Freddie Mac CEO Casts Doubt on Joint $125 Billion Fannie Funding

[SimSla]

Freddie Mac CEO Casts Doubt on Joint $125 Billion Fannie Funding

Jesse Westbrook and Steve Matthews

,

Bloomberg•May 21, 2019

(Bloomberg) -- U.S. regulators want Fannie Mae and Freddie Mac to build up massive amounts of capital before being freed from government control. Freddie’s outgoing chief executive officer says that’s easier said than done.

Don Layton, who plans to step down July 1, said Tuesday that a capital plan issued a year ago by the companies’ regulator would require the mortgage giants to raise a combined $125 billion, in part by selling shares. To underscore how big a figure that is, Layton noted that the biggest initial public offering ever was Alibaba Group Holding Ltd.’s, in which the online retailer raised $25 billion.

Layton, speaking at a Federal Reserve conference in Florida, said it might take a stock sale and four to five years of Freddie retaining earnings to get to the $50 billion capital level envisioned under the Federal Housing Finance Agency’s June 2018 proposal. He also questioned whether any unresolved issues -- such as the federal government’s huge stakes in Fannie and Freddie -- might dampen investor demand for the companies’ shares should they hold IPOs.

“This is unprecedented to my knowledge,” Layton said.

The comments provide some insight into why Congress has failed for more than a decade to agree on a plan for fixing Fannie and Freddie, and why the Trump administration will face hurdles in its current push to end their conservatorships. The companies, which backstop about $5 trillion of mortgage securities, received a taxpayer bailout and were taken over by the government at the height of the 2008 financial crisis.

Fannie and Freddie don’t issue mortgages. Instead, they buy loans from lenders and package the debt into bonds that are sold to investors with guarantees of interest and principal. The process makes housing more affordable, while keeping the mortgage market humming.

FHFA Director Mark Calabria said in a Monday speech that he’s determined to free Fannie and Freddie from federal control, and that doing so will be “driven, first and foremost, by their ability to raise capital.” To protect against losses, he said he wants them to have buffers that are essentially the same as giant Wall Street banks.

While Calabria hasn’t laid out a clear plan for how he envisions Fannie and Freddie getting to his desired capital levels, he said it will require ending a 2012 policy implemented by the Obama administration that forces the companies to send their profits to the Treasury. He added that holding a “public offering of some kind” will probably be necessary.

--With assistance from Austin Weinstein.

https://finance.yahoo.com/news/freddie-mac-ceo-casts-doubt-160914523.html

[skibrian]

I would be very nervous holding a majority common position.  Risk reward seems difficult.  A follow on public offering to raise capital will dilute current common owners (currently ~20% ownership in each company) to something well below that.

Ugh.  There is a reason common isn't up as much as preferred.  I don't know the aggregate investor psychology, but I would certainly be offsetting risk in common with a larger position in preferred.

For the record, I am all in preferreds, no common since May 2011.  I sold my common at $3.20 (FMCKJ 25's) back then.

I could see dilution bringning value down below $1 for current holders. 

for all you thinking you'll see a $60 price target again, that will be well after recap is complete and you are diluted beyond what you might be imagining.  The investors in the secondary offering envisioned will get the best deal as they will negotiate and dictate terms.  Without a recap plan, today's common stock would be worth $0.  To salvage any value these guys have to be recapped and released and only after building the capital base will they again be able to declare dividends on common stock.

Common stock value is driven by expected future cash flows for mature companies and nothing else (the cat birds of the world that argue that tech stocks rise without dividends keep missing the point that growth companies and mature companies are very different animals.  When Microsoft finally decided explosive growth had leveled, they institutted their first dividend in 20 years with a special $3 dividend per share, then a much smaller one quarterly going forward.  Yes, even Amazon will one day pay dividends or buy back shares once they have FINALLY built out all their infrastructure.  Someday the cash flow will return to AMZN common shareholders).

Anyway, common stock holder, please hedge your downsides.  The beauty of preferred is the maximum value is known and full rights are baked in with the leverage to negotiate any change in terms.  They will be paid in full before common stock holders see one cent of dividends.

respectfully....

[Chris Roberts]

US govt. stands in as a common holder.  That's their warrant position.

