navycmdr
11 시간 전
FYI email - From Rule of Law Guy
A Hypothetical Valuation of GSE Common Stock (and Junior Preferred Stock for Context and Comparison)Hopeful Assumptions, Necessary Conjectures, IRRs, Ifs and Buts, Valuing FNMA Compared to FNMAS
Rule Of Law Guy - Dec 12
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Let’s assume we think there is a reasonably good probability that the GSEs will be recapitalized and released from conservatorship (“recap/release”) during Trump 47. The question arises whether one should try to profit from this opportunity by an investment in GSE junior preferred stock or common stock.
This is a question that can be approached by assessing an investor’s investment time horizon, risk appetite and investment objectives, and considering the necessary assumptions and valuation conjectures necessary to value the respective investments, which I will address in this free public post.
For purposes of this exercise, I will compare an investment in (i) FNMA, Fannie Mae’s common stock, and (ii) FNMAS, the series of Fannie Mae junior preferred stock that has the highest dividend rate and most liquidity. Full disclosure: I own FNMAS.
It is important to keep in mind that this exercise will depend on some important assumptions about how the recap/release will proceed. The release/recap process may not unfold in a way consistent with these assumptions, and there may even be important political forces that will arise to oppose a GSE recap/release. If the recap/release is not accomplished during Trump 47 or does not proceed in a manner that is consistent with the assumptions listed below, then the GSE investment opportunity, whether FNMAS or FNMA, will prove unavailing.
By engaging in this exercise, my primary objective is to make clear to readers how uncertain and conjectural a valuation of FNMA is, as compared to a valuation of FNMAS, even if all of the assumptions to the exercise set forth below come to fruition.
Aside from questions of uncertainty, until the end of 2027, I expect FNMA’s market trading value to be less than its intrinsic value, while FNMAS’ market value will match its intrinsic value. This may make an investment in FNMAS more suitable than FNMA for some investors, although given a sufficiently lengthy investment horizon, an investment in FNMA rather than FNMAS may make sense for other investors.
Put briefly, FNMA may have more eventual upside, but on a deferred time horizon, than compared with FNMAS.
So, let’s begin.
Assumptions
Let’s assume that the recap/release process takes three years from start to finish, and is fully complete at the end of 2027. I say fully complete for a reason. The process of Treasury monetizing its GSE investment by selling FNMA shares will depress the trading value of FNMA until Treasury’s monetizing program is complete. The full completion of the recap/release process will not depress the trading value of FNMAS after Fannie Mae closes its first public offering (likely a combined primary offering by Fannie Mae of newly-issued shares to raise additional capital, and a secondary offering by Treasury of its first tranche of FNMA), which I believe may occur as early as the beginning of 2026.
A three year recap/release process from commencement to full completion may sound like a long time to many of you. I beg to differ.
The GSE recap/release plan will require coordination among the GSEs, Treasury and FHFA. This coordination was totally absent in Trump 45, and we all should be looking for signs of its presence in Trump 47. For example, the GSEs can’t hire investment bankers and put together capital restoration plans leading to recap/release until they know what capital targets they must hit and when from FHFA, and what Treasury will do with its senior preferred stock (“SPS”). At some point, hopefully early in 2025, a comprehensive and cohesive plan emerges from these participants.
My experience is that (i) financial transactions on Wall Street take longer than initially expected, (ii) large Wall Street financial transactions like the GSE recap/release require a longer than linearly-greater timeframe when compared to smaller transactions, and (iii) there will likely be unnecessary impediments, such as for example Congressional hearings seeking oversight over the process, even though Congressional authorization is not required.
Treasury will likely look to sell its common stock in the public markets in several underwritten offerings over a period of time. During this time, the overhang represented by a motivated shareholder seller selling down 80% (based on another assumption set forth below) of the fully diluted Fannie Mae common stock will depress FNMA’s trading price until Treasury’s selling program is complete. That market price overhang for FNMA would continue until the end of 2027 by my estimation.
So if we are to compare anticipated market equilibrium trading prices of FNMAS vs. FNMA in order to compare their investment return over time if an investment is to be made now, we should expect FNMAS’ trading price to reach its post-conservatorship market equilibrium price much sooner than FNMA’s trading price, likely two years earlier in my view. If one’s anticipated holding period for any Fannie Mae investment is not three years or longer, then one might be inclined to invest in FNMAS rather than FNMA.
