Craig Philips did pro-GSE folks a big favor; he deserves thanks

Why I liked and like Craig Phillips but never met him…

Before he came from Wall Street to Washington to work for Treasury Secretary Steven Mnuchin, word on the street was that Craig Philips was a “Good Dude,” smart, not an ideologue and knew the GSE business. Nice package!

He turned out to be all those things, as well as efficient. Phillips quickly put together for the Admin and the Secretary a viable plan to end the Conservatorship and quickly establish Fannie and Freddie as viable active mortgage market players consistent with their last several years under tight Federal Housing Finance Agency (FHFA) control.

These were the things Secretary Mnuchin had been predicting and promising and Philips provided the means for him to deliver.

But nothing in DC is easy when it comes to the GSEs.

A few months ago, Philips was asked to leave Treasury, not because he did bad work or sabotaged Mnuchin. It was because Craig Phillips --at some point in his professional life, before coming to the nation’s capital--generated some campaign funds for D presidential candidate Hilary Clinton.

I raise this about Craig Phillips—as a predicate—to posting an excellent background and informative article about Phillips, his plan, and perspective, written by Dennis Hollier of Inside Mortgage Finance, one of the best mortgage industry information sources.

Former Treasury Official Stands Up for GSE Shareholders

November 21, 2019
Dennis Hollier


Craig Phillips, the former Treasury official who served as Secretary Steven Mnuchin’s point man on housing issues until departing for the private sector in June, has come out in defense of Fannie Mae and Freddie Mac investors.

Speaking midweek at a conference in Washington, the man widely credited as the author of the Treasury’s plan for housing-finance reform said the recap and release of the GSEs should “really respect the rights of the current shareholders.”

Phillips’ comments were couched in a how-we-got-here description of “the role of capital markets and the pesky nature of the existing shareholders.”

“When a company fails,” he said, “the capital structure is typically eliminated and there are no shares left. But when these companies were put into conservatorship, for a variety of reasons, the interests of the common stockholders and the preferred stockholders were not eliminated. So those shares continued to exist. They trade freely. It wasn’t a bailout or a sweetheart deal that got them there.”

The result, Phillips said, is an unusual circumstance where there are both historic shareholders who suffered catastrophic losses when the companies failed, and opportunistic investors who purchased the stocks at pennies on the dollar in the hopes of a windfall when the companies emerge from conservatorship.

The other oddity about the GSEs is that in conservatorship both the shareholders and the company leadership are essentially powerless. That leaves Fannie and Freddie under the control of the director of the Federal Housing Finance Agency, as conservator, and the secretary of the Treasury, through the terms of its preferred stock purchase agreements.

Phillips said legally there are two paths forward for the GSEs. If FHFA Director Mark Calabria decides the two entities cannot be saved, he can put them in receivership and liquidate them. “The other option,” Phillips said, “is simply to have them exit conservatorship, which is an act that the Treasury secretary and the FHFA director can decide to do when they want under the PSPAs.”

Calling receivership impractical, he said, “The companies should leave conservatorship, and these shareholders would continue to have their rights.”

The former Treasury official then sketched out what he called “the math of the situation.”

Noting that Fannie and Freddie are strong earners with reasonable returns on equity, he said, “I truly believe they can be fully recapitalized in four to five years, between retained earnings and raising shares from the public.”

That new capital could come in the form of an initial public offering or, more precisely, what Phillips called a “re-IPO,” a capital raise by a company that, like Fannie and Freddie, has been dormant for some time.

Phillips also reminded the audience that Treasury owns warrants to buy 80% of the common stock of the companies. That too, he said, will have to be accounted for in any recapitalization plan for the GSEs.

This complex mix — historic shareholders and speculators; common, junior preferred and senior preferred stocks; Treasury’s ownership of senior preferred stocks and warrants on the commons; and finally, multiple litigants fighting it out in court —makes any recap and release of Fannie and Freddie daunting.

Phillips suggested one way to proceed: Treasury should write down its senior preferred stocks.

“The government did put $190 billion into these companies,” he said. “But they’ve now received dividends in excess of $300 billion. That’s a pretty good private equity deal. Now, we just have to turn the page on how we got here.”

Phillips then offered a plan to move the net worth of Fannie and Freddie from negative to positive.

“I think the only way to square the circle and give shareholders appropriate treatment is to really respect the rights of the current shareholders,” he said. That means selling new shares without completely wiping out current common shareholders.

“The common shares would be substantially diluted by the exercise of the Treasury warrants options, but they would still exist,” Phillips said. “I think that a sensible path forward would also include an exchange of the junior preferred shares and the common shares to align their interests in the exercise.”

But these moves wouldn’t be sufficient to put Fannie and Freddie in the black again, Phillips acknowledged.

“We want a positive net worth,” he said. “Right now, we still have a negative net worth because of the bailout. But if the Treasury … writes down the senior preferred, that’s a big part of getting to zero.”

New GSE Mortgage Ceilings, accepted or limited?  Watch and wait?

FHFA has finished its annual loan survey of the size mortgages, which determines any changes, up or down, made to eligible loans the GSEs can fund in the coming year.

That percentage increase, derived from querying 1500 diverse lenders in size, location, and charter, historically, but not always, show larger loans financed than the previous year. Those new figures are made available to lenders for mortgages originated in the last three months of 2019 for GSE securitization and delivery on Jan. 1, 2020 (unless the agency has changed its process).

By indexing future GSE securitizations in this manner, the idea is to keep Fannie and Freddie serving the same percentage American mortgagors as they always have.

I mention this otherwise somnolent yearly review, to allow you to see if--this year--FHFA and Director Calabria will permit Fannie and Freddie to naturally increase their applicable mortgage ceilings, since FHFA has the discretion NOT to allow the ceilings to grow?

If Calabria is serious about his goal to “reduce the GSE footprint,” he may not let those loan values go up in 2020, meaning next year the GSEs will serve a smaller share of the mortgagors—despite the increase called for in the FHFA mechanism (put in place long before the current Director arrived).

His actions on that score will give a hint about how much he plans to impose himself and interfere with their business order.

Of course, that would be another negative sign to the very investors FHFA needs to capitalize future Fannie and Freddie activities.

Maloni, 11-25-2019