If the offsetting entry is in retained earnings then the answer to both is yes, while if it's AOCI (or some new item that they don't count towards core capital) then it's no.

[Guest cherzeca]

Have we settled on what the capital requirement is yet?

Could anyone clearly explain this to their boss?

 

The main restraint to reach level 1 (non buffer) freedom is the $152bn leverage requirement.  This can include common + preferred.  I guess the $152bn drops to about $140bn in the final rule and $40bn is preferred so roughly $100bn common equity to hit this threshold. 

 

The buffers are level 2.  The buffers are in the document to satisfy the anti-FnF'rs.  There is wiggle room both in the size and time to get there.  Dividends aren't crucial right away and the exec bonus rules can be massaged per the document's questions.  I guess the $100bn buffers will drop to $80bn so I think about it in four $20bn increments.

 

So the real common equity requirements are somewhere between 100bn and 180bn but the latter is many years out, big phase in.

 

the real question is whether investors in capital markets will get fussed by these div restrictions in the capital buffers...I can only say that they have seen this before re the banks after the GFC.  I also think that for issuers like the GSEs that earn a ton of net income, having even a restricted div bucket permits them to repurchase plenty of stock

 

assuming this is real, this is important:

 

[Guest cherzeca]

@midas

 

"When (if?) FnF get a tax credit from Treasury, they will book it in the asset section of the balance sheet. The offsetting entry has to go in the equity section somewhere. My question is: will it go to a line item that counts towards core capital (tier 1) and/or CET1? If the offsetting entry is in retained earnings then the answer to both is yes, while if it's AOCI (or some new item that they don't count towards core capital) then it's no"

 

this is what I thought, but TH said no B/S treatment, just take untaxed income into income as it comes...(if I understood him right)

[Guest cherzeca]

As I am settling in, I am getting more comfortable with this capital rule.  I like the incentives to get JPS holders to exchange for new common capital and current JPS holders, linked to future distributions.  Also, with the exceptions to distributions while building capital (hat tip:  Midas and Holden Walker), the current JPS holders see a distribution relatively quickly and are not hostage to new common capital or current common.  And I like the high CET1 for the businesses moving forward.  It means there will never be a concern about capital again.  Overall, a balanced effort.  It's early days in interpretation, but that's my current view.

 

I come out the same...with the proviso that Calabria will have to be accommodating on the capital buffer build up, so as to help GSEs hit those targets, and can be more of a hard ass on any rebuild up down the road.

 

but remember, GSEs dont need to hit a 100% payout level...why would fannie need to dividend or repo stock  equal to >$10B per year?  those higher % tranches should look good to politicians though...

[beaufort]

As I am settling in, I am getting more comfortable with this capital rule.  I like the incentives to get JPS holders to exchange for new common capital and current JPS holders, linked to future distributions.  Also, with the exceptions to distributions while building capital (hat tip:  Midas and Holden Walker), the current JPS holders see a distribution relatively quickly and are not hostage to new common capital or current common.  And I like the high CET1 for the businesses moving forward.  It means there will never be a concern about capital again.  Overall, a balanced effort.  It's early days in interpretation, but that's my current view.

 

I come out the same...with the proviso that Calabria will have to be accommodating on the capital buffer build up, so as to help GSEs hit those targets, and can be more of a hard ass on any rebuild up down the road.

 

but remember, GSEs dont need to hit a 100% payout level...why would fannie need to dividend or repo stock  equal to >$10B per year?  those higher % tranches should look good to politicians though...

 

I agree with you on the payout ratio observation, competition and that Calabria becomes more of a hard ass as time goes on. 

 

I also don't accept the common assertion that raising massive amounts of capital, all of it in one lift, is not substantially possible, or even probable.  With clear rules, the GSEs become more attractive.  Even the arguably excessive conservatism can be construed as a positive.  There are lots of huge holders of capital looking for utility-like returns, which is what they will be getting.  It is better to put the money to work and start earning, rather than sitting in cash and watching a respectable, conservative return walk away.

