Interest Rate Roundup

Monday, August 18, 2008

Fannie and Freddie at the center of a credit storm ... again

Another day, another credit crisis. That's how things seem to be going lately. Today, it is Freddie Mac and Fannie Mae at the center of the maelstrom (though I'm kind of in the center of my own storm, given that T.S. Fay is barreling toward me here in South FL!). What is going on with Fannie and Freddie?

Well, Barron's published a nasty story on the GSEs this weekend. Entitled "The Endgame Nears for Fannie and Freddie," it started out as follows:

"IT MAY BE CURTAINS SOON FOR THE MANAGEMENTS and shareholders of beleaguered housing giants Fannie Mae and Freddie Mac. It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer's dime, availing itself of powers granted it under the new housing bill signed into law last month. Such a move almost certainly would wipe out existing holders of the agencies' common stock, with preferred shareholders and even holders of the two entities' $19 billion of subordinated debt also suffering losses. Barron's first raised the possibility of a government takeover of Fannie and Freddie in a March 10 cover story, "Is Fannie Mae Toast?"

"Heaven knows, the two government-sponsored enterprises, or GSEs, both need resuscitation. Soaring mortgage delinquencies and foreclosures have led the companies to gush red ink for the past four quarters, and their managements concede the outlook is even grimmer well into next year. Shares of Fannie Mae (ticker: FNM) and Freddie Mac (FRE) have lost around 90% of their value in the past year, with Fannie now trading at $7.91, and Freddie at $5.88.

"Similarly, the balance sheets of both companies have been destroyed. On a fair-value basis, in which the value of assets and liabilities is marked to immediate-liquidation value, Freddie would have had a negative net worth of $5.6 billion as of June 30, while Fannie's equity eroded to $12.5 billion from a fair value of $36 billion at the end of last year. That $12.5 billion isn't much of a cushion for a $2.8 trillion book of owned or guaranteed mortgage assets.

"What's more, the fair-value figures reported by the companies may overstate the value of their assets significantly."

That is rekindling fears in the bond market. The pricing on Credit Default Swap contracts tied to the $19.2 billion in subordinated debt that Fannie and Freddie have outstanding is going up, indicating greater concern about how that debt will perform.

Moreover, Freddie Mac's latest sale of short-term bills didn't go so well. The bid-to-cover ratio came in at just 2.19 on the 3-month bill portion of the auction, compared to 2.73 a week earlier. The bid-to-cover ratio on the 6-month sale fell to 2.42 from 2.92.

Fannie Mae 10-year debt is now yielding about 86.5 basis points more than comparable Treasuries. That's up 5.5 basis points on the day ... well above the low of 48.8 bps back in early May ... and closing in on the peak of 104 bps during the Bear Stearns panic this March.

And those swap spreads I mentioned late last week? They're wider again too.


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