FannieMae and FreddieMac

Let's understand the mortgage market today: the only reason this industry hasn't imploded completely is that FannieMae and FreddieMac are still market-makers for traditional loans. Many lenders have said that is the only kind of loan that they will do because it is the only kind of loan that they can sell.

Both of these companies have seen a precipitous drop in the price of their stocks, once in the $60 range and both have seen an increase in the number of loans that are in trouble even though they did, to a great extent, only loans to qualified borrowers.  Bottom line, mostly they were doing good loans and the figures show that the default rate on the good loans was still about ½%.

But they also did subprime loans and Alt-A loans, somewhere between subprime and A-paper quality, and it is here that the problem arises. The default rate on those loans is significantly higher and resulted in their having to repurchase loans and do significant write-downs. They also had to value these loans on the likely value that might arise. That number on recent repurchase seems to be about 60% of the face value of the notes. That means losses!

What set in this week was, however, seems to have been pure panic selling, just a desire to get out of anything that sounded anything like the word "mortgage."  Indeed, FannieMae continued to get battered and today it closed at $10.25, down 22% on the day but significantly higher than the $7.16 opening price. Shares of FreddieMac opened at $4.26 per share and ended up the day at $7.75, about where they closed yesterday. 

Here's the deal as I see it. There are three issues here. The first is stock price which is horrible right now. There is no question that when you have to raise money by selling additional shares of common stock, you have to sell many more shares at a low price to raise a given amount of capital. If they raise money by selling preferred stock, as seems to be the case, depending on its convertibility into common, it is likely to be less dilutive.

The second, and larger issue, is that capital requirements that are required by their government regulators, the Office of Federal Housing Enterprise Oversight. Both have successfully raised capital to make sure that they are well capitalized, exceeding their regulators' requirements. So unless there are more losses, they are OK on that front.

The third, and most important issue, is how THEIR lenders view them in the future. Already the spread between what they have to pay for money is about 8/10 of a percent higher than what the government has to pay, a significant increase from the traditional value of less than ½%. That has to translate into higher costs for mortgages, so be prepared. 

Finally, I do not want to talk about the worst case scenario which is if their lenders just don't even want to buy securities on A-paper loans, but if I were thinking about buying a home or refinancing a mortgage, I would do it sooner rather than later as the volatility ahead is likely to be worse for consumers.   

Comments

[Chris]

Just because the GSE regulator says they are well capitalized doesn't make it so...

[Jim]

Too Big to Fail? I've failed more than I have succeeded.