[Guest cherzeca]

As I am settling in, I am getting more comfortable with this capital rule.  I like the incentives to get JPS holders to exchange for new common capital and current JPS holders, linked to future distributions.  Also, with the exceptions to distributions while building capital (hat tip:  Midas and Holden Walker), the current JPS holders see a distribution relatively quickly and are not hostage to new common capital or current common.  And I like the high CET1 for the businesses moving forward.  It means there will never be a concern about capital again.  Overall, a balanced effort.  It's early days in interpretation, but that's my current view.

 

I come out the same...with the proviso that Calabria will have to be accommodating on the capital buffer build up, so as to help GSEs hit those targets, and can be more of a hard ass on any rebuild up down the road.

 

but remember, GSEs dont need to hit a 100% payout level...why would fannie need to dividend or repo stock  equal to >$10B per year?  those higher % tranches should look good to politicians though...

 

I agree with you on the payout ratio observation, competition and that Calabria becomes more of a hard ass as time goes on. 

 

I also don't accept the common assertion that raising massive amounts of capital, all of it in one lift, is not substantially possible, or even probable.  With clear rules, the GSEs become more attractive.  Even the arguably excessive conservatism can be construed as a positive.  There are lots of huge holders of capital looking for utility-like returns, which is what they will be getting.  It is better to put the money to work and start earning, rather than sitting in cash and watching a respectable, conservative return walk away.

 

+1.  there is something for everyone in this proposal, and if calabria is accommodating as the capital buffers are built (permitting dividends before the 25% capital buffer tranche is satisfied), then the payout limitations are an acceptable limitation on capital if and when on the way down

[investorG]

common has more obstacles than jr pref for imo similar upside.

 

edit: the max public re-IPO size is probably something like $60bn.  the private markets perhaps could handle more.  whoever puts up that money has to deal with probably further supply for the buffer and/ or secondary sales so they are going to want something cheap. 

 

edit 2:  if seila doesnt provide backward relief I don't see Tsy providing overage payments in a potential settlement unless collins wins at SC in 2021.

[orthopa]

https://www.treasury.gov/press-center/press-releases/Pages/tg1796.aspx

 

"Over the last 19 months, Treasury has conducted six public offerings of AIG common stock, selling a total of 1,655,037,962 shares (originally 92 percent of AIG’s outstanding common stock) at an average price of $31.18 per share. Treasury's $20.7 billion AIG common stock offering in September 2012 alone represented the largest single U.S. common stock offering in history [2]."

 

Treasury sold 51B worth of AIG stock in just over a year and a half and that company had much lower quality earnings and a horrible book of legacy business that came with the purchase of that stock. I know, I held the warrants that went nowhere for years before I dumped them.

 

If priced well enough and with another 6-8Q of retained earnings, +/- treatment of return $ from Treasury and preferred issuance getting to the first hurdle in 18 months seems very doable.

 

I think we will all be very surprised by how much the largest public offering in history is (the upcoming GSEs re IPO).

[Guest cherzeca]

the mortgage finance business seems to be holding up very well...housing prices steady, interest rates low.  I understand there are millions of mortgages in forbearance, but congress said have at it...how many of these forborne mortgages become truly delinquent is where rubber meets road, but if you told me that something like 1/3 of the nation's businesses would be shut down and housing prices would remain stable, I would say that is crazy

[DRValue]

So rough math for Fannie Mae (it's all I can do...)

 

Total capital requirement 81b

Current equity 14b

Treasury 'refund' 15b

Junior preferred par value 19b

One years 'covid' earnings 6b

 

Leaves a gap to total capital of 27b.

 

Right to assume that 27b may be the target common / preferred raise? I know junior preferred could be converted etc..

 

As this is a new capital paradigm and there are hints of flexibility, retained earnings low dividends and opportunistic capital raises, including debt for the buffers?

 

[Midas79]

So rough math for Fannie Mae (it's all I can do...)

 

Total capital requirement 81b

Current equity 14b

Treasury 'refund' 15b

Junior preferred par value 19b

One years 'covid' earnings 6b

 

Leaves a gap to total capital of 27b.

