Fannie, Freddie Shares Suffer Hit
As Mortgage-Default Fears Mount

Shares of Fannie Mae and Freddie Mac plunged as fears grew that home-mortgage defaults eventually will force the two government-sponsored companies to raise more capital.

Large sales of common stock by the companies would dilute the value of existing shares. In 4 p.m. composite trading on the New York Stock Exchange, Fannie shares fell 13%, or $2.96, to $19.81 apiece, while Freddie shares fell 12%, or $2.26, to $17.39.

Anxieties over the companies' prospects have been rising for months and were fueled yesterday by a bearish report from a Credit Suisse analyst and a weekend article in Barron's magazine entitled, "Is Fannie Mae Toast?"

The Bush administration and Congress are counting on Fannie and Freddie to play a big role in propping up the housing and mortgage markets. But they recorded losses totaling about $9 billion in last year's second half, and analysts expect continued losses this year as house prices sink and defaults pile up. Those losses are constraining the companies' ability to buy or guarantee mortgages, even as other investors dump mortgage-backed securities. As a result, mortgage interest rates for consumers have risen in recent weeks despite the Federal Reserve's cuts in short-term interest rates.

Treasury Secretary Henry Paulson last week argued that financial institutions generally should seek to raise capital. Both Fannie and Freddie have said recently they don't have any immediate need for more capital, a stance backed by their regulator, the Office of Federal Housing Enterprise Oversight.

But the two companies "would be best off by raising capital," said Frederick Cannon, chief equity strategist at Keefe, Bruyette & Woods. That would allow them to buy mortgage securities whose yields have soared to attractive levels, Mr. Cannon said.

Moshe Orenbuch, an analyst at Credit Suisse, yesterday nearly doubled his projected loss for Freddie this year to $2.6 billion, or $4 a share. He forecast a slight profit of $32 million, or five cents a share, for 2009. For Fannie Mae, Mr. Orenbuch forecast a loss of $3.4 billion, or $3.50 a share, this year, and a profit of $245 million, or 25 cents a share, in 2009.

Kenneth Posner, an analyst at Morgan Stanley, sees "moderate" losses for the two companies in the current quarter but expects both to recover to about the break-even level for the rest of the year. He believes the companies can avoid raising more capital this year. If needed, they could conserve capital by cutting their dividends and buying fewer mortgages, Mr. Posner said.

The Barron's article said Fannie may need to write down the value of $13 billion of deferred tax credits carried on its books. These credits can be used only to the extent that the company is profitable. Fannie acknowledged in its recent 10-K securities filing for 2007 that it would need to write down the value of the tax credits if it determines that it is unlikely to be able to use all of them and said the effects on its capital likely would be "material."

Freddie reported $10.3 billion of deferred tax credits at the end of 2007 and also acknowledged it would have to write them down if it can't generate sufficient earnings.

Fannie said about 1% of the conventional single-family loans it owns or guarantees were 90 days or more overdue at the end of 2007. The Mortgage Bankers Association reported an industrywide rate of 3.6% of all home mortgages at the end of last year.

But the companies guarantee so many mortgages that even a relatively small rise in defaults translates into billions of dollars of losses. At year end, Fannie owned or guaranteed about $2.53 trillion of single-family mortgages, around a quarter of U.S. home loans outstanding. About 89% of those loans have fixed rates and 5% involve borrowers with credit scores below 620, generally considered subprime.

Fannie puts its overall exposure to subprime mortgages at $54.1 billion and its exposure to Alt-A loans -- a category between prime and subprime, typically involving loans for which borrowers don't fully document their incomes -- at $350.6 billion. Most of that subprime and Alt-A exposure comes from holdings of AAA-rated mortgage securities created by Wall Street firms. Fannie already has had to write down the value of those securities, and some analysts say bigger write-downs may be needed.

Freddie, which also holds subprime and Alt-A mortgage securities, is due to meet with investors and analysts in New York tomorrow.

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