Fannie, Freddie Face "Severe" Capital Pressures, Say Analysts
(Update 1: expanded discussion of losses and the effect on GSE purchases; adds discussion of debt securities and FHA) Both Fannie Mae and Freddie Mac face strong capital pressures, even as a Federal regulator has eased up on prior limitations in an effort to boost liquidity in the mortgage-led secondary markets. According to a report published this week by analysts at UBS Investment Research, however, fresh efforts to deliver more capital to the GSEs would seem likely to do little to enable either company to have the sort of impact regulators and policymakers might otherwise hope. "As we have looked critically at these organizations, it is clear that there is a conflict between their mission -- to guarantee as many mortgages as they can to keep the housing market from going into freefall -- and the fact that they are thinly capitalized," the analysts wrote. Counting measures put in place by OFHEO this week, Fannie Mae and Freddie Mac are currently sitting on $7.1 billion in excess capital each. Yet both face multi-faceted losses from their exposure to mortgage insurers, continued expansion of their guarantee business, as well as potential mark-to-market losses with each company's retained portfolio, UBS said. The fair value of Fannie's exposure to mortgage insurers alone, for example -- estimated by the GSE at $4.6 billion in the fourth quarter -- is itself more than half of the excess capital now available to it. Yet it's the more immediate mark-to-market activity in each GSE's retained portfolio that could prove most problematic. It shouldn't be hard for regular HW readers to fathom why, if you've been reading our front-page coverage recently. UBS analysts estimated that, net of write-downs already on the books for Q4, Freddie Mac could face as much as $30 billion in write-downs in the first quarter of 2008. Likewise, Fannie Mae faces a possible $15.5 billion in write-downs, based on UBS' pricing estimates. It should be noted that whether such substantial expected write downs would actually impact regulatory capital would depend on whether a given security is likely to take a principal loss. And both GSEs are heavily hedged against such losses, as well. But the fact that those losses are there at all likely means neither will be rushing out to buy up non-agency paper, UBS said. The great capital raise? Faced with losses this large, some analysts have suggested that more capital is clearly on the menu. And not just a small amount, like an extra $2 billion -- we're talking gobs of it. The Wall Street Journal reported earlier this month that Friedman, Billings, Ramsey & Co. analyst Paul Miller had estimated that Freddie requires $38 billion of capital, while Fannie would need $41 billion. While those numbers may represent an extreme, both GSEs earlier this week said they would "begin a process to raise significant capital," as part of an agreement between OFHEO and Adminstration officials. Freddie Mac has already gone on record saying that it won't dilute existing shareholders by issuing more common stock. "From a defensive position we feel okay," Piszel was quoted by Reuters as saying at recent investor conference. "There is no dilutive capital raise planned." Which, of course, doesn't mean that capital can't be raised; only that doing so will cost more. "If they raise capital, it could well be more expensive risk-based stuff," said one source that spoke with Housing Wire earlier this week. Some think that there is only so much of that sort of capital that can be prudently had, even in the case of a partly-public institution. John Dizard at the Financial Times is one of them, and has argued that the endgame here is a likely nationalization of the GSEs -- and, by extension, much of the U.S. residential housing market. "These 'public-private' mutants will simply become public agencies," he wrote in a recent column. "There is no way to raise the equity capital for them to remain halfway in the private sector." Dizard may very well end up being proven wrong on two accounts: first of all, the GSEs can raise significant capital through debt offerings, and already do so -- which means the ability to raise equity capital might matter less than he thinks. Secondly, we already have a nationalized mortgage entity, known as the Federal Housing Administration -- and Congress is ramping up to turn it into a revitalized force as mortgage industry woes continue to mount.