Treasury’s Long GSE Capital To-Do List
As the year ends, the momentum for the two government-sponsored enterprises (GSEs), Freddie Mac and Fannie Mae, to exit conservatorship after more than a decade is palpable. The head of the Federal Housing Finance Agency (FHFA), their regulator and conservator, talks about it frequently, focusing naturally on the issues under his control to prepare the companies to sell new shares, and to prepare his agency for a post-conservatorship environment. He mentions dates as early as the beginning of 2021 for actual capital-raising transactions.
That’s all well and good, but it’s hardly sufficient. The other side of the equation – getting global equity investors ready to purchase extraordinarily large amounts of equity at reasonable valuations – falls more to Treasury to address or worry about than FHFA. And there are many issues that Treasury needs to address before investors will, indeed, be ready to purchase equity. In fact, I list no less than 14 of them in my new paper, Treasury’s Long GSE Capital To-Do List: Clearing the Decks for Investors. And some of them look like they may take a long time – possibly well past the beginning of 2021 – to resolve before investors can properly do the analysis to value the shares in order to buy at a scale and valuation matching the companies’ readiness to sell.
Some issues are obvious. How is the projected $240 billion of senior preferred shares in the two companies, owned by Treasury in exchange for it providing funds to support the companies during conservatorship, to be resolved? How will another $33 billion of junior preferred shares, owned by the public, be resolved? What fee will Treasury charge the GSEs for its ongoing support when conservatorship ends, which will likely materially reduce their earnings? Not only does Treasury need technical solutions to these issues, it needs to face what may be very strong and negative political reaction in Congress to its choices, which can complicate, slow, or even stop any conservatorship exit.
Some are not so obvious. How will the separate equity sales by the two GSEs be coordinated so they don’t crash into each other in the marketplace, causing one or both to become failures? What promises will Treasury make to purchasers of newly-issued equity in terms of how long it will hold off before selling the shares it obtains via exercising the 79.9 percent warrant it has on the common stock of the two companies, which was part of the original takeover more than a decade ago? Will the FHFA somehow maintain power to set the politically-sensitive guarantee fees of the two companies, even after they exit conservatorship?
And what will happen with the well-publicized court cases in which certain owners of the historic (i.e. pre-conservatorship) equity are suing the government for taking excessive value from the companies when it implemented, at the end of 2012, the “net worth sweep,” in which virtually all profits of the companies went to Treasury (and which was ended this past September)? Will they be settled? Will Treasury win or lose in court? Or will the cases continue for several more years, preventing any equity raises as the outcome could dramatically help or hurt the value of the shares?
All of these questions will need answers before investors will know enough to properly value the shares, which is a requirement before any new equity raises are possible on the scale required.
Treasury is surely working on these issues, but it is characteristically silent about them, following the standard procedure that it should only speak about a market-impacting topic when there are concrete results to announce. Therefore, the timing of how these issues will play out is quite uncertain.
And, of course, one must ask: “What’s the rush?” The companies are now retaining earnings and only need to do equity raises via new stock sales in order to speed up their eventual exit from government control. Since some of these issues will be easier to solve later rather than sooner, perhaps the balance will shift over time with the government deciding to emphasize somewhat more retained earnings and somewhat less (and later) stock sales?
My conclusion in the new paper, therefore, is that everyone should be less excited about near-term stock sales, expect it to take longer before investors can properly value and purchase the shares in the required large size, and that more retained earnings in the mix is probably not a bad thing.