FREJN - White House And Treasury Can Solve Affordability Crisis With GSEs

2023-11-16 01:51:46 ET

Summary

• Fannie Mae and Freddie Mac are still in conservatorship despite their record-high net worth and profitability.
• There is a path to accessing funds to solve the affordable housing crisis.
• The Biden administration has the opportunity to secure a future of equal opportunity affordable housing, and there is a sense of urgency.

Fannie Mae ( FNMA ) and Freddie Mac ( FMCC ) are two companies still in conservatorship despite making more money than ever before and having more net worth than ever before. It can be argued that:

1. There is an affordable housing crisis .
2. The companies have been reformed .
3. There is a path to accessing $100B to solve the affordable housing crisis.
4. There is a sense of urgency.

The Biden administration can lock in its future of housing finance reform and allocate the $100B if it wants to, but it would have to start moving quickly with direction from the White House or the US Treasury.

Fannie and Freddie shareholder Gary Hindes wants to know " When do we get our companies back? " Gary Hindes led Delaware's Democratic party, helping Joe Biden build a prodigious network beyond its narrow borders. So far, the Biden administration has been unresponsive toward any restructuring initiatives or requests. In about a year we will have a general election and President Trump is leading in the polls . Previously Trump wrote a letter saying that he would end the conservatorships if he had a year or two more time without an Obama-era official incumbent that he could not fire. If the Biden administration does not take action, eventually a Republican administration will release Fannie and Freddie and implement their policy objectives in the process and likely void a lot of Biden's policy objectives that Biden could have locked in, a potentially easily missed opportunity to secure a future of equal opportunity affordable housing.

Investment Thesis

As Gary Hindes points out, Fannie and Freddie's combined net worths are at record highs and they returned to profitability over a decade ago. On August 14, a jury ruled that the government acted in bad faith when it imposed the Net Worth Sweep. Lawyers representing plaintiffs and the government will be posting a joint motion for calculation of prejudgment interest on Friday. Then, we can expect Lamberth to enter a final judgment for the shareholder plaintiffs against the government. Junior preferred shares currently trade at less than 10 cents on the dollar despite the only possibility of them being zeroed out or impaired (receivership) being well off the table noting prior CEO of Freddie Mac Don Layton's comments that "Given the existing level of capital at the two companies, the probability of taxpayers having to inject more funds into the GSEs is approaching levels that I believe are so small they cannot be statistically measured." In any recap and release, if junior preferred refuses any conversion offer, dividends would eventually resume when common dividends resume and junior preferred would appreciate closer to or above par value depending on the series.

Is Conservatorship Undermining Established Solvency Law?

Prior FHFA director Mark Calabria got hired on to lead FHFA where he stopped the cash payments from Fannie and Freddie to Treasury after he wrote a paper "The Conservatorships of Fannie and Freddie Mac: Actions Violate HERA and Established Insolvency Principles".

Investment titan Bruce Berkowitz this past month gave an interview on WealthTrack saying that his experience with the government's handling of Fannie and Freddie now makes him:

more hesitant to deal with highly regulated businesses where one civil servant can decide whether a very large company lives or dies based upon a perception of social good and without any respect for owners.

In fact, the Fannie Mae and Freddie Mac situation made me think that ownership is becoming an illusion in highly regulated companies.

Jury Verdict Pending Lamberth Judgment

On August 14, a jury ruled that FHFA violated reasonable expectations when arranging the net worth sweep:

Lamberth has not yet issued a judgment on this. Judgment in favor of plaintiffs is expected later this year.

Stress Tests Reveal Reformed GSEs

Gary Hindes points out in his letter that even if there was a 38% housing price decline that Fannie and Freddie would earn $9.9B according to their stress tests. He argues that after 16 years of conservatorship and all-time highs in shareholder equity this last quarter there simply is no legitimate reason to keep these companies in conservatorship any longer.

FHFA Annual Performance Plan for FY 2024

The number 1 strategic goal jives with being adequately capitalized outside of conservatorship:

• Strategic Goal 1: Secure the regulated entities' safety and soundness

The only potential blocker I foresee to achieving this goal may be addressed by this Annual Performance plan, possibly as soon as this year:

• 1.3.3 | Issue a final rule enhancing the Enterprise Regulatory Capital Framework (ERCF) | Target: December 31, 2023
• Measure 1.3.3 - FHFA will publish a final rule amending the ERCF to address guarantees on commingled securities, multifamily loans secured by properties with a government subsidy, derivatives and cleared transactions, and to make other enhancements. The final rule will be published in the Federal Register and on FHFA's website.