 

Right to assume that 27b may be the target common / preferred raise? I know junior preferred could be converted etc..

 

As this is a new capital paradigm and there are hints of flexibility, retained earnings low dividends and opportunistic capital raises, including debt for the buffers?

 

The $19B of junior par value is already included in the $14B. That is, everything else that contributes to the $14B adds up to a combined negative $5B.

 

Also, the refund from Treasury could come in the form of a tax credit. In that case, I believe that Fannie (and Freddie too, of course) would only add their tax savings to capital as they occur. It could very well take 5-6 years to earn all of that refund.

 

The upshot is that if a capital raise is needed to hit a particular number then the full amount of the refund won't count, only the taxes they would have paid. At best I can see Fannie getting $2.5B of it back per year, and that would be on earnings of around $13B. Also, I think Fannie will make more than $6B this year ($10B imo) but for now I'll use your number.

 

If the capital raise happens a year from now, adjusting your numbers for these things leaves a gap of $56B: your $27B plus the $19B of prefs and $10B of unearned tax credits.

 

Another thing to keep in mind is that $81B is Fannie's risk-based capital requirement. For some reason I can't explain, Calabria decided on a minimum capital standard (he calls it the Leverage Capital Requirement) that's higher than the risk-based one: $89B. Now the gap is $64B if that's the milestone.

 

Similar calculations give a gap of $42B between Freddie's current core capital (once the seniors are dealt with) and their minimum capital requirement of $63B: Freddie has $9B of current equity, $7B of earnings between now and the capital raise, and $5B of earned tax credits.

 

So I'm getting core capital shortfalls of $64B for Fannie and $42B for Freddie, or $106B combined. This would have to be the size of the capital raise if it occurs a year from now and is designed to hit the minimum capital standard.

 

Treasury returning the overpayments in cash instead of tax credits would lower each company's numbers by $10B, for a total capital raise size of $86B.

[DRValue]

So rough math for Fannie Mae (it's all I can do...)

 

Total capital requirement 81b

Current equity 14b

Treasury 'refund' 15b

Junior preferred par value 19b

One years 'covid' earnings 6b

 

Leaves a gap to total capital of 27b.

 

Right to assume that 27b may be the target common / preferred raise? I know junior preferred could be converted etc..

 

As this is a new capital paradigm and there are hints of flexibility, retained earnings low dividends and opportunistic capital raises, including debt for the buffers?

 

The $19B of junior par value is already included in the $14B. That is, everything else that contributes to the $14B adds up to a combined negative $5B.

 

Also, the refund from Treasury could come in the form of a tax credit. In that case, I believe that Fannie (and Freddie too, of course) would only add their tax savings to capital as they occur. It could very well take 5-6 years to earn all of that refund.

 

The upshot is that if a capital raise is needed to hit a particular number then the full amount of the refund won't count, only the taxes they would have paid. At best I can see Fannie getting $2.5B of it back per year, and that would be on earnings of around $13B. Also, I think Fannie will make more than $6B this year ($10B imo) but for now I'll use your number.

 

If the capital raise happens a year from now, adjusting your numbers for these things leaves a gap of $56B: your $27B plus the $19B of prefs and $10B of unearned tax credits.

 

Another thing to keep in mind is that $81B is Fannie's risk-based capital requirement. For some reason I can't explain, Calabria decided on a minimum capital standard (he calls it the Leverage Capital Requirement) that's higher than the risk-based one: $89B. Now the gap is $64B if that's the milestone.

 

Similar calculations give a gap of $42B between Freddie's current core capital (once the seniors are dealt with) and their minimum capital requirement of $63B: Freddie has $9B of current equity, $7B of earnings between now and the capital raise, and $5B of earned tax credits.

 

Cheers midas. Double counted that 19b real quick! Mustn't skim read.

Close to taking my slim profits on the commons and moving them to prefs on the dip. Pspa amendment and the cap raise terms are the wildcard but that perfect world seems far away now.

