Wednesday, August 20, 2008

Fannie, Freddie Bailouts May Hinge on Debt Rollover

(Bloomberg) Fannie Mae and Freddie Mac's success in repaying $223 billion of bonds due by the end of the quarter may determine whether they can avoid a federal bailout.

Fannie, based in Washington, has about $120 billion of debt maturing through Sept. 30, while McLean, Virginia-based Freddie has $103 billion, according to figures provided by the government-chartered companies and data compiled by Bloomberg.

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 on record in a debt sale yesterday amid concern that credit losses are depleting the capital of the beleaguered mortgage-finance companies. Shares of Fannie and Freddie tumbled to the lowest since at least 1991, a sign that stockholders view a bailout as increasingly likely.

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.''

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.''

New Capital

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.

Freddie Mac ``continues to have strong access to the debt markets at attractive spreads,'' spokeswoman Sharon McHale said. Fannie spokesman Brian Faith declined to comment.

``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.

Fed Clash

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.''

``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.

Widening Spreads

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.

``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.

Reducing Holdings

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.

Fannie rose 12 cents to $6.13 in early New York Stock Exchange trading after falling to a 19-year low yesterday. Freddie advanced 3 cents to $4.20 after closing at the lowest level since January 1991. Both have tumbled more than 90 percent in the past year.

Fannie's market value has shrunk to $6.47 billion as of yesterday and Freddie's declined to $2.7 billion, making 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.

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.

Highlighting Problems

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 are trading at $9.37 to yield 15.3 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 16.4 percent, up from 7.83 percent on June 30.

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.

Looking for More

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.

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