This final rule may address the disconnect between the ERCF and G-fees that would address the issue of commercially reasonable returns. Earlier this year, FHFA pointed out :

The Enterprises are in the process of phasing in the effects of the ERCF by gradually increasing returns over time to help ensure that they achieve commercially reasonable returns

This final rule may address the responses to the RFI with respect to the following two questions:

1. What is an appropriate long-term commercially reasonable return on capital threshold for the Enterprises to achieve?
2. Should risk-based pricing be calibrated to the ERCF?

Calabria originally forecasted IPOs in 2021, so I am not sure if these questions mentioned above are that important to reprivatizing Fannie and Freddie, I just take an interest in the back and forth here.

FHFA 2023 PAR

FHFA issued its FY 2023 Performance and Accountability Report on November 8. I have bolded the part that I want to emphasize:

FHFA continues to strengthen the safety and soundness of its regulated entities. In March 2023, FHFA published a notice of proposed rulemaking to further enhance the Enterprise Regulatory Capital Framework (ERCF) that would implement the lessons learned through the continued application of the ERCF, adopted in FY 2021, and better reflect the risks inherent in the Enterprises' business models . FHFA also issued guidance, such as Advisory Bulletin 2023-03 on model risk management, to address and set expectations for the regulated entities' business practices

...

In May 2023, FHFA also published a request for input ((RFI)) on the Enterprises' single-family pricing framework to gather further feedback regarding the goals and policy priorities FHFA should pursue in its oversight of this framework. Together, these steps will strengthen safety and soundness, better ensure the Enterprises fulfill their statutory missions, and more accurately align pricing with the expected financial performance and risks of the underlying loans.

It looks like the FHFA is looking to align risk with pricing to me as part of this final rule amending the ERCF in the next month and a half. As an aside, it looks like FHFA has not met their stated goal as follows:

1.3.1: Provide decision to Enterprises regarding completeness of resolution plan submissions in conjunction with readiness activities | July 31, 2023 | NOT MET

They probably want to have resolution plans in place before moving forward with letting Fannie and Freddie chart their path out of conservatorship. Be not worried for FHFA's 2024 plan has this target for December 31, 2023:

1.3.2 | Assess the resolution plan submissions against applicable regulatory standards and requirements | December 31, 2023

This is shaping up for an interesting end of year 2023.

Enterprise Regulatory Capital Framework

FHFA spoke to the annual capital plans in this section:

Finally, FHFA implemented requirements that each Enterprise submit annual capital plans to FHFA and provide prior notice for certain capital actions. The capital planning requirements allow the Enterprises to identify the amount of capital they need to raise to meet the requirements in the Enterprise Regulatory Capital Framework and to consider the timing of when to raise capital and what types of capital to raise. The amendments help provide a stable regulatory capital framework for the Enterprises as they continue to build capital, as well as after they achieve adequate capitalization under the Enterprise Regulatory Capital Framework.

Note that it is impossible for this capital planning rule to have any practical application with the SPSPA currently laying siege to the companies' earnings and their balance sheets with terms that crowd out any chance of attracting third-party capital as hypothecated by the executed US Treasury agreement with Fannie Mae and Freddie Mac .

Thoughts On Timing

Prior White House National Economic Council Director Brian Deese posted a month ago that "We need more active fiscal policy on housing. We need to incentivize the building of affordable housing. We should do that now, and not admire the problem in 2025,25,27." His replacement, Lael Brainard, is scheduled to speak on December 7 at the National Press Club with FHFA's Sandra Thompson. The 2023 Solutions For Affordable Housing's event posts a focus of:

Our focus is on housing priorities that are tangible, impactful, and achievable.

It is hard for me to imagine that such an event could be held with the head of the WH and the head of the FHFA both speaking where a solution that addresses the affordable housing crisis ignores the potential combination attack of government spending of $100B plus locking in of future administrative priorities.

Summary and Conclusion

The companies' 16,000 employees of these public companies and their thousands of shareholders want to at least know what the reason is for the continued conservatorship at this point where:

1. The companies have more net worth than ever before in history.
2. The companies have been profitable for over a decade.
3. The companies will be profitable during a 38% housing price decline.
4. A jury ruled the government acted in bad faith when arranging the NWS to prevent the companies from exiting conservatorship.
5. The administration that lets them out of conservatorship gets to lock in their policies for future administrations.
6. The government is no longer incentivized to keep them in conservatorship. In fact, financially they are incentivized to end the conservatorships.
7. The administration that lets them out can allocate ~$100B.

Shares of Fannie and Freddie junior preferred stock trade at less than 10 cents on the dollar -- which indicates that people have given up on the Biden administration's ability to make a rational decision and a series of Democrat-only presidencies are similarly situated for the foreseeable future.

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