Fannie, Freddie Shares Slump, Bonds Rise on Bailout Speculation

By Dawn Kopecki


Aug. 20 (Bloomberg) -- Fannie Mae and Freddie Mac shares tumbled in New York trading to the lowest levels since at least 1990 and the bonds rose as speculation increased that the U.S. Treasury will bail out the mortgage-finance companies, wiping out shareholders.

Fannie, based in Washington, slumped 27 percent and McLean, Virginia-based Freddie dropped 22 percent, extending its losses to 90 percent for the year. The companies' debt yields fell the most in a month against benchmarks in anticipation that the government would fully support the bonds in any rescue.

``Using taxpayer money to bail them out looks like it's becoming reality now,'' said Michael Nasto, the senior trader at U.S. Global Investors Inc., which manages $5 billion in San Antonio. ``That's going to leave the shareholders holding worthless paper.''

Rising borrowing costs and evidence that demand for their debt was waning last month led Treasury Secretary Henry Paulson to seek the authority to pump unlimited amounts of capital in Fannie and Freddie in an emergency. Freddie paid its highest yields over U.S. Treasuries on record in a debt sale yesterday amid concern that credit losses are depleting the capital of the beleaguered mortgage-finance companies.

Fannie and Freddie have $223 billion of bonds due by the end of the quarter and their success in rolling over that debt may determine whether they can avoid a federal bailout. Fannie has about $120 billion of debt maturing through Sept. 30, while Freddie has $103 billion, according to figures provided by the government-chartered companies and data compiled by Bloomberg.

Rolling over the debt ``is the single most important factor to their ability to remain liquid,'' said Moshe Orenbuch, an analyst at Credit Suisse in New York. ``So far, they've been able to do that.''

Market Value Shrinks

Fannie declined $1.61 to $4.40, the lowest since 1989, in New York after falling as low as $3.95. Freddie dropped 92 cents to $3.25, the lowest level since 1990, and earlier fell to $2.95.

Fannie's market value has shrunk $34 billion, or 88 percent, to $4.73 billion this year and Freddie's declined $20 billion, or 90 percent, to $2.1 billion. That makes it increasingly difficult for the companies to raise equity through public markets, Miller said. The companies have reported a combined $14.9 billion of net losses the past four quarters.

The difference between yields on Fannie's 5-year debt and 5- year Treasuries fell 12.6 basis points to 87.6 basis points at 4:45 p.m., data complied by Bloomberg show. The drop was the largest since Paulson said July 11 that he supported keeping the companies ``in their current form.'' Freddie's 5-year debt spreads fell 12.9 basis points to 88.9 basis points.

Asian Investors

Investors in Asia, the biggest foreign owner of Fannie's $3 trillion of bonds, are reducing their share of purchases, potentially increasing the need for Paulson to make good on his pledge to backstop the companies.

``This whole backstop mechanism was set up so the actual need for it could be avoided,'' said Mahesh Swaminathan, a mortgage strategist for Credit Suisse in New York. ``The market is testing the Treasury's resolve.''

The companies, responsible for 42 percent of the U.S. home loan market, need as much as $15 billion each in fresh capital to reserve against losses on mortgages and related securities that they either own or guarantee, Paul Miller, an analyst with Friedman Billings Ramsey & Co. in Arlington, Virginia, said.

The Treasury will probably be forced to buy as much as $30 billion of preferred shares in both Fannie and Freddie by the end of next month, according to Bill Gross, who manages the world's biggest bond fund at Pacific Investment Management Co.

Fed Clash

Fannie hasn't asked the Treasury for help in funding the mortgage-finance company and the government hasn't offered, Chief Executive Officer Daniel Mudd told National Public Radio today. Freddie ``continues to have strong access to the debt markets at attractive spreads,'' spokeswoman Sharon McHale said.

``Treasury is monitoring market developments vigilantly. We are focused on encouraging market stability, mortgage availability, and protecting the taxpayers' interests,'' Treasury spokeswoman Jennifer Zuccarelli said.