Let’s also assume that Treasury decides to cancel its Fannie Mae SPS and exercise its 79.9% fully-diluted interest in Fannie Mae common stock. This means that Treasury will own and sell in connection with the recap/release less common stock as a percentage of FNMA outstanding than would be economically justified if Treasury converted its Fannie Mae SPS into FNMA.
As I stated in Glimpsing the GSE Restructuring, one cannot undertake a reasonably coherent valuation for Fannie Mae’s common stock until one is assured that Treasury will cancel its senior preferred stock. As I also stated in Trump Gets Treasury Right, the nomination of Scott Bessent as Treasury Secretary was an inspired choice by Trump for many reasons, but especially for a particular reason relating to Treasury’s senior preferred stock.
One reason why GSE investors should be interested in the Bessent nomination is that Mr. Bessent has a prominent history as a hedge fund investor, and it would have been natural for Mr. Bessent to have observed the GSE conservatorship saga unfold, including the outrageous imposition of the Net Worth Sweep, and the GSE’s subsequent and remarkable full payment of all dividends (at the original dividend rate of 10%) on and principal of Treasury’s senior preferred stock investment.
I have no idea whether Mr. Bessent’s funds ever owned GSE stock and I cannot read his mind. But GSE stock was a crowded trade at certain times within the hedge fund community during the GSE saga, and I have no doubt that given the investment neighborhood that Mr. Bessent lived and thrived in, Mr. Bessent is aware that Treasury’s senior preferred stock has been de facto completely paid off as a financial investment return matter. This lends credence to the proposition that Treasury will cancel its SPS.
To repeat, this assumption that Treasury will cancel its senior preferred stock in the recap/release is at this time of writing an important but hypothetical assumption.
Let’s also assume that Fannie Mae will meet whatever regulatory capital rules are in effect that permits it to pay the full 8.25% FNMAS dividend by early 2026, when I believe the initial offering in the recap/release process will close, and will permit the Fannie Mae board of directors to declare a market dividend rate on FNMA during 2026 and not later than the end of 2027, when I believe Treasury’s sales of FNMA in the recap/release process will be completed.
Treasury will want to maximize its common stock sales proceeds as it sells its common stock during 2026-2027, so that it would be in Treasury’s interest for FHFA to structure the GSE regulatory capital rules (perhaps initially via consent decree with the GSEs) to allow a market dividend rate on FNMA once it commences its selling program. Even if Treasury benefits from this FHFA coordination, Treasury’s own selling overhang will need to be exhausted through sales before the Fannie Mae common stock will reach its anticipated full market value.
Let’s also assume that Fannie Mae projects that during the period of the recap/release and Treasury’s common stock selling program, Fannie Mae earns $18 billion of net income over year, and there is no recession or instability in the financial markets that might frustrate the realization of the recap/release.
FNMA should be able to manage a $18 billion net income yearly run rate in the near future, and may even do better if mortgage rates decline. The assumption regarding market and financial conditions is a standard assumption underlying investment forecasts. These assumptions would support the market’s willingness to buy the FNMA shares offered in the recap/release.
FNMAS Valuation
Based upon the assumptions set forth above, the FNMAS valuation is straightforward. Approximately one year from today, FNMAS would trade at about $25 per share, its par value. This is based on the assumption that the initial public offering in the recap/release process will close in early 2026, and that Fannie Mae will be able to declare dividends on FNMAS going forward from that date at the contract 8.25% yearly dividend rate.
To reiterate, this assumes that there is sufficient coordination among the GSEs, FHFA and Treasury to move forward diligently with the recap/release in 2025, and this coordination results in a regulatory GSE regulatory capital standard that permits the GSEs to declare contract dividends on its junior preferred stock (in order for FNMAS to trade at par), and sufficient dividends on FNMA in order for Treasury to proceed with its FNMA sales at acceptable sales prices.
Given current market rates, the 8.25% annual dividend is at least a market preferred stock dividend rate for a credit such as Fannie Mae. FNMAS will no longer be subordinated to Treasury’s senior preferred stock, which by assumption will be cancelled. Treasury’s FNMA selling program after early 2026 should not affect the trading value of FNMAS.
