Fannie, Freddie Feel the Heat
As Mortgage Defaults Rise

Fannie Mae and Freddie Mac are proving more vulnerable than expected to anxiety over rising mortgage defaults.

Nervous investors will be watching Freddie's third-quarter results tomorrow for signs of how much costs related to mortgage defaults are mounting. Freddie's results follow unease last week by Fannie investors over a change in how that mortgage titan reports credit losses.

The results also come amid growing unease over the impact of the fallout in the U.S. housing market on the two mortgage companies, until recently seen as fairly well-insulated against the full blast of the foreclosure crisis.

On the New York Stock Exchange, shares of Freddie were down 2.7% to $40.72 at 4 p.m. Friday, while Fannie stock was down 5.5% to $40.69. Fannie's stock was down 17% for the week and 41% from a peak of $69.38 in August.

"We are seeing unprecedented foreclosures and declines in home prices not seen since the Great Depression," said Joshua Rosner, an analyst at Graham Fisher & Co., a research firm in New York. He expects at least three years of depressed earnings for Fannie and Freddie and thinks they eventually will need to raise capital or shrink their mortgage holdings to maintain the minimum capital backing required by their regulator.

Spokesmen for both companies declined to comment.

The two government-sponsored mortgage investors buy mortgages from lenders, helping to ensure capital remains available for homeowners. Fannie and Freddie focus mostly on plain-vanilla, fixed-rate mortgages. As a result, the companies have shunned some of the riskiest types of mortgages over the past few years. For instance, they have relatively small amounts of loans that let people make minimal initial payments but under which borrowers may face sharply higher ones later.

In fact, Fannie and Freddie have increased their market share in recent months by continuing to buy or provide guarantees for home loans as other investors have retreated.

But as growth in home values has dropped and home sales have plunged, the wave of resulting defaults has also hit Fannie's and Freddie's typically more-stable borrowers. The companies also have some exposure to loans to subprime borrowers, or those with poor credit.

Over the past few weeks, investors have started focusing more closely on the costs of defaults. The two companies own or guarantee a combined $4.8 trillion of U.S. home mortgages, or nearly half of those outstanding. When borrowers default, Fannie and Freddie must reimburse holders of securities backed by the loans.

On Nov. 9, Fannie reported that its net income for this year's first nine months sank to $1.51 billion from $3.46 billion a year earlier, largely because of default costs and write-downs in the value of loans and related securities.

It reported that credit losses in the nine months equaled 0.04% of the company's $2.8 trillion of mortgages and related securities owned or guaranteed, up from 0.018% a year earlier. But Fannie had changed its method of presenting the figure, excluding unrealized losses on certain delinquent loans marked down to reflect current market conditions. Including those unrealized losses, the rate was 0.075%, up from 0.023% a year before.

Fannie officials said the change was made to separate realized losses from ones that haven't been realized and depend on fluctuating market values for loans. In a conference call with analysts Friday, Fannie executives said many of the unrealized losses will vanish or shrink because borrowers will resume payments after being given easier terms. But they didn't provide detail on the success rate for such loan workouts.

Fannie officials noted that both the realized and unrealized losses were reflected in the earnings reported for the nine months. J.P. Morgan Chase & Co. analyst George Sacco said the new method is similar to that used by Freddie Mac.

For next year, Fannie officials forecast that realized losses on defaulting mortgages will be 0.08% to 0.1% of loans owned or guaranteed. That implies credit losses of about $2.2 billion to $2.8 billion. But Fannie officials said income from guarantee fees is rising fast, helping to offset those losses. The company raised those annual fees to more than 0.30% on new loans acquired in the third quarter from an average of about 0.22% in effect on all loans guaranteed in this year's first nine months.

Late Friday, Fannie reported that it had raised $500 million through the sale of preferred stock with an annual dividend rate of 7.625%. A Fannie spokesman said the proceeds will bolster capital and provide money for "profitable opportunities" in the mortgage market.

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