Freddie Mac (FRE)

Freddie Mac fell to the lowest in 13 years in New York Stock Exchange composite trading July 7th, 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.

The word began spreading across Wall Street trading desks on Monday morning: Fannie Mae and Freddie Mac, the giant companies at the heart of the nation’s housing market, might be in trouble.

Even as senior Washington officials struggled on Thursday to reassure worried investors and discussed a government intervention that could cost taxpayers billions of dollars, the companies’ stock prices plummeted again in a rush of selling, this time to their lowest level in 17 years. Freddie Mac closed down 22 percent, at $8, and Fannie Mae fell 13.8 percent, to $13.20.

“There is a real panic about these companies on Wall Street right now, and sometimes a blaze like that grows almost without reason,” said Tom Lawler, an economist who worked at Fannie Mae for over two decades before leaving in 2006 to become a consultant. “There wasn’t really any new news to set off this crisis. The stocks just started falling, and didn’t stop.”

as the companies’ stock prices decline, wary investors have begun charging higher premiums for those loans. Since January, that premium, measured by the difference between what the companies pay for debt and what the United States government pays, has more than doubled, to nearly nine-tenths of a percentage point for Fannie Mae. Spread over billions of dollars in borrowing, that increase will cost the companies dearly.

If the spread ever became too pronounced, Fannie and Freddie could end up in the disastrous situation of paying so much for loans that it would become unprofitable for them to borrow. It has happened before: as interest rates soared in the 1980s, Fannie Mae’s borrowing costs rose above what it was earning on its mortgages, and the company lost $1 million a day before it was able to right itself.

Moody’s is looking into downgrading FRE and FNM. It is clear that the companies that are in dire need of credit expansion (builders, retailers) and may be acting on a last-ditch-effort approach that will have them spin positive on any plan, no matter how detrimental it will be to our financial health.

The company’s estimated regulatory core capital was $37.9 billion at the end of 2007, $3.5 billion in excess of the 30% mandatory target capital surplus directed by OFHEO. The core capital may seem like a substantial number at first glance but put that into perspective against the backdrop of an estimated mortgage portfolio of $1.8 trillion. In addition, the losses that have been reported for 2007 are more than they have experienced in the last 7 years. FRE is also reporting that the average current adjusted loan-to-value ratio for their single-family home portfolio has been increasing steadily over the past few years. It now is 60%, up from a low of 56% in 2005.

Even so, they have 16% of subprime ARM loans that are 90-days or more delinquent or now in foreclosure. This is far greater than any time over the past 10-years. ARMs are considered Hybrid Mortgages and as this category currently makes up 17% of their portfolio, there is reason to be cautious.

^[1]

As housing prices continue to decline, loan-to-value ratios will continue to suffer. This is just one more part of the larger concern that investors will have to ingest as they are asked to commit more funds in the form of debt and preferred stock offerings. In the face of a credit rating panic, it will be interesting to see how they adjust their portfolio strategy to ensure that investors see the highest rating available in order to efficiently peddle their debt at the lowest cost.

^[2]

Either way, FRE and FNM will surely have a higher cost of operations as they move forward. Everything points to lower net earnings and higher investor anxiety.

Moody’s is looking into downgrading FRE and FNM. It is clear that the companies that are in dire need of credit expansion (builders, retailers) and may be acting on a last-ditch-effort approach that will have them spin positive on any plan, no matter how detrimental it will be to our financial health.

The company’s estimated regulatory core capital was $37.9 billion at the end of 2007, $3.5 billion in excess of the 30% mandatory target capital surplus directed by OFHEO. The core capital may seem like a substantial number at first glance but put that into perspective against the backdrop of an estimated mortgage portfolio of $1.8 trillion. In addition, the losses that have been reported for 2007 are more than they have experienced in the last 7 years. FRE is also reporting that the average current adjusted loan-to-value ratio for their single-family home portfolio has been increasing steadily over the past few years. It now is 60%, up from a low of 56% in 2005.

Even so, they have 16% of subprime ARM loans that are 90-days or more delinquent or now in foreclosure. This is far greater than any time over the past 10-years. ARMs are considered Hybrid Mortgages and as this category currently makes up 17% of their portfolio, there is reason to be cautious.

^[1]

As housing prices continue to decline, loan-to-value ratios will continue to suffer. This is just one more part of the larger concern that investors will have to ingest as they are asked to commit more funds in the form of debt and preferred stock offerings. In the face of a credit rating panic, it will be interesting to see how they adjust their portfolio strategy to ensure that investors see the highest rating available in order to efficiently peddle their debt at the lowest cost.

^[2]

Either way, FRE and FNM will surely have a higher cost of operations as they move forward. Everything points to lower net earnings and higher investor anxiety.