Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) are two companies in conservatorship where the government takes all their money for itself less a $3 billion capital buffer on each. The government also has over $180 billion in liquidation preference, should they be placed into receivership. Bloomberg's Joe Light first put out the summary here. FHFA says 3.24% capital would have prevented the companies from needing to be placed into conservatorship. FHFA's director, Melvin L. Watt, made the following statement regarding the publication:
We think it is important for FHFA, as the prudential regulator for Fannie Mae and Freddie Mac, to articulate our views on capital requirements and to start a healthy discussion about the amount of capital the Enterprises should have to appropriately shield taxpayers from assistance.
Wes Anderson from the Community Mortgage Lenders of America pointed out at the last GSE hearing that Director of FHFA Watt has the authority to require a GSE that does not meet the minimum or risk-based capital standards to submit a capital restoration plan. I expect this to take place after the 60-day Q&A period regarding the Proposed Rule on Enterprise Capital that started yesterday. It is more than ironic that FHFA's capital plan calls for 3.24% capital, which is the same as the Moelis plan's 3.25%. The Moelis plan puts common shares $8-13 and preferred shares at par as part of a 2-year long recapitalization where the companies issue new common and preferred to build capital as well as retain earnings.
Has All The Markers Of An Insider Deal
If you ask me, there is a lot to be said about this being an insider deal. Trump flipped a coin with Moelis over $1 million. Brian Brooks, who is now at Fannie Mae, used to work with Mnuchin at OneWest and is now lobbying specifically for administrative action. The OneWest operation was funded by John Paulson on Mnuchin's analysis. Trump's ties to Blackstone are strong, and the Moelis plan was put together on behalf of John Paulson and Blackstone. John Paulson was deeply involved in Trump's run for president.
The Moelis plan seems to appear to be the framework that FHFA used to build its Proposed Capital Rule. The chief problem to solve in any recapitalization is: "Just how much capital can these companies raise at any given level of g-fees." From there, the goal has always been to show that the bailout wouldn't have been necessary.
Rob Zimmer eloquently points out:
What prevents FHFA from mandating excessive non-cash writedowns that juice up the "bailout" amount?
This is basically what happened here. Lawsuits were filed against the auditors who signed off on the financial statements, and one was settled while the other was dismissed due to the prevailing interpretation of HERA 2008 letting the government do whatever it wants. It would seem that we need a court victory or perhaps legislation that prevents accounting-based contracts that put the GSEs at the discretionary mercy of people who benefit from making them look as bad as possible.
The real question to ask here is, "What prevents the government from enacting a second conservatorship where they implement the net worth sweep on the first day?" Currently, the prevailing legal interpretation of HERA doesn't provide any answer. That is to say, the government can take the companies with $180 billion of capital in 2020 if they are to be recapitalized and force the board members to sign them into conservatorship where they arrange for the net worth sweep that same day. $180 billion would get swept to the government and shareholders would be furious, but that's not much different from what has happened so far in this conservatorship. Many lawsuits have been filed, but no injunctive relief has yet been achieved.
Another reservation is the future level of guarantee fees. Consider, for instance, that the expectations of future guarantee fee levels is what drives investor expectations for how much the companies will earn going into the future. If you look at the Moelis plan, guarantee fees are set in order to carry out a capital raise of 3.25% over two years. What prevents guarantee fees from being lowered in the future? Will they always be set based on capital requirements? I don't really know, but it is disappointing to speculate that the net effect of conservatorship on the actual business here is an increase of guarantee fees - one that I'm not sure I entirely agree with, but it is what it is.
Josh Rosner's Analysis
If there ever was a man - you know, a man among men - Josh Rosner would be in the contending. He would have to be:
With FHFA having a Proposed Capital Rule applying post conservatorship, the companies will have to come up with a capital restoration plan if Watt wants to do his favorite thing on earth: fund affordable housing trust funds.
If you're wondering how the net worth sweep gets handled, HERA provides restrictions on capital distributions if the regulated entity is undercapitalized:
This is a done deal by those mechanics. What do you think? Share your comments below.
Summary and Conclusion
FHFA's Proposed Capital Rule basically is identical to the Moelis recapitalization plan. This is a huge step. The next step is to have the GSEs put together capital restoration plans after a rule like this is put into place. The Moelis plan puts preferred at par and common at around $8-13.
Disclosure: I am/we are long FMCCH, FMCCI, FMCCL, FMCCN,FMCCP, FMCCT, FMCKP, FNMFN, FNMFO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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