I think common has much better upside than 6.81 vs. $22 FMCCI to be $50 (2.27 ratio)

Moelis has $12 or $14.  I'll go with the smart guys on WS, like Trump.

(Converted to 20% common)

On Tuesday, May 21, 2019 at 12:00:31 PM UTC-5, skibrian wrote:

I would be very nervous holding a majority common position.  Risk reward seems difficult.  A follow on public offering to raise capital will dilute current common owners (~20% ownership in each company) to something well below that.

[SimSla]

Common share price is determined by future earnings. Preferred share price is determined by dividends paid. Ponder the situation where the companies do not pay dividends for the next 5 years because they need to build capital and come back to tell me which is the best trade. There is a better chance preferreds drop in value than for the common to be zero at any point in time going forward.

On Tuesday, May 21, 2019 at 12:00:31 PM UTC-5, skibrian wrote:

I would be very nervous holding a majority common position.  Risk reward seems difficult.  A follow on public offering to raise capital will dilute current common owners (~20% ownership in each company) to something well below that.

[neo]

Per skibrian ... “for all you thinking you'll see a $60 price target again, that will be well after recap is complete and you are diluted beyond what you might be imagining.”

... this has been and remains my biggest fear ... once the bankers get their grubby little hands on this deal all bets are off as to what they will do to maximize profits for themselves and new shareholders they entice to buy in ... these new shareholders will NOT be mom & pop but institutional shareholders who will behind the scenes demand as much as they can get for as little as they can give ... unless we get a nice court victory they will continue on with the ruse that govt keeps what it has taken and FnF needs a large capital infusion done with some sort of restructuring.... we may still do ok, but I fear banker greed ... FYI I am 100% in common

[neo]

To be clear I am all common because minus any shenanigans there is much more upside, especially if any court comes to their goddamned senses... the one saving grace could be that the govts interest in commons/warrants (which I believe should be declared illegal, but that’s a whole other battle) could keep them from destroying current common holder value

Past history from railroad & steel industries almost certainly guarantees the return of our companies to private shareholders and a real court with balls would find in our favor returning excess capital payments to the companies negating the need for raising billions through new offering ... in a just world capital gets returned to companies, capital retention is allowed, after couple of years preferreds get their divies, & commons return to pre-crises levels in 3 years or so

[skibrian]

I agree with Tim Howard.  Calabria needs to shut up.  But he won't.

Reporting I can't verify is on Seeking Alpha now...Liz Kiesche.

"He said that common shareholders are part of the discussions.  Existing shareholders could see their stakes shrink if the GSEs issue and sell new shares to build up the capital needed." [bad for common owners]

This sounds like she is rephrasing his speech.  But that's the first reporting I've heard confirming common shareholders are "in the room" discussing.  [good for common owners]

Is there some reporting out there that we are missing that can confirm her scant details?  Sorry I don't have link.  It was emailed to me and I'm on my phone.

---ski

[skibrian]

here's where she was grabbing her facts...here's the initial reporting...

https://www.marketwatch.com/story/fannie-freddie-shareholder-payout-is-part-of-the-reform-discussion-regulator-says-in-surprise-move-2019-05-21?siteid=yhoof2&yptr=yahoo

Fannie, Freddie shareholder payout is part of the reform discussion, regulator says in surprise move

Published: May 21, 2019 2:49 p.m. ET

New regulator’s task: Disentangling the hornet’s nest of temporary patches that have propped up the housing finance system for the past decade

By

AndreaRiquier

Bloomberg

There may be a payout for the common shareholders of Fannie Mae and Freddie Mac.

Shares of Fannie Mae FNMA, +2.96%   and Freddie Mac FMCC, +2.59%   surged Monday after their chief regulator emphasized that the two mortgage enterprises would be allowed to hold their capital instead of sweeping it to the Treasury Department.

But Mark Calabria, who has helmed the Federal Housing Finance Agency since April, went a step further. In a public appearance in New York, Calabria affirmed that his agency and the Treasury Department have been discussing ways to allow Fannie and Freddie to raise additional capital.