Freddie executives met with Treasury today, according to a person with knowledge of the talks. The talks are part of a regular series of meetings between Treasury and finance officials from Freddie, said the person, who declined to be named because the discussions are confidential. Treasury won't confirm particular meetings and receives regular updates from the companies, Zuccarelli said.

Richmond Federal Reserve Bank President Jeffrey Lacker became the first Fed official to clash publicly with the Bush administration's strategy yesterday, saying the companies should be ``credibly and demonstrably privatized.''

Best Path

``I think a path like what Chairman Greenspan suggested is probably the best path,'' Lacker said in a Bloomberg Television interview in Washington. Former Fed chief Alan Greenspan has advocated nationalizing the two largest U.S. mortgage financers, splitting them up and selling them off.

Freddie yesterday sold $3 billion of five-year reference notes at its highest yields over benchmarks in at least 10 years as demand fell from Asian investors and central banks. The debt priced to yield 4.172 percent, or 113 basis points more than U.S. Treasuries of similar maturity. The company sold five-year notes in May at a spread of 69 basis points. A basis point is 0.01 percentage point.

In market trading, investors this week demanded an extra 104 basis points in yield to own Freddie's five-year debt rather than Treasuries of similar maturity, the most since reaching a 10-year high of 114 basis points in March. The gap narrowed to 74 basis points after Paulson's announcement.

Fannie spreads approached a 10-year high of 104 basis points on Aug. 18, from 74 basis points on July 28. In the decade before 2008, the spread averaged 43 basis points.

Losing Faith

``The fixed-income markets are starting to lose faith,'' Miller said.

Fannie paid a record high yield in a $3.5 billion sale of three-year benchmark notes last week that drew less demand from Asia. Investors in the region bought 22 percent of the offering, almost half the demand of three months ago and about two-thirds of Asia's usual purchases.

``The 22 percent of Asian participation is worrying,'' said Ajay Rajadhyaksha, the head of fixed-income strategy for Barclays Capital in New York.

Not Good Environment

JPMorgan Asset Management Japan is reducing its holdings of Fannie and Freddie debt, according to Shinji Kunibe, a senior money manager at the firm in Tokyo. And Yuuki Sakurai, the general manager of financial and investment planning in Tokyo at Fukoku Mutual Life Insurance Co., said his firm is also ``a little bit worried about the fate of'' Fannie and Freddie.

``The conditions don't seem to be turning into a good environment,'' Sakurai said.

After receiving authority last month to inject unlimited capital into Fannie and Freddie, a Treasury spokeswoman this week said Paulson had no plans to use his new power.

Initial optimism that Paulson's proposal would bolster confidence in the companies has vanished on concern that the deteriorating housing market may force a bailout, a move that would likely wipe out common shareholders and potentially some preferred stockholders, Miller said.

``It hasn't restored any faith, it just highlighted their problems,'' Miller said. ``The market has come to accept the fact that the government has got to do something.''

Freddie's 5.57 percent perpetual preferred shares slumped to $7.15 today to yield 20.2 percent, compared with $17.99 and a yield of 7.77 percent on June 30 before the crisis erupted. Fannie's 5.5 percent preferred shares yield 18.8 percent, up from 16.4 percent yesterday and 7.83 percent on June 30.

More Explicit

Fannie was created as part of Franklin D. Roosevelt's New Deal in the 1930s and became a publicly owned company in 1968. Freddie was started in 1970, when the economy was strained by the Vietnam War.

The companies, which own or guarantee about $5 trillion of the $12 trillion of outstanding U.S. home loans, help expand financing to homebuyers by purchasing home loans from lenders and packaging other loans into securities that they then guarantee.

Fannie and Freddie issue new debt to pay off outstanding obligations as they mature and have a combined $1.7 trillion in outstanding unsecured notes and bonds. The companies can also sell securities to raise cash.

Freddie had $70 billion of cash and non-mortgage investments on June 30 and $470 billion of agency mortgage securities that it could pledge for secured borrowing, the company said Aug. 6.

``While the plan was extraordinarily aggressive, it seems that the market is looking for something even more explicit and more guidance about what form that will take,'' said Margaret Kerins, the managing director of agency debt strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut.