Comment

My name is Christian S. Herzeca.  I am a corporate finance and securities attorney with substantial expertise and experience in equity underwritings and other capital markets transactions.  I am now retired from the active practice of law, and I own shares of a GSE junior preferred stock.

I am pleased to submit my comments to FHFA’s proposed capital rule (RIN-2590-AA95).  I believe the proposed capital rule is the result of a diligent effort by FHFA staff to achieve an appropriate capital standard.  My comments seek to promote the capital rule’s financeability…the GSEs’ ability to execute the substantial capital raising transactions that will be required in order to first satisfy this capital standard.  

I reply below to two requests for responses contained in the proposed capital rule.  But first, I want to frame my comments within this proposed capital rule’s historical context.  My principal concern with the proposed rule’s capital standard is that it must, during a period of time commencing with the rule’s adoption, facilitate the capital markets transactions required by the GSEs to meet the rule’s standards. I believe FHFA is obliged, given this historical context, to facilitate at the outset the GSEs’ capital market transactions required by this rule.

FHFA’s commendable objective with this proposed rule is to set forth the requisite capital structure basis for the safe and sound operation of the GSEs.  But the proposed capital rule must also at the outset promote the conditions under which this capital structure objective can be achieved by the GSEs.  Until recently with the confirmation of Dr. Calabria as Director, the GSEs have suffered over 11 years under a dysfunctional conservatorship, including 7 years in which capital was siphoned off from the GSEs for purposes unrelated to housing finance.  It was on FHFA’s watch that the GSEs’ capital was depleted to near zero for purposes unrelated to the GSEs’ and FHFA’s missions.

Given this historical context, I believe it is insufficient for FHFA to simply set forth the desired capital structure of the GSEs as an end-state objective without also affirmatively providing the “regulatory runway” for the GSEs to execute the capital market transactions that will enable the GSEs to reach this objective. I believe my comments if adopted by FHFA would help to provide this runway.

1.	 FHFA asks in Question 27: “Should the payout restrictions be phased-in over an appropriate transition period? If so, what is an appropriate transition period?” (p. 103 of the proposed rule)

I believe that it will be very difficult for the GSEs and their respective bankers to execute the capital markets transactions necessary in order to raise sufficient capital to satisfy both the risk-based and leverage capital standards and the capital buffers. The GSEs will be required to conduct numerous underwritings over a lengthy period of time, and these offerings will be made even more difficult by the presence of the overhang represented by Treasury’s 79.9% warrant position in each GSE, and by Treasury’s secondary sales of common stock as it monetizes its investment.  

There should not be any regulatory dividend restriction impediments during this capital raising period.  Investors will not be inclined to provide new money to the GSEs while dividend restrictions are in place.  Once the capital buffers are satisfied, then investors will abide by dividend restrictions tied to capital levels.  It should be remembered that while the GSEs may be familiar to credit investors, the GSEs have not offered equity securities to investors for some 13 years.  There is an entire generation of equity analysts and investors who are totally unfamiliar with the GSEs as issuers.  The process of raising equity, until such time as the capital buffers are satisfied, should encounter as few regulatory headwinds as possible.

I would propose that the payout restrictions contained in the proposed rule be delayed with respect to a GSE until the earlier of (i) five years form the date the proposed rule is adopted, and (ii) the date at which such GSE has satisfied its capital buffers.

2.	 FHFA asks in Question 26: “Should there be any sanction or consequence other than payout restrictions triggered by an Enterprise not maintaining a capital conservation buffer or leverage buffer in excess of the applicable PCCBA or PLBA?” 

No, and I would ask that FHFA clarify in the proposed rule that, in and of itself, the failure to meet the capital buffers will not result in any regulatory consequence other than the payout restrictions set forth on p. 101 of the proposed rule.

FHFA states at p. 102: “…it would not be consistent with the safe and sound operation of an Enterprise for the Enterprise to maintain regulatory capital less than its buffer-adjusted requirements in the ordinary course except for some reasonable period after a financial stress, pending the Enterprise’s efforts to raise and retain regulatory capital.”   

I believe that this admonition is too vague to be meaningful (indeed, it seems to conflict with Question 26 itself, which leads one to believe there are no regulatory consequences apart from the payout restrictions in the proposed rule as proposed), and it unnecessarily sends a bad signal to the capital markets.  As FHFA continues to state on p.102, “Nothing in this proposed rule limits the authority of FHFA to take action to address unsafe or unsound practices or violations of law, including actions inconsistent with an Enterprise’s charter. FHFA could, depending on the facts and circumstances, determine that it is an unsafe or unsound practice, or that it is inconsistent with the Enterprise’s statutory mission, for an Enterprise to maintain regulatory capital that is less than its buffer-adjusted requirements during ordinary times.”

I believe the equity capital markets are quite aware that FHFA maintains the regulatory authority to determine, on a case by case basis based upon the particular facts and circumstances, whether a GSE is operating in an unsafe and unsound manner.  I believe that the equity capital markets also understand that FHFA as regulator may be more inclined to determine, if there are additional operational concerns present, to take some form of enforcement action with respect to a GSE’s operation at a time when the capital buffers are not satisfied than when they are satisfied, depending on the facts and circumstances.

But I believe it is important for the capital rule make clear that, in and of itself, failure to maintain the capital buffer will not result in a FHFA regulatory determination that the GSE is operating in an unsafe and unsound manner.  This is an important signal that must be sent to the capital markets.

I believe it is important to make clear to the equity capital markets that the market discipline represented by the payout restrictions will be the sole capital rule mechanism that is automatically triggered by a failure to maintain the capital buffers.  No automatic FHFA regulatory response will be triggered in the event that the capital buffers are not maintained…although this failure to maintain the capital buffers may trigger an appropriate FHFA regulatory response if coupled with other independent operational concerns, depending on the facts and circumstances.
  
If you have any questions or desire further information, please contact me at cherzeca@gmail.com
Thank you.