Assuming FNMAS starts trading at $25 per share at about 1.5 years from now, an investment in FNMAS now at $11.40 per share will yield an internal rate of return (“IRR”) over that period of 68.8%. After this period, the FNMAS yield would equal 8.25% per year, assuming Fannie Mae declares and pays preferred stock dividends, which it must do in order to declare and pay any FNMA dividends. Unpaid FNMAS dividends do not accumulate.
As an investor, one has to decide whether a 68.8% IRR over the 1.5 year holding period is sufficient given the risks that the recap/release will either not be completed, or be completed on terms that are inferior to the assumptions made above.
FNMA Valuation
The FNMA valuation is quite a bit more complicated and uncertain.
I will assess FNMA valuation, which is now trading at $2.70/share, by means of a balance sheet book value test, and an income statement price/earnings multiple test.
Book Value Valuation
In addition to the assumptions listed above, I need to make an additional assumption regarding how much common stock dilution Fannie Mae will suffer in making additional issuances of FNMA in order to satisfy its regulatory capital requirements. This will permit me to come up with a post-recap/release FNMA book value, which should inform FNMA’s intrinsic value going into the recap/release.
There are currently 1.58 billion shares of FNMA outstanding (numbers hereinafter are rounded). Once Treasury exercises its 80% warrant position (and assuming that there is no junior preferred stock-to-common stock conversion feature adopted in the recap/release), there will be 5.79 billion shares of FNMA outstanding. Once Treasury cancels its FNMA senior preferred stock, FNMA’s book value (for which I will use a calculated regulatory capital amount) will be approximately $87.4 billion (see comments to Tim Howard’s recent blog post).
To get to Fannie Mae’s book value per common share pre-offering, subtract out $19.13 billion of junior preferred stock book value, to get $68.27 billion, divided by 5.79 billion FNMA shares, equals $11.79/share.
But we are not done with a book value analysis.
At $87.4 billion of equity capital (or $68.27 billion of common equity capital), Fannie Mae does not have sufficient regulatory capital to support its current book of MBS guaranty business. Fannie Mae needs to issue more FNMA to raise more common equity capital, which will dilute the current FNMA holders ownership percentage.
The question arises whether Fannie Mae’s book value per share will also be reduced by the issuance of new primary FNMA shares. Put simply, if Fannie Mae issues additional FNMA at $11.79 per share, then Fannie Mae’s common stock book value will not be diluted by they issuance of more FNMA stock. In that case, one might argue that FNMA’s intrinsic value should be around $11.79 per share (assuming that common stock per share book value is a good heuristic for its intrinsic value).
So once we estimate what Fannie Mae’s common stock book value will be after the additional primary issuance necessary to raise additional regulatory capital, we will be able to estimate the fair value of FNMA by reference to the post-primary issuance per share book value.
Be aware though that even as we might have calculated a FNMA intrinsic value based upon a book value analysis, we won’t have a reliable indication of what the market trading value of FNMA might be. We would need to further estimate to what extent FNMA’s trading value will be depressed by Treasury’s market overhang of FNMA stock, that Treasury will sell into the market over the next (by my estimation) two years.
Now, back to the question whether Fannie Mae’s book value will be reduced by the issuance of new primary FNMA shares. One way of approaching that answer is to first determine how many additional FNMA shares Fannie Mae will need to issue in order to comply with whatever regulatory capital standard is imposed by FHFA at the initial stage of the recap/release process.
Fannie Mae has two sources of additional regulatory capital: retained earnings and the proceeds of FNMA issuances. During 2025, let’s assume that Fannie Mae can retain $18 billion of earnings, resulting in 2025 year-end equity capital of $105.4 billion. How much additional regulatory capital will Fannie Mae require?
To answer this question, one would need to know whether the new FHFA Director will suspend or amend the ERCF’s current requirements, or enter into a consent decree to pause these requirements until Fannie Mae can add regulatory capital through additional retained earnings and primary FNMA issuances. Moreover, the public equity market may also have its own view as to what would be a minimum capital level to ensure enterprise safety and thus investment merit.
I am going to assume that Fannie Mae will need to raise an additional $50 billion of equity capital during the three year recap/release process (in addition to retained earnings). This could occur in a single primary FNMA issuance early 2026, or more likely a series of primary issuances as Treasury also sells its shares through the end of 2027.
I arrive at this $50 billion amount by reference to the existing ERCF standard, and estimating how much capital Fannie Mae will have to raise under that standard (in addition to additional retained earnings) in order to declare an adequate amount of dividends on FNMA to make it an attractive investment for investors to buy, and for Treasury to sell.
