Tuesday, August 19, 2008

Fannie Mae, Freddie Mac Are Pounded

Two Stocks Plunge On Growing Fears Of a U.S. Bailout

August 19, 2008; Page A3

Share prices of Fannie Mae and Freddie Mac plunged Monday amid growing fears that the two largest providers of funding for U.S. home mortgages won't be able to avoid a government bailout.

In 4 p.m. trading on the New York Stock Exchange, Freddie shares were down 25% to $4.39. Fannie stock dropped 22% to $6.15. Both stocks are down more than 90% from a year ago.

Many investors and analysts fear the two companies may not be able to raise more capital by selling shares, amid gloom over the huge losses they face on mortgage defaults. On Monday, some preferred shares previously issued by Fannie and Freddie were quoted at dividend yields of more than 16%, up from 14% Friday. With investors demanding such high yields, raising money through new preferred shares may be too expensive.

Selling common shares also would be difficult, because the companies' market values have shrunk drastically. At Monday's close, Fannie's market value was $6.6 billion and Freddie's $2.8 billion. Raising even a modest $5 billion would mean severely diluting the value of existing shares.

The latest price declines came after an article in the financial weekly Barron's asserted that a government bailout is likely and could wipe out the value of common shares in Fannie and Freddie.

In early July, a previous plunge in the companies' shares prompted the U.S. Treasury to announce a package of measures aimed at shoring up investor confidence. Among other things, the Treasury said it would lend money to the companies or make equity investments in them if needed.

"As the secretary has said many times, we have no plans on using the authority," Treasury spokeswoman Jennifer Zuccarelli said Monday, referring to Treasury Secretary Henry Paulson. She declined to comment on "speculation" that Treasury might inject some capital into the firms.

Investors fear that a Treasury purchase of preferred stock in the companies would come with conditions that would leave previously issued common and preferred shares with little or no value. "I think every day that goes by without the companies raising capital, the possibility of the Treasury stepping in increases," said Paul Miller, an analyst at Friedman, Billings, Ramsey & Co.

Representatives of Fannie and Freddie reiterated that their capital remains at levels above the minimum required by their regulator. But many analysts consider that minimum level too low to withstand the potential credit losses ahead.

Fannie and Freddie bond prices also fell Monday, and their yield spreads over safe Treasury securities increased significantly as investors saw greater risk to holding the companies' debt. Yields on two-year Fannie bonds rose by 0.055 percentage point to 0.9 percentage point over Treasury yields, a gap last seen in mid-July. Their subordinated debt was harder hit; spreads on two-year Freddie subordinated notes increased by around 1.7 percentage points to 4.9 percentage points.

As defaults on home mortgages soar, Fannie and Freddie have recorded combined losses of about $14 billion in the past four quarters. Those losses are expected to continue for at least another few quarters, and some analysts don't think the companies will return to the black before 2010 or 2011.

Freddie has said it plans to raise at least $5.5 billion of capital, likely through offerings of common and preferred stock, but it is waiting for market conditions to improve. Fannie raised $7.4 billion through common and preferred offerings in May but said recently that it may need to raise more capital eventually.

In a research note, Merrill Lynch said it doesn't expect any "sustained recovery" in Freddie shares until investors get a clearer view of the losses the company will sustain and the government response.

-- Deborah Solomon and Serena Ng contributed to this article.

Write to James R. Hagerty at bob.hagerty@wsj.com and Aparajita Saha-Bubna at Aparajita.Saha-Bubna@dowjones.com

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