“It would likely take a very long time to build sufficient capital through retained earnings alone,” he said. That’s obvious from a quick look at the math — the two companies made about $25 billion last year. The former FHFA acting director said the two companies could need up to $200 billion in capital, and some analysts say that number could stretch even higher.

In a subsequent appearance on CNBC, Calabria mentioned that the companies’ common shareholders are part of the discussions now underway, a comment that took many housing finance observers by surprise.

“Existing common shareholders have not been a significant part of the discussion,” said Brandon Barford, a partner with Beacon Policy Advisors, a boutique research firm. Before co-founding Beacon, Barford worked alongside Calabria on the Senate Banking Committee at the height of the crisis. “Frankly, there hasn’t been a lot of emphasis on the mechanics of how this would work. I’m curious about that and I’m not sure that’s all been worked out in FHFA, let alone in negotiations with Treasury.”

TimeFannie MaeSep 16Jan 17May 17Sep 17Jan 18May 18Sep 18Jan 19May 19

US:FNMA

$0$1$2$3$4$5

Calabria’s comments on CNBC, on the sidelines of a major industry gathering, were somewhat rushed as he tried to explain the nuances behind the notion of a “public offering” for companies that already have shares outstanding. Holders of common shares “were never wiped out,” he said. “Whether we can do some kind of conversion with preferreds, or whether they would get par, it’s way too early to figure that out.”

As a reminder: the plan that rushed Fannie and Freddie into conservatorship as the financial system melted down in 2008, and subsequent amendments, gave the Treasury Department warrants representing about 80% of each enterprise, payable as “senior preferred shares.”

There are also outstanding preferred shares, many owned by well-known investors like John Paulson, and common shares (Bill Ackman’s Pershing Square is one of the biggest single shareholders of the common stock.)

As MarketWatch has previously reported, there is broad agreement about the basic outlines of what the future housing finance system should look like. But the stickier questions remain: how to disentangle the hornet’s nest of temporary patches that have propped up the housing finance system for the past decade in a way that’s fair to everyone.

What if Treasury just sold its warrants? That would keep taxpayers whole – it was the public purse that backstopped Fannie and Freddie during the crisis, so it seems only fair to many observers – but it wouldn’t raise new capital. Conversely, if Treasury were to write off its investment, or gift it back to the companies, it would “be giving up a lot of money that could be paying down the deficit,” in Barford’s words.

Related: Congress wouldn’t do it, so Fannie and Freddie reformed themselves

What if the two companies issued more stock? That would “dilute” the value of the shares currently outstanding, in market jargon.

Barford described the conundrum thus: “to the extent that there’s dilution of current shareholders, that creates controversy. Paying out at par – well, those enterprises wouldn’t have existed if not for the government stepping in.”

It’s also important to note that anyone with any power over Fannie and Freddie’s future must tread lightly when discussing their fates. After MarketWatch reported on internal FHFA discussions on ending the conservatorship in January, a watchdog group suggested insider trading may have been involved.

Yet figuring out what to do is just half the battle. Making it happen – lining up investment banks, wooing interested investors, explaining the companies’ story to capital markets – is another battle.

Calabria on Monday emphasized multiple times on stage and on television that the process of figuring out next steps was, in fact, a process – “not calendar dependent,” as he put it.

But nothing in Washington operates independently of the calendar. Barford has an uneasy eye on the 2020 elections. If President Trump does not win re-election, he thinks a Democratic Treasury secretary might fight any efforts to bring more private-sector market participants into the housing finance system.

Also on the minds of many observers: the aging business cycle. The next downturn in housing won’t look like the last one, but it may cause Fannie and Freddie to have losses that complicate the narrative for capital markets. And bearish conditions in financial markets may make a big public offering more difficult.

“Housing’s hard,” Barford said. “The details are really hard. I think they’re going to find so is the financial engineering, especially in this very politically charged environment where there’s issues of equity involved.”

[skibrian]

CNBC interview:

https://www.cnbc.com/video/2019/05/20/fhfa-chief-wont-wait-for-congress-to-take-frannie-and-freddie-public.html

[XXX]

"He said that common shareholders are part of the discussions. Existing shareholders could see their stakes shrink if the GSEs issue and sell new shares to build up the capital needed." [bad for common owners]“

Skib,

This is about as interesting as all bachelors are male. Sure, an ipo dilutes commons, but that’s hardly news. I’m not busting on you. You obviously get that recap isn’t a free ride. My point is singular. That potion of the report isn’t negative. It’s just, well, the cost of recap. The cost of the trade.

