Interest Rate Roundup

Friday, August 08, 2008

Fannie Mae joins Freddie Mac in reporting ugly numbers

Quarterly results from the two GSEs have been pretty awful. On Wednesday, Freddie Mac reported an $821-million quarterly loss, more than three times what Wall Street analysts were looking for. It's now sitting on 22,000 foreclosed homes, the highest in the company's 38-year history. And it was forced to set aside $2.5 billion in the second quarter to cover loan losses, more than double what it reserved just three months prior.

Those losses are helping shrink Freddie's capital cushion. It fell to $37.1 billion in the quarter, only $2.7 billion above what its regulator requires. The company is responding in a couple of ways to preserve capital:

First, it's cutting its stock dividend. Shareholders will now get just $0.05 per share, down from $0.25 per share previously.

Second, it's looking to sell new common or preferred shares — more than $5 billion worth (analysts are openly questioning whether Freddie can do so in this market environment, however).

Third, — and this is most important — Freddie will likely SLOW the growth of its portfolio of mortgages and mortgage securities. Specifically, take note of this excerpt from a Dow Jones story:

"Freddie, along with Fannie, is a dominant provider of funding to the U.S. housing market. Together they own or guarantee about $5 trillion of mortgages or nearly half of all U.S. home-mortgage debt outstanding.

"One of the two ways Freddie and Fannie make money is by holding on to a heap of mortgages and securities made up of bundles of home loans that they buy from lenders.

"In addition, they earn money from guaranty fees charged to insure mortgage payments. Bundles of these guaranteed loans are then packaged into securities to be sold to investors in the asset-backed market.

"The mortgage-related investments that Freddie stores on its books fall in its so-called retained portfolio. And the company earns income from the interest and principal payments from the underlying loans held.

"But Buddy Piszel, Freddie’s chief financial officer, said Wednesday that the company intends to slow the growth in its $791.8 billion retained portfolio of mortgage-related securities, in an effort to shore up capital."


"More than half of this portfolio - or $413.9 billion - is made up of securities of mortgage loans guaranteed by Freddie. By buying securities whose loans it guarantees, the company provides support in the marketplace for these investments, encouraging others to buy them. In addition, this also kept borrowing costs for homeowners low as there was steady buying support for mortgages.

"Piszel said the company will pause growing its portfolio but will continue to buy mortgage securities from capital freed up from the possible sale of securities from within this portfolio and the repayment of principal on the underlying home loans."

What does this reduced activity mean for consumers? It will likely drive mortgage rates up, or at least keep them higher than they would otherwise be, by causing the spread between Treasury yields and yields on MBS to widen out. In fact, that's already happening. The difference between yields on Freddie Mac's actively traded, 30-year mortgage-backed securities and yields on 10-year Treasury Notes has ballooned to about 218 basis points. That's far above the 136-point average of this decade and just shy of the record high of 242 set during the credit market panic in March.

Result: Rates on 30-year fixed-rate mortgages are now averaging 6.52%, according to Freddie Mac. That's up notably from the recent low of 5.48% in late January and closing in on a six-year high.

Fannie Mae's results probably won't help spreads -- or market confidence -- either. Per Bloomberg:

"Fannie Mae, the largest U.S. mortgage- finance company, sliced its dividend after posting its fourth straight quarterly loss and cut its dividend as record delinquencies pushed up credit costs.

"The second-quarter net loss was $2.3 billion, or $2.54 a share. Before a one-time gain, the loss was $2.51 a share, compared with the 72-cent average estimate of 10 analysts in a Bloomberg survey. The common-stock dividend will be cut to 5 cents from 25 cents a share, Washington-based Fannie said today in a regulatory filing."


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