[orthopa]

the mortgage finance business seems to be holding up very well...housing prices steady, interest rates low.  I understand there are millions of mortgages in forbearance, but congress said have at it...how many of these forborne mortgages become truly delinquent is where rubber meets road, but if you told me that something like 1/3 of the nation's businesses would be shut down and housing prices would remain stable, I would say that is crazy

 

One of the daily mailers IMF I think it was yesterday made a comment that 20-40% of those mortgages in forbearance were being paid on despite the status. Not sure if this was overall or per an individual servicer but encouraging regardless.  If that is truly the case that provides some upside to reserves that were taken.

[Midas79]

I posted a bunch of thoughts after my first read-through of the fact sheet and (what I believe to be) the relevant parts of the full capital rule for us shareholders on Tim Howard's blog. While he does occasionally delete posts, and mine is rather verbose, it is entirely aprpros and should stay up.

https://howardonmortgagefinance.com/2020/05/05/first-quarter-takeaways/comment-page-1/#comment-15295

 

I'll post a link to that on Twitter too, but probably not until I'm sure that the post will stay up.

[orthopa]

To show how crazy the market is last time alot of Fannie preferred traded to the upside at these levels was after Ottings comments in early 2019. Since that time we have had:

 

1. Calabria sworn in as FHFA head

2. Treasury plan

3. En Banc decision

4. Selia case argued

5. September capital cap PSPA amendment

6. FHFA hired a financial advisor

7. FHFA hired new council

8. FHFA releases capital rule

9. Freddie/Fannie announced RFP to underwrite/come up with recap plan.

 

Still at these levels market not believing FNMA will be recapped or Preferred get more then ~30% of par. Nuts.

 

[Luke 532]

Very well stated, orthopa.

 

To show how crazy the market is last time alot of Fannie preferred traded to the upside at these levels was after Ottings comments in early 2019. Since that time we have had:

 

1. Calabria sworn in as FHFA head

2. Treasury plan

3. En Banc decision

4. Selia case argued

5. September capital cap PSPA amendment

6. FHFA hired a financial advisor

7. FHFA hired new council

8. FHFA releases capital rule

9. Freddie/Fannie announced RFP to underwrite/come up with recap plan.

 

Still at these levels market not believing FNMA will be recapped or Preferred get more then ~30% of par. Nuts.

[Guest cherzeca]

the mortgage finance business seems to be holding up very well...housing prices steady, interest rates low.  I understand there are millions of mortgages in forbearance, but congress said have at it...how many of these forborne mortgages become truly delinquent is where rubber meets road, but if you told me that something like 1/3 of the nation's businesses would be shut down and housing prices would remain stable, I would say that is crazy

 

http://www.mortgagenewsdaily.com/05202020_covid_19_forbearance.asp

 

5% of those seeking forbearance said they really needed it

 

"Five percent of homeowners who were approved for forbearance said they wouldn't have been able to make their mortgage payment without it and 26.2 percent said they could have paid their mortgages but would have needed to skip other essential bills. Almost 70 admitted they just wanted a break from their normal payments. That response was most prevalent among Millennials and Gen Xers, at 71 percent."

[WB_fan82]

I posted a bunch of thoughts after my first read-through of the fact sheet and (what I believe to be) the relevant parts of the full capital rule for us shareholders on Tim Howard's blog. While he does occasionally delete posts, and mine is rather verbose, it is entirely aprpros and should stay up.

https://howardonmortgagefinance.com/2020/05/05/first-quarter-takeaways/comment-page-1/#comment-15295

 

I'll post a link to that on Twitter too, but probably not until I'm sure that the post will stay up.

 

Great post Midas.  The bigger capital deficiency is on the total leverage test, which they can meet with any amount of Tier 1 capital (prefs).  But probably the more difficult capital hole to fill is the smaller deficiency on the risk-weighted test since they still need to gin up tens and tens of billions of CET1 (no prefs).

 

It is somewhat helpful that the GSEs are organically retaining CET1 capital internally on a pre-tax basis, since the DTAs are used up and that asset is effectively replaced with cash (assuming the higher liquidation pref gets converted to CET1 in the future).