This implies that almost 50% of Fannie Mae’s book value of $105.4 billion at the end of 2025 will have to be added by additional FNMA issuances. To be clear, this additional capital would not be deployed to expand Fannie Mae’s business, but to simply support from a capital safety perspective Fannie Mae’s existing business.
Will Fannie Mae be able to issue $50 billion of common stock without diluting the estimated FNMA book value at the end of 2025, that we calculated as $11.79?
My judgment is no, and the question arises what would be the necessary discount to book value to facilitate raising the necessary additional public offering proceeds.
This will be a market testing process that Fannie Mae’s underwriters will conduct, sounding out large institutional investors in building their underwriting book. There is no way for me, or frankly the underwriters, to make a reliable estimate until the underwriters have heard from the market.
My gut sense is that an offering price that is a 30% discount to pre-offering common stock book value will be necessary to raise the requisite additional capital, which would result in a FNMA public offering price of $8.25/share.
This will result in the issuance of about an additional 6 billion shares of FNMA outstanding, or a total of about 11.8 billion shares of FNMA outstanding after the primary issuances in the recap/release. We will use this 11.8 billion FNMA outstanding share amount for purposes of the price/earnings multiple valuation below.
Now let’s proceed to the price/earnings multiple valuation.
Price/Earnings Multiple Valuation
We have assumed that FNMA will earn $18 billion per year on a sustainable basis. If we select an appropriate earnings multiple to be applied to this earnings figure, we can derive an enterprise equity value. Financial institutions have a range of P/E multiples, but they range generally around a 10X PE. Let’s assume Fannie Mae starts out with a PE of 8X, given that it will be a new issuer in the public markets, albeit a very profitable one.
This implies an equity valuation of Fannie Mae to be $144 billion. Subtracting $19 billion of junior preferred stock value yields a common stock valuation of $125 billion. Dividing this by 11.8 billion shares of FNMA yields an intrinsic value for FNMA based on earnings of about $10.60.
There is one additional step needed. The incremental $50 billion of Fannie Mae capital will earn a return that should be added back into the earnings calculation. Assuming Fannie Mae invests this in short term securities earning 4%, Fannie Mae will earn an addition $2 billion of net income, resulting in a sustainable annual net income of $20 billion, which flows through the above price/earnings multiple calculation to result in an intrinsic value for FNMA of about $11.95 per share.
Intrinsic Value vs Market Trading Value
So I have calculated a FNMA offering price of $8.25 per share, based upon a pre-offering per share book value of $11.79. I have also calculated a post offering FNMA intrinsic value of $11.95 per share, using the price/earnings multiple method and the expected number of shares outstanding post-offering.
Which is right, and do I have any particular degree of confidence in either of these calculations?
Not really. Not because I think the methodologies I used are wrong (although they are not exclusive or even above substantial tweaking), but because securities valuation is as much a practical art as a spreadsheet science, and applying this art/science in the context of a massive recapitalization is extraordinarily fraught with conjecture.
Which of these calculated figures is more likely to correspond to the actual trading value of FNMA in my view, understanding the selling pressure that FNMA will experience from Treasury’s overhang ownership of FNMA? Probably the $8.25 per share amount. If I was pressed for my best guess, I would say that FNMA’s market price will range around $8.25 per share from the initial public offering, assumed to be in early 2026, until Treasury has sold all of its FNMAS shares, assumed to be the end of 2027. Thereafter, FNMA shares may appreciate substantially, depending on market conditions.
Using the $8.25 calculated per share amount as the trading value that will persist for FNMA until the end of 2027 (because of Treasury’s ownership overhang), an investment today in FNMA at $2.70 per share will provide an IRR over the next three year period of about 45%.
Of course, after Treasury’s ownership overhang is eliminated, FNMA shares may appreciate in value significantly, whereas FNMAS shares will likely have a return after 2026 capped at its dividend rate (though FNMAS may appreciate thereafter if market dividend rates go down).
So pick your potion, or your poison.
* * *
As always, this substack provides investment analysis, not investment advice. Do your own due diligence.
navycmdr
16 시간 전
If Trump wants to kill inflation, the first thing
he needs to do is get more homes built
(TRUMP already said he will OPEN UP GOVT LAND for HOUSING)
During the presidential campaign, Trump made deregulation
a cornerstone of his economic platform, and that could spill into the
housing market by opening up federal land for construction and
generally lowering barriers for homebuilders.
