Saturday, August 6, 2016

Thoughts on GSE's

1) Before the GSE shareholders can get anything the government is entitled to be paid back with interest.  ETA is 2017 year end.

2) Before the GSE's can be released from conservatorship they must have adequate capital.
   a) Someone has to make a decision and actually determine what is adequate capital.
      Historical ratio = 0.45% - near unanimous opinion that it needs to be more
      Ackman recommends 2.5% capital ratio or $123B
      Mulvaney bill called for 5% or $250B
      Corker-Warner and Johnson-Crapo called for 10% or $500B
      The UST has officially stated 10% too, but internal memo states 3-4% would be adequate.
   b) Where is this $125B-$500B going to come from?
      Ackman projects that just allowing the GSE's to retain earnings until the end of 2024 will build up capital to his recommended 2.5% ratio.  However, the FDIC precedent is to dilute the shareholders through a share issuance.  For example, if all of the warrants for 7.2 billion shares in both GSE's are cancelled (government is not entitled to anything after it has been paid back with interest), then the 2.5% capital ratio could be raised by selling 7.2 billion new shares in both GSE's at at price of $17 per share; a discount to the $23 per share as shown on slide 104 of Ackman's slide deck "It's Time to get off our Fannie".

However, if the government insists on a 10% capital ratio then a capital raise via a share issuance is a non-starter without higher g-fess (and therefore higher interest rates on mortgages).  Ackman's slide 104 shows that using a 14x earnings multiple and a 60 bps G-fee that the value of the GSE's is $206B.  Rational market participants should refuse to invest $500B of capital for $206B of value.  

SUMMARY - insisting on a 10% capital ratio without increasing g-fees (g-fees would need to be approximately 217 bps to attract investment) may be the government's strategy to prevent the GSE's from ever going (pretend) private again.

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