[joseph s]

As long as ppl understand that there is a possibility of more dilution due to a poor capital market, poor housing market or a low valuation dampening returns

[Dave _]

Again with the Fannie / Freddie were going to die narrative. I wish they'd stop threading that into things.

[Chris Roberts]

Dilution - Moelis lays out the dilution - except maybe if Calabria says you need 5% when Layton (who has seen the estimates) says 125 to 150 (I think Moelis was 160 to 180B)

At 160-180, the valuation is $12 to $14 PPS.  Note that feet dragging has positively impacted the money in the coffers, and continues to do so.

Poor capital market - Unless world unravels, market will absorb this; and, if only $9 to $10 instead of $12 to $14, then that 10% to 20% less that conversion nets would buy 10 to 20% more of your next big stock.

Poor housing market - that would / could / might impact the PPS.  Hand-in-hand with capital market, I think the long-term prospects are more important here. Poor housing market would mean no competition from banks, perhaps.

MOST CRITICAL - they can't be wishy-washy about the business model.  As Layton lays out, the earnings of $20-$25B a year support valuations. Also, he says they have done a lot administratively. CRT and limiting non-core business.  IF the model is mostly the same, the GSE are valuable as common.  Layton also suggest JPS take less than par; I do not see that happening, but if it did, common enhanced a bit, but also, back-dividends of any sort to JPS would be negative to the kitty.

At $22 for the 'cheapies', common at sub-$3 is a very fine play, IMO. Not a recco, etc., etc.

(I expect the big news to move common 2x and cheapies to $35 or so - common has been $6 on less known prospects.  The JPS is like the Queen Mary in their movement up, as $33B in valuation is a lot to move quickly)

[joseph s]

I agree mostly. The stock has not been 6 since pre cship.

Calabria does want to slowly move the biz model.

Not a recco

[Chris Roberts]

In mid-March 2014, it hit mid to high 5's - thought it touched $6, but I guess not.

[18436572]

In March of 2014 FMCC hit an intraday high of $6.00 (I actually sold some of those), FNMA did an intraday high of $6.35.

[Chris Roberts]

It was wacky - not sure the deal... short squeeze (temporary) or someone thought they got wind of a plan?!

In any event, no one blinked an eye when the Mnuchin 2016 rally hit.  That was a long time ago.

Again, Common will spike hard and preferreds are stuck in neutral - and then catch up.

Like our numbered friend, you would want to be nimble and exit common and back to preferred when you felt happy with results.

Just sayin', not a recco (tax consequences for some might preclude - I get that)

[joseph s]

I stand corrected. On March 7, 2014 it hit 6 and closed at 5.33

On March 11th, it hit 6.35 and closed at 4.03.

It hit 6 briefly on two biz days out of 3.

[XXX]

Wowza. I didn’t remember those intraday highs!

[joseph s]

Might be bogus prints, but they show on historical prices

[Brian Adams]

I distinctly remember $6.35. That was easily the craziest day in FNMA trading since I got in in 2010.

I ended up selling the falling knife at $5.50 if I remember. It was so illiquid and falling so fast I had to put my limit order in $.25 below the last trade just to get a buyer and make the trade go through.

Ended up buying back in a few days later around $4, at which point it eventually tested sub $1 again as we all know.

But as said above, if it was $6.35 before on the dim prospects then, it should be at least that again. Soon, I think. I often calculate where I'd be at $6.35 with my current allocation.

What a ride. I won't miss it. Ready to wrap this up and go back to biotechs.

[Crownjewels]

I suggested that Maloni use this when he commented in his recent blog Layton at the Fed event.

Freddie and Layton touting their CRT success is bullshit.

They are not transferring risk. More often then not, they are transferring positive monthly payments from decent loans, i.e. those that bring revenue into the GSEs coffers not the other way around, under the guise of hewing to an FHFA line about reducing their portfolios.

&^%$#@* bureaucrats, at Freddie and FHFA.