 

What do you make of this random thought...  Wouldn't the recap be a cinch if the government exercised its warrant for the 80% of common, then did a rights offering at the appropriate common share multiple (X shares for each share owned)?  The government buys its slug of common to maintain the 80% it already has, existing shareholders pump in the small minority of the common raised, the GSEs hit their thresholds (at least the minimum level), and the government can then sell its shares in the market over time?

 

 

[Midas79]

Here is the rest of the post from Tim Howard's blog; he just kept the first 4 points for brevity. I also had forgotten to finish point 5 at the time.

 

5) I didn't realize that Freddie had so many more off-balance sheet assets than Fannie: $300M worth. Will this have any effect on the capital standards or raises?

6) Table 4 on page 28 is a mess. The numbers $25B, $42B, $209B, and $122B should be $27B, $32B, $145B, and $101B respectively. The first two are in Fannie Mae's 2017 10-K, and the latter two come from Table 3b on page 236 (I multiplied Adjusted Total Assets of $2.524.6T by 4% to get the $101B). Freddie's table (Table 5 on page 30) has similar problems.

7) Normally I would chalk this up to typos and human error, but it actually undermines Calabria's point that his capital standard would have been enough to avoid the peak "losses" that Fannie and Freddie would have sustained after the crisis in 2008. However, his simplistic method of just adding net worth, equity issuance in 2007, and total draws from Treasury ignores that a significant chunk of the Treasury draws were circular, i.e. only taken to pay Treasury its 10% dividend on the seniors. Backing that out might well cancel out the effect of accidentally overstating the capital requirements in Tables 4 and 5 on pages 28 and 30.

8 ) I think Calabria's mistake (or whoever drafted the report) was that they somehow added the PCCBA twice to the Total Capital Requirement in Tables 3a and 3b on pages 235-236. That gives the exact (erroneous) number of $209B for Fannie, and gives $124B for Freddie (close to the $128B shown in Table 5 on page 30).

[Guest Covid-19_Survivor]

Nice day of posts from the accountants and lawyers. Thank you.

 

I, who has neither of these degrees still has an opinion.

 

1) TH is wrong in thinking this deal sucks. The sizable capitals buffers mean no more treasury backstop, that's why they're so large. That ends, which is fantastic news. Enough of the intervention and control, kinda.

 

2) Isn't there a g-fee increase proposal with '21 budget?

 

2a) Money machines.

 

(minus any g-fee increases)3) 10x (non-covid) earnings is a $160b mc. PMI AGCL sells at 15x earnings which would value us instead at 250B. I suspect Calabria knows the actual value of FnF. Largest IPO in history? why not. Remove the govt and they're solid co's.

 

4) With FnF being such money makers and our treasury being so historically greedy, I still don't know about those seniors. From what I see it would be illogical to just cancel or equitize them, court actions withstanding. I suspect Mnuchin is knee deep on what he can get away with in support of taxpayers (and having his admin look good).

.

[investorG]

To show how crazy the market is last time alot of Fannie preferred traded to the upside at these levels was after Ottings comments in early 2019. Since that time we have had:

 

1. Calabria sworn in as FHFA head

2. Treasury plan

3. En Banc decision

4. Selia case argued

5. September capital cap PSPA amendment

6. FHFA hired a financial advisor

7. FHFA hired new council

8. FHFA releases capital rule

9. Freddie/Fannie announced RFP to underwrite/come up with recap plan.

 

Still at these levels market not believing FNMA will be recapped or Preferred get more then ~30% of par. Nuts.

 

major political risk.  mnuchin and calabria might have a plan for the next 8 months before a likely transition but it's sure not apparent to the mkt.  The political punt in summer of 2019 - per bloomberg story in july - to post-election for a potential 4th amendment + capital raise was disastrous.

[Wiggins]

So rough math for Fannie Mae (it's all I can do...)

 

Total capital requirement 81b

Current equity 14b

Treasury 'refund' 15b

Junior preferred par value 19b

One years 'covid' earnings 6b

 

Leaves a gap to total capital of 27b.

 

Right to assume that 27b may be the target common / preferred raise? I know junior preferred could be converted etc..

