Fannie Mae (FNM)

The government will probably spend billions to keep Fannie Mae from defaulting on its obligations to creditors - but it may wipe out FNM shareholders in the process. This would be similar to what happened with bear stearns - all the debtholders got paid, to avoid a larger economic crisis, but bear shareholders were screwed.

The only thing working in your favor as a FNM shareholder is that regional banks in the US own a lot of FNM preferred shares - so if the government wipes out FNM shareholders, they would wipe out assets of banks whose balance sheets are already not doing so hot.

Bad Market: Now is a terrible time for the US housing market. The subprime meltdown may benefit Fannie, but otherwise the market is in retreat as the bubble of the early 2000s continues its slow collapse.Like several of its ailing peers, Fannie Mae (FNM) reported a wide quarterly loss and stocked its financial armory for continued financial strain with a dividend cut and $6 billion planned in raised capital.

The largest U.S. mortgage-finance company said it lost $2.19 billion, or $2.57 per share, in the first quarter, citing widening of credit spreads, higher-than-expected home price declines and "loan loss severity."

Chief Executive Officer Daniel Mudd was almost defensive in a company statement, mentioning nearly every ailment to the economy before speaking of company results. The statement also said the company expects "housing weakness will lead to increased delinquencies, defaults and foreclosures on mortgage loans."

"Our first quarter results, although an improvement over the last quarter, reflect these challenging market conditions," Mudd said.

To help recover, Fannie cut its divided for the second time this year, to 25 cents a share from 35 cents. Previously, it’d been cut from 50 cents to 35 cents.

Fannie Mae also said it plans to raise $6 billion in capital through stock sales.

FNM fell to the lowest in 13 years in New York Stock Exchange composite trading July7th as concerns grew the two largest U.S. mortgage-finance companies may need to raise more capital to overcome writedowns and satisfy new accounting rules.

Rocketing foreclosure rates are only serving to exacerbate the problems of the largest U.S. lenders as one in every 501 households was at some stage of the foreclosure process in June, industry watch-dog RealtyTrak announced yesterday.

“The foreclosure problem is getting worse and will stay with us well into the next decade,” Mark Zandi, chief economist for Moody’s Economy.com (MCO) in West Chester, Pennsylvania, said in an interview with Bloomberg News. “The job market is eroding and homeowners have less equity. Lenders are much less willing to work with you if you’ve got negative equity, and you’re more likely to give up your house if you’re deeply underwater.” Former St. Louis Federal Reserve President William Poole questioned the solvency of Freddie Mac and Fannie Mae, saying the government might need to step in to rescue the struggling lenders.

“Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer,” Poole, who left the Fed in March, said in the interview Wednesday, Bloomberg reported. While the two firms are considered government-sponsored enterprises, neither Freddie Mac nor Fannie Mae receives funding from the U.S. government. Likewise, the government does not guarantee any debt-issued by the firms.

Too leveraged: The capital controls help reduce Fannie's debt-to-equity ratio, but even so the company remains a huge liability. A single slip or misfire, and it could collapse; it simply does not have the money on hand to repay its obligations, should they be called in.

Fannie announced 1st quarter results yesterday (Tue) before the open. In conjunction, they announced they will be raising another $6 billion in capital (FNM 1Q Earnings Release).

But the article raises the issue of if this is really enough. They are exceeding their regulatory capital requirements but from a fair value standpoint Fannie Mae appears to be skating on thin ice.

According to their Fair Value Balance Sheet, they have $854.4 billion in liabilities and $866.7 billion in assets. That means the net worth of the company, the difference between the value of what they own and what they owe, is only $12.2 billion. That means they can only absorb a 1.4% drop in the value of their assets, which are primarily mortgage backed securities and mortgages, before their entire net worth is evaporated.

Given the current state of the housing, mortgage and secondary mortgage markets, such a drop in the value of their assets doesn’t seem far fetched. In fact, it strikes as an all but certainty. It appears that Fannie Mae is on pretty shaky ground. The article really hammers home the idea that Fannie is exposed to some potentially toxic liabilities given the $3 trillion book of mortgages that it holds or guarantees. With their net worth so small at this point, it wouldn’t take much to bankrupt the company. Fannie may very well have to be bailed out by the Federal government.

Too many questions: Fannie has come through its accounting controversy with a solid investment rating, but still questions abound. It has yet to release its 2006 report, making it difficult to analyze. Even when we have those numbers, the company is problematic because of its relation with the federal government. It faces risk of regulation, but that aside it is difficult to say whether the government is prepared to bailout Fannie. If not, investors are left paying for security that does not exist.