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Bloomberg.com: Worldwide: "Fannie, Freddie May Need to Lose $77 Billion Before Bailout

By Caroline Salas and Dawn Kopecki

Fannie, Freddie May Need to Lose $77 Billion Before Bailout

By Caroline Salas and Dawn Kopecki

July 11 (Bloomberg) -- Fannie Mae and Freddie Mac shareholders, battered by losses of more than 80 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. Fannie Mae and Freddie Mac shares plunged for a third day on concern shareholders would be wiped out even if the companies are rescued.

A government takeover of one or both companies is among several options that have been considered by White House officials, Joshua Rosner, an analyst at Graham Fisher & Co., said after meetings with administration officials. The U.S. is reluctant to step in before Fannie Mae and 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.

``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,''

Shares Plunge

Fannie Mae and McLean, Virginia-based Freddie Mac tumbled in New York Stock Exchange composite trading to their lowest in more than 17 years on concern the companies don't have enough capital to withstand the biggest housing slump since the Great Depression.

Fannie Mae dropped $6.05, or 46 percent, to $7.15 at 9:33 a.m. and Freddie Mac fell $3.61, or 45 percent, to $4.39. A year ago, Fannie Mae and Freddie Mac were trading at about $60.

``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.''

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.

Critical Capital

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.

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.

`Very Unlikely'

``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.

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.

`Too Big to Fail'

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.

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 csalas1@bloomberg.net; Dawn Kopecki in Washington at dkopecki@bloomberg.net
Last Updated: July 11, 2008 09:38 EDT