 

As this is a new capital paradigm and there are hints of flexibility, retained earnings low dividends and opportunistic capital raises, including debt for the buffers?

 

The $19B of junior par value is already included in the $14B. That is, everything else that contributes to the $14B adds up to a combined negative $5B.

 

Also, the refund from Treasury could come in the form of a tax credit. In that case, I believe that Fannie (and Freddie too, of course) would only add their tax savings to capital as they occur. It could very well take 5-6 years to earn all of that refund.

 

The upshot is that if a capital raise is needed to hit a particular number then the full amount of the refund won't count, only the taxes they would have paid. At best I can see Fannie getting $2.5B of it back per year, and that would be on earnings of around $13B. Also, I think Fannie will make more than $6B this year ($10B imo) but for now I'll use your number.

 

If the capital raise happens a year from now, adjusting your numbers for these things leaves a gap of $56B: your $27B plus the $19B of prefs and $10B of unearned tax credits.

 

Another thing to keep in mind is that $81B is Fannie's risk-based capital requirement. For some reason I can't explain, Calabria decided on a minimum capital standard (he calls it the Leverage Capital Requirement) that's higher than the risk-based one: $89B. Now the gap is $64B if that's the milestone.

 

Similar calculations give a gap of $42B between Freddie's current core capital (once the seniors are dealt with) and their minimum capital requirement of $63B: Freddie has $9B of current equity, $7B of earnings between now and the capital raise, and $5B of earned tax credits.

 

So I'm getting core capital shortfalls of $64B for Fannie and $42B for Freddie, or $106B combined. This would have to be the size of the capital raise if it occurs a year from now and is designed to hit the minimum capital standard.

 

Treasury returning the overpayments in cash instead of tax credits would lower each company's numbers by $10B, for a total capital raise size of $86B.

 

Quick question: are you factoring in price appreciation of common after cancellation of SPS and re-list to NYSE? Moelis had commons in the range of $14-$17 after warrants and JPS conversion dilution. That adds a lot of Tier 1 capital over the current price of ~$2.20.

[Midas79]

Quick question: are you factoring in price appreciation of common after cancellation of SPS and re-list to NYSE? Moelis had commons in the range of $14-$17 after warrants and JPS conversion dilution. That adds a lot of Tier 1 capital over the current price of ~$2.20.

 

FnF's capital has nothing to do with the market price of the commons.

 

There is also no guarantee of any price appreciation after said events, let alone enough to get the price above $4 for 30 days to re-list. For all the good news FnF shareholders got in the last 16 months, the price is around 40% lower than it was at the end of January 2019.

 

A reverse split is the only realistic way to get an over-$4 share price to stick, and I fully expect it to happen later this year. Somewhere between 1:10 and 1:20 is my guess for now.

 

Moelis 2.0 is completely unrealistic anyway. Why would junior pref shareholders sign up for a plan that involves them converting at a re-IPO price in the teens (a far worse ratio than they could get right now in the open market), and giving existing common holders a much greater return than the junior prefs themselves?

[Wiggins]

Quick question: are you factoring in price appreciation of common after cancellation of SPS and re-list to NYSE? Moelis had commons in the range of $14-$17 after warrants and JPS conversion dilution. That adds a lot of Tier 1 capital over the current price of ~$2.20.

 

FnF's capital has nothing to do with the market price of the commons.

 

There is also no guarantee of any price appreciation after said events, let alone enough to get the price above $4 for 30 days to re-list. For all the good news FnF shareholders got in the last 16 months, the price is around 40% lower than it was at the end of January 2019.

 

A reverse split is the only realistic way to get an over-$4 share price to stick, and I fully expect it to happen later this year. Somewhere between 1:10 and 1:20 is my guess for now.

 

Moelis 2.0 is completely unrealistic anyway. Why would junior pref shareholders sign up for a plan that involves them converting at a re-IPO price in the teens (a far worse ratio than they could get right now in the open market), and giving existing common holders a much greater return than the junior prefs themselves?

 

OK, thanks for correcting me nicely. Stupidly confusing market cap with capital, to say the least.