Published Wed, Dec 11 2024 - Jeff Cox
Key Points
-- If President-elect Donald Trump is going to push inflation back down to a more tolerable level, he will need help from housing costs.
-- It’s not clear that inflation is consistently and convincingly headed back to the Federal Reserve’s 2% goal, at least not until housing inflation eases even more.
-- The average national rent in October stood at $2,009 a month, down slightly from September but still 3.3% higher than a year ago.
If President-elect Donald Trump is going to push inflation back down to a more tolerable level, he will need help from housing costs, an area where federal policymakers have only a limited amount of influence.
The November consumer price index report contained mixed news on the shelter front, which accounts for one-third of the closely followed inflation index.
On one hand, the category posted its smallest full-year increase since February 2022. Moreover, two key rent-related components within the measure saw their smallest monthly gains in more than three years.
But on the other hand, the annual rise was still 4.7%, a level that, excluding the Covid era, was last seen in mid-1991 when CPI inflation was running around 5%. Housing contributed about 40% of the monthly increase in the price gauge, according to the Bureau of Labor Statistics, more than food costs.
With the CPI annual rate now nudging up to 2.7% — 3.3% when excluding food and energy — it’s not clear that inflation is consistently and convincingly headed back to the Federal Reserve’s 2% goal, at least not until housing inflation eases even more.
“It would be expected that over time, we would start to see year-over-year slower growth in rents,” said Lisa Sturtevant, chief economist at Bright MLS, a Maryland-based listing service that covers six states and Washington, D.C. “It just feels like it’s taking a long time, though.”
Still rising but not as fast
Indeed, housing inflation has been on a slow, uneven trek lower since peaking in March 2023. Much like the overall CPI, shelter components continue to rise, though at a slower pace.
The housing issue has been caused by ongoing cycle of supply outstripping demand, a condition that began in the early days of Covid and which has yet to be resolved. Housing supply in November was about 17% below its level five years ago, according to Realtor.com.
Rents have been a particular focus for policymakers, and the news there also has been mixed.
The average national rent in October stood at $2,009 a month, down slightly from September but still 3.3% higher than a year ago, according to real estate market site Zillow. Rents over the past four years are up some 30% nationally.
Looking at housing, costs also continue to climb, a condition exacerbated by high interest rates that the Federal Reserve is trying to lower.
Until mortgage rates come down we won't see prices come down, says Howard Hughes Corp CEOwatch now
Though the central bank has cut its benchmark borrowing rate by three-quarters of a percentage point since September, and is expected to knock off another quarter point next week, the typical 30-year mortgage rate actually has climbed about as much as the Fed has cut during the same time frame.
All of the converging factors post a potential threat to Trump, whose policies otherwise, such as tax breaks and tariffs, are projected by some economists to add to the inflation quandary.
“We know that some of the president-elect’s proposed initiatives are quite inflationary, so I think the prospects for continued progress towards 2% are less sure than they might have been six months ago,” Sturtevant said. “I don’t feel like I’ve been compelled by anything in particular that suggests that targeting the supply issue is something that the federal government can meaningfully do, certainly not in the short term.”
Optimism for now
During the presidential campaign, Trump made deregulation a cornerstone of his economic platform, and that could spill into the housing market by opening up federal land for construction and generally lowering barriers for homebuilders. Trump also has been a strong proponent for lower interest rates, though monetary policy is largely out of his purview.
The Trump transition team did not respond to a request for comment.
The mood on Wall Street was generally upbeat about the housing picture.
“Rents may finally be normalizing to levels consistent with 2% inflation,” Bank of America economist Stephen Juneau said in a note. The November housing data “will be viewed as encouraging at the Fed,” wrote economist Krushna Guha, head of central bank strategy at Evercore ISI.
Still, shelter expenses “continue to be the number one source for higher prices, and that the rate of increase has slowed is no comfort,” said Robert Frick, corporate economist at Navy Federal Credit Union.
That could cause trouble for Trump, who faces a potential Catch-22 that will make easing the housing burden difficult to solve.
“We’re not going to drop rates until shelter costs come down. But shelter can’t come down until rates are lower,” Sturtevant said. “We know that there are some wild cards out there that we might not have been talking about two or three months ago.”
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