Sunday, July 13, 2008

Fannie, Freddie May Need to Lose $77 Billion First

By Caroline Salas and Dawn Kopecki

July 11 (Bloomberg) -- Fannie Mae and Freddie Mac shareholders, battered by losses of more than 74 percent this year, shouldn't bet on an imminent government bailout of the biggest U.S. mortgage-finance companies.

Fannie Mae and Freddie Mac would have to post pretax losses and writedowns of about $77 billion before the U.S. would be compelled to start a rescue, according to estimates by Fox-Pitt Kelton and Friedman, Billings, Ramsey & Co. analysts. The government-chartered, publicly traded companies have already raised $20 billion to cover losses amid the highest delinquency rates in at least 29 years.

A government takeover of one or both companies is among several options that could be considered, Joshua Rosner, an analyst at Graham Fisher & Co., said after meetings with administration officials. U.S. Treasury Secretary Henry Paulson said today that federal regulators are backing Fannie Mae and Freddie Mac in ``their current form.''

``The administration is considering all options in its contingency planning,'' Rosner said. ``That doesn't mean to say that we're at an inflection point where any decision is required immediately.''

Fannie Mae dropped $2.95, or 22 percent, to $10.25 today in New York Stock Exchange composite trading on concern a bailout would wipe out common shareholders. Freddie Mac fell 25 cents, or 3.1 percent, to $7.75.

`Current Form'

The U.S. is reluctant to step in before Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac, which own or guarantee about half the $12 trillion in home loans outstanding, exhaust their options for raising capital, according to Rosner and U.S. Representative Spencer Bachus of Alabama.

``Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission,'' Paulson said in a statement today. ``We are maintaining a dialogue with regulators and with the companies.''

Paulson's comments signal administration intent to keep Fannie Mae and Freddie Mac as shareholder-owned companies, rather than placing them under government control.

Fannie Mae and Freddie Mac may have [=^]several[^=] [=^]options[^=] for capital and liquidity, including gaining access to the Federal Reserve's discount window, Senate Banking Committee Chairman Christopher Dodd said at a press conference in Washington today.

``There are a number of things, including things like the discount window, that they're, I know, considering,'' Dodd said. ``They are certainly examining what other means might be taken in order to shore up a situation should it become necessary.''


A credit line extension, or a lending facility similar to the one the Fed created to prevent a collapse by investment banks in March, is an option, Credit Suisse interest-rate strategist Ira Jersey said on a conference call with investors today.

Dodd said facts don't warrant the negative reaction by investors.

``There is sort of a panic going on, and that is not what ought to be,'' Dodd said. ``Fannie Mae and Freddie Mac were never bottom feeders in the residential mortgage market.''

Fannie Mae and Freddie Mac tumbled by about 50 percent earlier in the day until Paulson made his comments.

``Shareholders, investors and creditors need to step up to the table,'' Bachus, the top Republican on the House Financial Services Committee said in an interview with Bloomberg Television. ``They profited in the good times and they will need to assume those liabilities, not the taxpayers.''

Critical Capital

Bush administration officials are considering putting at least one company under the full control, or conservatorship, of government regulators, Rosner said.

Under a conservatorship, the companies would be run by their regulator, the Office of Federal Housing Enterprise Oversight, which could require them to raise capital ``through any means,'' New York-based Fox-Pitt analyst Howard Shapiro said in a report yesterday. ``This is the situation that would put common shareholders at risk of complete dilution,'' Shapiro wrote.

Conservatorship would be triggered if the companies fell below a so-called critical capital level. That threshold is defined as half of minimum capital, which is 2.5 percent of assets plus 0.45 percent of balance sheet obligations, mainly guaranteed mortgage securities, Shapiro said.

Fannie Mae is $26 billion above that level and Freddie Mac is $24 billion above, Shapiro said. Adjusting for tax, that means Fannie Mae would need to lose $40 billion and Freddie Mac $37 billion ``immediately'' to fall below that limit, he said.

Arlington, Virginia-based Friedman Billings analyst Paul Miller estimates losses of about $45 billion and $30 billion before they would fail.

`Very Unlikely'

For Fannie Mae, house prices would need to decline 40 percent nationally and delinquency rates would need to rise as much as 10-fold to 12 percent on loans from 2006 and 2007 to reach those levels, Shapiro said.

``We believe this is very unlikely,'' Shapiro said.

In the meantime, Fannie Mae and Freddie Mac are also increasing revenue, Shapiro said. Total claims paying resources, measured by adding the statutory surplus, current loss reserves and estimated revenue, are $56 billion to $92 billion for Fannie Mae and $52 billion to $88 billion for Freddie Mac, he said.

Freddie Mac is technically insolvent under fair value accounting, which measures a company's net worth if it had to liquidate all its assets to repay liabilities, former St. Louis Federal Reserve President William Poole said in an interview. Fannie Mae may become insolvent this quarter, Poole said, increasing pressure on the government to instigate a rescue.

`Too Big to Fail'

Freddie Mac owed $5.2 billion more than its assets were worth in the first quarter, making it insolvent under fair value accounting rules. The fair value of Fannie Mae's assets tumbled 66 percent to $12.2 billion and may be negative next quarter, Poole said.

Freddie Mac currently has Ofheo's highest capital rating and ``holds a surplus above our regulatory requirement that will enable us to continue to support the nation's housing markets,'' spokeswoman Sharon McHale said. Fannie Mae is ``maintaining a capital position'' to help fulfill its mandate of supporting the housing market, spokesman Brian Faith said.

Fannie Mae and Freddie Mac make money by borrowing in the bond market and reinvesting the proceeds in higher-yielding mortgages and securities backed by home loans. Congress created Freddie Mac and expanded Fannie Mae in 1970 to promote home buying in the U.S. The companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default, implying the government will stand behind the companies' debt.

Market Share

The U.S. is counting on Fannie Mae and Freddie Mac, which have $5.2 trillion of debt outstanding, to help revive the housing market. Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger so-called jumbo mortgages to spur demand for home loans as competitors fled the market.

The companies bought or guaranteed 81 percent of all mortgage securities created in the first quarter, almost double their share of a year earlier, according to Ofheo data.

Fannie Mae and Freddie Mac ``are the definition of too big to fail,'' said Ajay Rajadhyaksha, head of U.S. fixed income strategy at Barclays Capital in New York.

To contact the reporter on this story: Caroline Salas in New York at; Dawn Kopecki in Washington at

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